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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K/A
(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, 1993
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from _____________ to _________________
Commission File number 1-7184
B. F. SAUL REAL ESTATE INVESTMENT TRUST
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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.)
8401 Connecticut Avenue
Chevy Chase, Maryland 20815
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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:
Name of each exchange on which
Title of each class 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 required to file such reports), and (2) has been subject to such
filing requirements 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 amendment to this
Form 10-K. /X/
There were no Common Shares of Beneficial Interest held by non-affiliates
of the registrant as of December 1, 1993.
The number of Common Shares of Beneficial Interest, $1 Par Value,
outstanding as of December 1, 1993 was 4,826,910.
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ITEM 1. BUSINESS
GENERAL
B. F. Saul Real Estate Investment Trust (the "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, following shareholder approval,
the Trust amended its Declaration of Trust to qualify the Trust as a statutory
real estate investment trust under Maryland law.
The principal business activity of the Trust and its real estate
subsidiaries is the ownership and development of income-producing properties.
The Trust owns 80% of the outstanding common stock of Chevy Chase Savings Bank,
F.S.B. ("Chevy Chase" or the "Bank"), whose assets accounted for 95.7% of the
Trust's consolidated assets at September 30, 1993. The Trust is a thrift holding
company by virtue of its ownership of a majority interest in Chevy Chase. See
"Real Estate - Holding Company Regulation."
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 the
parent company and its wholly-owned subsidiaries, as well as Chevy Chase, Chevy
Chase's subsidiaries and the parent company's other majority-owned subsidiaries.
"Real Estate Trust" refers to the parent company and its wholly-owned and
majority-owned subsidiaries, excluding Chevy Chase and Chevy Chase's
subsidiaries. The business conducted by Chevy Chase and its subsidiaries is
identified by the term "Banking," while the operations conducted by the Real
Estate Trust are designated as "Real Estate."
The principal offices of the Trust are located at 8401 Connecticut Avenue,
Chevy Chase, Maryland 20815, and the Trust's telephone number is (301) 986-6000.
REAL ESTATE. The principal business activity of the Real Estate Trust and
its subsidiaries is the ownership and development of income-producing
properties. 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 office projects, hotels and various undeveloped land parcels.
On August 26, 1993, the Real Estate Trust consummated a series of
transactions in which it transferred its 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.
Saul Centers, Inc. ("Saul Centers"), a newly organized, publicly held real
estate investment trust, 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. Saul
Centers, Inc. ("Saul Centers"), a newly organized, publicly held real
estate investment trust, 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. Saul Centers, which is the sole general
partner of Saul Holdings Partnership and its two subsidiary limited
partnerships, generally has full, exclusive and complete responsibility and
discretion in the management and control of each such partnership. B. Francis
Saul II, the Chairman of the Board of Trustees and Chief Executive Officer of
the Trust, serves as Chairman of the Board of Directors and Chief Executive
Officer of Saul Centers. See "Real Estate - Investment in Saul Holdings
Limited Partnership."
BANKING. Chevy Chase is a federally chartered and federally insured stock
savings bank which at September 30, 1993 was conducting business from 74
full-service offices and 284 automated teller machines ("ATMs") in Maryland,
Virginia and the District of Columbia. The Bank, which is headquartered in
Montgomery County, Maryland, a suburban community of Washington, D.C., also
maintains 17 loan production offices in Maryland, Virginia and the District of
Columbia which are operated by a wholly-owned mortgage banking subsidiary. At
September 30, 1993, the Bank had total assets of $4.9 billion and total deposits
of $3.9. Based on total consolidated assets at September 30, 1993, Chevy Chase
is the largest savings institution operating primarily in the Washington, D.C.
metropolitan area and is also the largest savings institution headquartered in
Maryland.
The Bank's tangible, core (or leverage) and total risk-based regulatory
capital ratios at September 30, 1993 were 4.60%, 5.35% and 11.70%, respectively,
compared to the regulatory requirements of 1.5%, 3.0% and 8.0%, respectively. At
September 30, 1993, the Bank's leverage, tier 1 risk-based and total risk-based
regulatory capital ratios of 5.35%, 7.29% and 11.70%, respectively, were
sufficient for the Bank to meet the standards of 5.0%, 6.0% and 10.0%,
respectively, for classification as "well capitalized" under the "prompt
corrective action" regulations of the Office of Thrift Supervision (the "OTS"),
the Bank's primary regulator. See "Banking - Regulation - Regulatory Capital."
Chevy Chase is subject to comprehensive regulation, examination and
supervision by the OTS and by the Federal Deposit Insurance Corporation (the
"FDIC"). Deposits 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 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, 1993.
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OFFICE AND INDUSTRIAL
Expiring
Leasing Percentages Leases (sf)
Gross -------------------- ---------------
Leasable September 30, October 1993 -
Location Name Area (sf) 1993 1992 1991 September 1994
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Florida
Fort Lauderdale Commerce Center-
Phase II 64,000 53% 62% 56% 9,000
Georgia
Atlanta 900 Circle 75 Parkway 346,000 85% 82% 93% 21,000
1000 Circle 75 Parkway 86,000 97% 82% 88% 20,000
1100 Circle 75 Parkway 267,000 49% 84% 98% 39,000
Perimeter Way 58,000 50% 52% 57% 19,000
Louisiana
Metairie Metairie Tower 91,000 90% 90% 93% 41,000
Virginia
Chantilly Dulles South (1) 38,000 55% 49% 39% 6,000
McLean 8201 Greensboro Drive 354,000 90% 87% 96% 16,000
Sterling Dulles North (2) 59,000 86% 84% 83% 8,000
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1,363,000 77% 81% 89% 179,000
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<FN>
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(1) A Trust subsidiary owns a 50% interest in this office building.
(2) A Trust subsidiary owns a 99% interest in this office building.
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HOTELS
Average Occupancy (1)
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Year Ended
September 30,
Available ---------------------
Location Name Rooms 1993 1992 1991
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Colorado
Pueblo Holiday Inn - Pueblo 193 76% 78% 75%
Maryland
Gaithersburg Holiday Inn - Gaithersburg 304 59% 66% 60%
New York
Rochester Holiday Inn - Rochester 282 69% 74% 77%
Ohio
Cincinnati Holiday Inn - Sharonville 276 52% 51% 49%
Virginia
Arlington Howard Johnsons - National Airport 276 73% 69% 69%
McLean Holiday Inn - Tysons Corner 314 78% 77% 68%
Norfolk Howard Johnsons - Hotel Norfolk 346 33% 69% 51%
Sterling Hampton Inn - Dulles Airport (2) 128 81% 71% 64%
Holiday Inn - Dulles Airport 297 66% 62% 60%
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Totals 2,416 63% 68% 63%
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<FN>
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(1) Average occupancy is calculated by dividing the rooms occupied
by the rooms available.
(2) A Trust subsidiary owns a 99% interest in this hotel.
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OTHER REAL ESTATE INVESTMENTS
Location Name
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PURCHASE - LEASEBACK PROPERTIES (1)
APARTMENTS Number
of Units
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Louisiana
Metairie Chateau Dijon 336
Tennessee
Knoxville Country Club 232
Texas
Dallas San Simeon 124
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Total 692
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Gross
Leasable
Area (sf)
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SHOPPING CENTERS
Georgia
Atlanta Old National 160,000
Warner Robbins Houston Mall 264,000
Wyoming
Casper Beverly Plaza 150,000
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Total 574,000
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MISCELLANEOUS PROPERTY (RETAIL)
MARYLAND
Oxon Hill Wheeler Road 24,000
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<FN>
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(1) The 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 Trust also
receives percentage rent based upon the income generated by the properties.
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LAND PARCELS
Location Name Acres Zoning
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Florida
Boca Raton Arvida Park of Commerce (1) 20 Mixed Use
Fort Lauderdale Commerce Center 14 Office & Warehouse
Georgia
Atlanta Circle 75 128 Office & Industrial
Perimeter Way 2 Office & Industrial
Kansas
Overland Park Overland Park 162 Residential, Office and
Retail
Maryland
Gaithersburg Avenel Business Park 8 Commercial
Rockville Flagship Centre 8 Commercial
New York
Rochester Holiday Inn - Rochester Airport 3 Commercial
Virginia
Loudoun County Church Road 40 Office & Industrial
Sterling Boulevard (2) 48 Industrial
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Total 433
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<FN>
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(1) A Trust subsidary owns a 50% interest in 11 acres of this parcel.
(2) A Trust subsidary owns a 99% interest in this parcel.
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The 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.
Real estate development in certain areas of the country suffers from
overbuilding or adverse local economic conditions, or both. In recent periods,
the Real Estate Trust's office building leasing rates have experienced a decline
due to recessionary economic conditions in the metropolitan areas in which the
office properties are located. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition - Real
Estate."
INVESTMENT IN SAUL HOLDINGS LIMITED PARTNERSHIP
On August 26, 1993, the Real Estate Trust consummated a series of
transactions (together with related transactions, the "Formation Transactions")
in which it transferred its 22 shopping center properties and one of its office
properties (the "Transferred 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 (the
"Subsidiary Partnerships" and, collectively with Saul Holdings Partnership, the
"Partnerships"). In exchange for the Transferred Properties, the Real Estate
Trust received securities representing a 21.5% limited partnership interest in
Saul Holdings Partnership, which it holds directly and through a wholly-owned
subsidiary. Saul Centers, Inc. ("Saul Centers"), a newly organized, publicly
held real estate investment trust, 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. Entities under common control with
the Trust (the "Trust Affiliates") received limited partnership interests
collectively representing a 5.5% partnership interest in Saul Holdings
Partnership in exchange for the transfer of property management functions (the
"Management Functions") and certain other properties to the Partnerships. In
addition, the Trust Affiliates 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.
Saul Centers, which is the sole general partner of each of the
Partnerships, generally has full, exclusive and complete responsibility and
discretion in the management and control of each Partnership. B. Francis Saul
II, the Chairman of the Board of Trustees and Chief Executive Officer of the
Trust, serves as Chairman of the Board of Directors and Chief Executive Officer
of Saul Centers.
The Transferred Properties accounted for revenues of $29.1 million in
fiscal 1993 prior to the Formation Transactions (31.3% of the Real Estate
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Trust's total revenues), $32.1 million in fiscal 1992 (32.1% of total
revenues) and $32.1 million in fiscal 1991 (31.4% of total revenues).
Because the Real Estate Trust does not allocate its expenses to different
classes of properties in its real estate portfolio, it is unable to provide
comparable data on the relative contribution of the Transferred Properties
to its operating profit (loss).
In determining the percentage interest in Saul Holdings Partnership
allocated to the Real Estate Trust in exchange for the contribution of the
Transferred Properties, the Real Estate Trust considered "funds from
operations" historically generated by the Transferred Properties and
currently projected increases or decreases therein. Funds from operations
was defined to mean net income (loss), as computed in accordance with
generally accepted accounting principles, excluding gains and losses from
debt restructurings and property sales, plus depreciation, amortization of
financing costs and property writedowns. Independent third-party appraisals
were not used in the determination of such percentage.
The Real Estate Trust disposed of the Transferred Properties in
exchange for an interest in Saul Holdings Partnership because of
management's belief that such disposition provided the best strategy under
current and reasonably foreseeable market conditions for maximizing the
Real Estate Trust's return on this portion of its investment portfolio and
providing for the repayment or refinancing of the mortgage debt encumbering
the Transferred Properties. The Transferred Properties were contributed
subject to mortgage debt of $184.9 million at June 30, 1993, which
constituted 43.3% of the Real Estate Trust's total mortgage debt at such
date. A substantial portion of such mortgage debt at the date of transfer
was scheduled to mature in fiscal years 1993 to 1997.
As a limited partner of Saul Holdings Partnership, the Real Estate
Trust will share in cash distributions from operations and capital
transactions involving the sale or refinancing of the properties of Saul
Holdings Partnership. The annual cash flow anticipated to be received by
the Real Estate Trust in the form of distributions from Saul Holdings
Partnership could be less initially than the annual cash flow (after debt
service, capital improvements and maintenance) generated by the Transferred
Properties prior to this transaction. However, because the mortgage debt
encumbering the Transferred Properties is no longer an obligation of the
Real Estate Trust, the transaction is expected overall to have a positive
effect on the Real Estate Trust's long-term liquidity position.
CONSEQUENCES OF FORMATION TRANSACTIONS. As a result of consummation
of the Formation Transactions:
- Saul Holdings Partnership currently owns, directly or indirectly
through the Subsidiary Partnerships, 26 community and neighborhood
shopping centers (including the 22 shopping centers transferred by the
Real Estate Trust) located in seven states and the District of
Columbia, one office property and one office/retail property located
in the District of Columbia and one research park located
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in the Maryland suburbs of Washington, D.C. (the "Portfolio
Properties").
- - Saul Centers is the sole general partner of, and owns a 73.0% interest
in, Saul Holdings Partnership and is the sole general partner of, and
owns a 1.0% interest in, each of the Subsidiary Partnerships.
- Saul Holdings Partnership holds directly the Management Functions and
the Portfolio Properties not held by the Subsidiary Partnerships and
holds a 99.0% limited partnership interest in each of the Subsidiary
Partnerships.
- The purchasers of common stock in the Saul Centers public offering own
96.0% of the Saul Centers common stock.
- The Trust Affiliates own 4.0% of the Saul Centers common stock, and
the Real Estate Trust and the Trust Affiliates own a 21.5% limited
partnership interest and a 5.5% limited partnership interest,
respectively, in Saul Holdings Partnership.
- The Real Estate Trust and the Trust Affiliates own rights (the
"Rights") enabling them to convert their limited partnership interests
in Saul Holdings Partnership into shares of Saul Centers common stock
on a one-for-one basis at the end of a 36-month period commencing
after the initial public offering, provided that they may not exercise
the Rights at any time that they collectively own, directly or
indirectly, more than 24.9% 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.
SAUL CENTERS. Saul Centers has announced that it intends to make an
election to be treated as a real estate investment trust ("REIT") for
federal income tax purposes under Sections 856 through 860 of the Internal
Revenue Code commencing with the year ending December 31, 1993. If Saul
Centers so qualifies, 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. Under the Internal Revenue
Code, REITs are subject to numerous organizational and operational
requirements. Saul Centers has announced that it intends to make regular
quarterly dividend distributions to its stockholders.
MANAGEMENT OF THE PROPERTIES. The Partnerships will manage the
Portfolio Properties and any subsequently acquired properties through the
Management Functions, which include personnel and such functions as
property management, leasing, design, renovation, development and
accounting. The Management Functions provide the Partnerships with a fully
integrated property management capability through approximately 150
employees and with an extensive and mature network of relationships with
tenants and potential tenants as well as with members of the brokerage and
property owners' communities.
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Saul Centers will share with the Real Estate Trust and the Trust
Affiliates certain ancillary functions at cost, such as computer and
payroll services, benefits administration and in-house legal services, and
will share insurance expense on a pro rata basis. The Real Estate Trust and
the Trust Affiliates will sublease office space to Saul Centers at their
cost. The terms of all sharing arrangements, including payments related
thereto, will be reviewed periodically by the independent directors of Saul
Centers, who constitute five of the nine members of the Board of Directors.
EXCLUSIVITY AGREEMENT AND RIGHT OF FIRST REFUSAL. The Trust has
entered into an Exclusivity Agreement (the "Exclusivity Agreement") with,
and has granted a right of first refusal (the "Right of First Refusal") to,
Saul Centers and the Partnerships (collectively, the "Company"). The
purpose of these agreements is to minimize potential conflicts of interest
between the Real Estate Trust and the Company. The Exclusivity Agreement
and Right of First Refusal generally require the Real Estate Trust to
conduct its shopping center business exclusively through the Company and to
grant the Company 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.
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.
REIMBURSEMENT AGREEMENT. Pursuant to a reimbursement agreement among
the partners of the Partnerships, the Real Estate Trust and those of 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 the date of the
Formation Transactions, the maximum potential obligations of the Real
Estate Trust and its subsidiaries under this agreement totalled $116.1
million. See Note 1 to the Consolidated Financial Statements in this
report. The Real Estate Trust believes that the Partnerships will be able
to make all payments due with respect to their debt obligations.
TAX CONFLICTS. The fair market value of each of the properties
contributed to the Partnerships by the Real Estate Trust and its subsidiaries
at the date of the Formation Transactions (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
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of the total gain for federal income tax purposes would be allocated to the
Real Estate Trust or its subsidiaries as a result of the property
disposition. 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), an amount of gain equal to the
FMV-Tax Difference (as adjusted) will be allocated to the Real Estate Trust
or its subsidiaries. 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 partners in Saul Holdings based
on their relative percentage interests. In general, the amount of gain
allocated to the Real Estate Trust or its subsidiaries 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 or its subsidiaries
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 or its subsidiaries (described above
under "Reimbursement Agreement"), could cause the Real Estate Trust or its
subsidiaries to have taxable constructive distributions without the receipt
of any corresponding amounts of cash.
REGISTRATION RIGHTS. Saul Centers has granted the Real Estate Trust
and the Trust Affiliates certain "demand" and "piggyback" registration
rights (collectively, the "Registration Rights") with respect to the shares
of Saul Centers common stock acquired in connection with the Formation
Transactions or as a consequence of exercise of the Rights (the
"Registration Shares"). Subject to certain limitations, the Registration
Rights grant the holders of Registration Shares the opportunity to register
all or any portion of their respective Registration Shares once in each
calendar year and to have such Shares registered incidentally to any
registration, by Saul Centers, of shares of common stock or other
securities substantially similar to common stock. Except with respect to
the Registration Rights incident to a pledge of Registration Shares or Saul
Holdings Partnership interests, the demand Registration Rights may be
exercised only after the transfer restrictions imposed in connection with
the Saul Centers initial public offering have lapsed and prior to such
time, if any, as the holder is permitted to sell the Registration Shares
pursuant to Rule 144(k) under the Securities Act of 1933. Saul Centers will
bear expenses incident to its registration obligations upon exercise of the
Registration Rights, except that it will not bear any underwriting
discounts or commissions, Securities and Exchange Commission or state Blue
Sky registration fees, or transfer taxes relating to registration of
Registration Shares.
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.
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ENVIRONMENTAL MATTERS
The Real Estate Trust's properties are subject to various laws and
regulations relating to environmental and pollution controls. Although the
effect upon the Real Estate Trust of the application of such 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. As
a matter of policy, 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 there are no
material environmental hazards associated with such property.
RELATIONSHIPS WITH B. F. SAUL COMPANY
The Real Estate Trust has significant relationships with B. F. Saul
Company (the "Saul Company") and two of the Saul Company's subsidiaries,
B. F. Saul Advisory Company (the "Advisor") and Franklin Property Company
("Franklin"). The Saul Company, founded in 1892, specializes in real estate
investment, financing and management services, including acquisitions,
management and leasing and insurance. B. Francis Saul II, Chairman of the
Board of Trustees and Chief Executive Officer of the Trust, is Chairman and
President of the Saul Company.
The Advisor acts as the Real Estate Trust's investment advisor and
carries on the day-to-day general management, financial, accounting, legal
and administrative affairs of the Real Estate Trust. Franklin acts as
leasing and management agent for most of 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.
The Trustees, including the two independent Trustees, review the fees
and compensation arrangements between the Trust and the Saul Company and
its related entities and affiliates and believe that such fees and
compensation arrangements are as favorable to the Trust as would be
obtainable from unaffiliated sources. See "Certain Relationships and
Related Transactions."
HOLDING COMPANY REGULATION
The Trust and the Saul Company, by virtue of their direct and indirect
control of the Bank (see "Security Ownership of Certain Beneficial Owners and
Management"), are "savings and loan holding companies" subject to comprehensive
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 Trust,
the Saul Company or other affiliates engaged in activities beyond those
permissible for bank holding companies and from investing in the securities
of the Trust, the Saul Company or other affiliates. Further, transactions
between Chevy Chase and the Trust or the Saul Company must be on terms
substantially the same, or at least as favorable to Chevy Chase, as those
that would be available to non-affiliates. See "Certain Relationships and
Related Transactions."
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The Trust and the Saul Company must obtain the prior approval of the
OTS before acquiring any federally insured savings institution or any
savings and loan holding company by merger, consolidation or purchase of
assets. As unitary savings and loan holding companies, the Trust and the
Saul Company are virtually unrestricted in the types of business activities
in which they may engage, provided the Bank continues to meet the qualified
thrift lender test. See "Banking - Regulation - Qualified Thrift Lender
("QTL") Test." If the Trust and the Saul Company were to acquire one or
more federally insured institutions and operate them as separate
subsidiaries rather than merging them into Chevy Chase, the Trust and the
Saul Company would become "multiple" savings and loan holding companies. As
multiple savings and loan holding companies, the Trust and the Saul Company
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 Trust and the
Saul Company 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 Chevy Chase's regulatory capital at the required levels and, if
necessary, to infuse additional capital to enable Chevy Chase to meet those
requirements. Since the execution of that agreement, the OTS has changed
its policy and now accepts more limited agreements from those acquiring
thrift institutions. In addition, the regulatory capital requirements
applicable to Chevy Chase have changed significantly as a result of the
Financial Institutions Reform, Recovery, and Enforcement Act of 1989
("FIRREA"). The OTS has stated that capital maintenance agreements entered
into prior to such modification of OTS policy and the enactment of FIRREA
were not affected by such changes. The Trust and the Saul Company have not
sought to modify the existing agreement.
Following the Bank's failure to meet its risk-based capital
requirement in June 1991, the OTS advised the Trust that, based on the
Trust's liquidity position, the OTS did not plan to enforce the Trust's
obligations at that time. Subsequently, at September 30, 1992, the Bank
returned to capital compliance. However, to the extent the Bank is unable
to meet its regulatory capital requirements in the future, the OTS could
seek to enforce the Trust's obligations under the agreement. The Bank's
business plan does not contemplate any future capital contributions from
the Trust.
If the Bank were to become undercapitalized under the prompt
corrective action regulations (See "Banking - Regulation - Prompt
Corrective Action"), it would be required to file a capital restoration
plan with 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 Trust and the Saul Company guaranteed in writing the Bank's
compliance with that plan. The aggregate liability of the Trust and the
Saul Company under such a commitment would be limited to the lesser of (i)
an amount equal to 5.0% of the Bank's total assets at the time the Bank
became undercapitalized and (ii) the amount
- 13 -
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.
FEDERAL TAXATION
The Trust terminated its status as a real estate investment trust for
federal income tax purposes in 1978 and is now taxable as a corporation.
The Trust's real estate operations have generated sizeable depreciation,
interest and other deductions in excess of its income, and as a result the
Trust has had substantial net operating loss carryovers for federal income
tax purposes ("NOLs"). The Trust and its affiliated subsidiaries join in
the filing of a consolidated federal income tax return using the accrual
method of accounting on the basis of a fiscal year ending September 30.
Since June 28, 1990, the Bank and its subsidiaries have joined in the
consolidated federal income tax returns filed by the Trust on a fiscal year
basis. Prior to June 28, 1990, the Bank and its subsidiaries filed a
consolidated federal income tax return on an accrual method, calendar-year
basis.
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.
The Internal Revenue Service ("IRS") has completed audits of the
federal income tax returns of the Bank for the taxable years ended
December 31, 1988, December 31, 1989 and June 27, 1990, and is auditing the
Bank's return for the taxable year ended September 30, 1990. The Trust is
included in the audit for the taxable year ended September 30, 1990.
BAD DEBT RESERVE. Savings institutions that satisfy certain
requirements (so-called "qualifying institutions" as defined by the
Internal Revenue Code) are 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 be treated as a qualifying institution, at least 60% of a savings
institution's assets must be "qualifying assets," which include cash,
certain U.S. Government and state government securities, obligations of
certain deposit insurance corporations, loans secured by interests in
residential real property and loans made for the improvement of residential
real property.
A qualifying institution may deduct in each taxable year the sum of
(i) an addition to a reserve for losses on "qualifying real property loans"
(generally, loans secured by interests in real property) and (ii) an
addition to a reserve for losses on "nonqualifying loans" (such as credit
card loans). A qualifying institution generally may compute the amount of
the addition to the reserve for losses on qualifying real property loans
under the more favorable
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of the "experience method," which is based on the institution's actual loan
loss experience over a prescribed period, or the "percentage of taxable
income method," which is based on a fixed percentage (i.e., 8%) of the
institution's taxable income. The Bank has calculated the bad debt
deduction for tax purposes under the experience method since calendar year
1988.
An institution's addition to the reserve for losses on qualifying real
property loans is determined by special rules. The amount of the addition
is generally limited to an amount necessary to increase the reserve to the
greater of (i) the reserve determined under the experience method or (ii)
the reserve allowed at the end of the institution's base year, which for
the Bank is 1987.
For fiscal year 1993 and prior years, the Bank was a qualifying
institution permitted to use the reserve method to determine the amount of
its bad debt deduction for federal income tax purposes. If the Bank were
not treated as a qualifying institution for any taxable year, it would be
required to recapture its bad debt reserve (for 1993, approximately $81.8
million) into taxable income. Under certain proposed regulations, the bad
debt reserve generally would be recaptured into taxable income over six
taxable years. In addition, the Bank would be allowed to deduct only those
bad debts that actually were sustained during the taxable year. If the Bank
were no longer permitted to use the reserve method, the change would not
have a significant adverse effect on the Bank's reported earnings under
generally accepted accounting principles.
CONSOLIDATED TAX RETURNS; TAX SHARING PAYMENTS. On June 28, 1990, the
Trust increased its equity interest in Chevy Chase from 60% to 80%. As a
result of the Trust's 80% ownership of the Bank, for federal income tax
purposes Chevy Chase became a member of the Trust's affiliated group filing
consolidated federal income tax returns for taxable years beginning on and
after June 28, 1990. In recent years, the operations of the Trust have
generated significant net operating losses, while during the same period
Chevy Chase has reported taxable income. The Trust's net operating loss
("NOL") carryovers to its taxable year beginning October 1, 1993 are
approximately $11.5 million. It is anticipated that, because Chevy Chase's
operations will be included in the Trust's consolidated returns, these
NOLs, and any other operating losses generated by the Trust or its other
subsidiaries, will be available to reduce the federal income taxes that
otherwise would be payable by Chevy Chase (and the other members of the
Trust's affiliated group that have taxable income). Under the terms of a
tax sharing agreement dated June 28, 1990 (the "Tax Sharing Agreement"),
Chevy Chase is obligated to make payments to the Trust based on its taxable
income, as explained more fully below. However, under the written agreement
between Chevy Chase and the OTS (see "Banking - Regulation - Regulatory
Capital"), Chevy Chase has agreed not to make tax sharing payments without
the prior approval of the OTS.
As noted above, the Trust, the Bank and the other companies in the
Trust's affiliated group have entered into the Tax Sharing Agreement. 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
- 15 -
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 tax liability or the group's
tax liability is less than the sum of such amounts. Under the Tax Sharing
Agreement, the Trust, in turn, is obligated to pay to the applicable taxing
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 such member on a dollar-for-dollar basis from the amounts paid
to the Trust by the other members of the group, thereby compensating the
member for the group's use of its net operating losses or tax credits.
The Bank made a tax sharing payment of $20.6 million in fiscal 1990,
tax sharing payments totaling $29.6 million in fiscal 1991 and a tax
sharing payment of $5.0 million in the third quarter of fiscal 1993. OTS
approval of the $5.0 million payment made in June 1993 was conditioned on a
pledge by the Trust of certain Real Estate Trust assets to secure certain
of its obligations under the Tax Sharing Agreement. Following execution of
such a pledge, the OTS approved, and the Bank made subsequent to September
30, 1993, additional tax sharing payments of $4.6 million to the Real
Estate Trust. It is expected that the Bank will have taxable income over
the next several years and that the Trust's NOLs and any additional
operating losses 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). At September 30, 1993, the amount of tax sharing payments due to
the Trust, but then unpaid, was $21.9 million.
If the Bank has net operating losses or unused tax credits in the
current or any future year, under the Tax Sharing Agreement the Trust would
be obligated to reimburse the Bank in an amount generally equal to (i) the
tax benefit to the group of using such tax losses or unused tax credits in
the group's consolidated federal income tax return for such year, plus (ii)
to the extent such losses or credits are not used by the group in such
year, the amount of the tax refunds 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 (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 such nonpayment as an unsecured 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 remedies upon a breach by any party of its
obligations under the agreement. As noted above, at September 30, 1993
$21.9 million of tax sharing payments are currently due to the Trust. Any
reimbursement obligation of the Trust should be available to be offset
against any obligation of the Bank to the Trust under the Tax Sharing
Agreement that is unpaid at the time the reimbursement obligation arises.
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STATE TAXATION
Maryland law does not provide for the filing of consolidated income
tax returns, and thus the Real Estate Trust, the Bank and the subsidiaries
of the Real Estate Trust and the Bank all file separately in Maryland.
Under Maryland law, the Real Estate Trust and the Bank and their respective
subsidiaries are each subject to a 7% tax on "taxable income." "Taxable
income," for purposes of Maryland taxation, is based on federal taxable
income, subject to certain modifications and apportionment. The Real Estate
Trust, the Bank and their respective subsidiaries are also subject to
income taxes in other states.
BANKING
REGULATION
Chevy Chase's operations have been significantly affected in recent
years by substantial changes in applicable banking laws and regulations.
The most significant changes resulted from the Financial Institutions
Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") and the Federal
Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA").
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the Federal
Home Loan Bank ("FHLB") of Atlanta. The 12 FHLBs are administered by the
Federal Housing Finance Board, an independent agency within the executive
branch of the federal government. The FHLBs serve as a central credit
facility for member savings institutions. Their primary credit mission is
to enhance the availability of residential mortgages.
Under the credit policies of the FHLB of Atlanta, credit may be
extended to any creditworthy member bank based on financial condition and
the adequacy of collateral pledged to secure the credit. Requests for
advances with an original term to maturity of five years or less may be
approved for any sound business purpose in which a borrower is authorized
to engage. Requests for longer term advances may be approved only for the
purpose of enabling the borrower to provide funds for residential housing
finance. Such borrowings 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. At September 30,
1993, the interest rates on the advances from the FHLB of Atlanta ranged
from 3.07% to 4.13%, depending on the maturity of the advance. See Note 22
to the Consolidated Financial Statements in this report.
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: (i) 1.0% of mortgage-related assets (i.e., home mortgage loans,
home- purchase contracts and similar obligations); (ii) 0.3% of total
assets; (iii) $500; or (iv) 5.0% of outstanding advances. Pursuant to this
requirement, the Bank had an investment of $31.2 million in FHLB stock at
September 30, 1993. The earnings of the FHLBs have been reduced as a result
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of legislation requiring contributions from the FHLBs to the Resolution
Funding Corporation and the provision of subsidies to certain low income
housing projects, thereby reducing the dividends paid by the FHLBs to
member institutions. The Bank earned dividends of $1.8 million and $1.9
million during the years ended September 30, 1993 and 1992, respectively,
at a weighted average rate of 5.63% and 6.58% per annum during such years,
respectively.
LIQUIDITY REQUIREMENTS. The Bank is required to maintain a daily
average balance of liquid assets (including cash, federal funds, certain
time deposits, certain bankers' acceptances, certain corporate debt
securities and commercial paper, securities of certain mutual funds and
specified U.S. Government, state government and federal agency obligations)
equal to a specified percentage of its average daily balance of deposits
(based upon the preceding month's average balances), plus borrowings (or
portions thereof) payable in one year or less. This liquidity requirement
is currently 5.0%. Federal regulations also require that each institution
maintain an average daily balance of short-term liquid assets equal to at
least 1.0% of its average daily balance of deposits, plus borrowings
payable in one year or less. If an institution's liquid assets at any time
do not at least equal (on an average daily basis for the month) the amount
required by the OTS, the institution could be subject to various monetary
penalties imposed by the OTS. At September 30, 1993, the Bank was in
compliance with both requirements, with a liquid assets ratio of 24.3% and
a short-term liquid assets ratio of 3.8%.
DEPOSIT INSURANCE PREMIUMS. Under FDIC insurance regulations, the Bank
is required to pay premiums to SAIF for insurance of its accounts. FIRREA
established the following levels of premiums for SAIF members expressed as
a percentage of deposits: 0.23% through December 31, 1993, 0.18% through
December 31, 1997 and 0.15% thereafter. However, amendments to FIRREA's
deposit insurance provisions enacted in November 1990 and December 1991
gave the FDIC broad authority to increase SAIF premiums beyond the levels
established by FIRREA and require that the FDIC convert to a risk-based
assessment system. Pursuant to this authority, the FDIC adopted a
transitional risk-based premium system, which took effect January 1, 1993,
that increased the premiums for all but the healthiest institutions. Under
this system, an institution pays premiums for deposit insurance ranging
from 0.23% to 0.31% based on supervisory evaluations and on the
institution's capital category under the OTS's prompt corrective action
regulations. See "Prompt Corrective Action." The deposit insurance premium
rate for the semi-annual periods beginning January 1, 1993 and July 1, 1993
were based in part on the Bank's capital ratios at June 30, 1992 and
December 31, 1992, respectively. Although the Bank's capital levels met the
standards for classification as well capitalized under the prompt
corrective action regulations at September 30, 1993, the Bank's capital
ratios did not meet the standard for classification as adequately
capitalized at June 30, 1992 or at December 31, 1992. As a result, the
Bank's deposit insurance premium for the semi-annual periods between
January 1, 1993 and June 30, 1993 and between July 1, 1993 and December 31,
1993 was increased to 0.31% of total deposits. Based on the Bank's June 30,
1993 regulatory capital ratios, the Bank's premium for the semi-annual
period between January 1, 1994 and June 30, 1994 will decrease. On June 25,
1993, the FDIC established a permanent risk-based premium system that
became
- 18 -
effective October 1, 1993 based substantially on the transitional system
then in effect.
SAIF insurance may be terminated by the FDIC, after notice and a
30-day corrective period, upon a finding by the FDIC that the 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, rule, order or condition imposed by the FDIC. The 30-day period
may be eliminated by the FDIC with the approval of the OTS.
REGULATORY CAPITAL. FIRREA imposed significantly more stringent
capital requirements upon federally insured savings associations than those
previously in effect. The requirements, as implemented by OTS regulations,
contain three elements: a minimum tangible capital requirement, a minimum
core (or leverage) capital requirement, and a minimum total risk-based
capital requirement. Each of these requirements generally must be no less
stringent than the capital standards for national banks. At September 30,
1993, the Bank's tangible, core and total risk-based regulatory capital
ratios were 4.60%, 5.35% and 11.70%, respectively, compared to the minimum
requirements of 1.50%, 3.00% and 8.00%, respectively, in effect at that
date.
Under the minimum leverage ratio, Chevy Chase must maintain a ratio of
"core capital" to tangible assets of not less than 3.0%. "Core capital"
generally includes common stockholders' equity, noncumulative perpetual
preferred stock and minority interests in consolidated subsidiaries, less
certain intangible assets, except that purchased mortgage servicing rights
("PMSRs") may be included at the lowest of 90% of fair market value (if
determinable), 90% of original cost or 100% of the current amortized book
value as determined under generally accepted accounting principles
("GAAP"). In addition, PMSRs are subject to a limit of 50% of core capital.
At September 30, 1993, the Bank had qualifying PMSRs of $18.1 million,
which constituted 7.0% of core capital at that date. The OTS also has
issued a proposed regulation that would permit the inclusion of PMSRs and
purchased credit card relationships ("PCCRs") in core capital up to an
aggregate amount equal to 50% of core capital. PCCRs would be subject to a
sublimit of 25% of core capital.
The amount of qualifying supervisory goodwill that may be included in
core capital was limited to 1.0% from January 1, 1992 through December 31,
1992, and is limited to 0.75% beginning January 1, 1993, 0.375% beginning
January 1, 1994 and 0% beginning January 1, 1995. Phase-outs from capital
are also established for investments in, and loans to, subsidiaries engaged
in activities not permissible for national banks, for equity investments
that are not permissible for national banks and for the portion of land
loans and non-residential construction loans in excess of an 80%
loan-to-value ratio.
The tangible capital requirement adopted by the OTS requires a savings
institution to maintain "tangible capital" in an amount not less than 1.5%
of tangible assets, which is the minimum limit permitted by FIRREA.
"Tangible capital" is defined as core capital less any intangible assets
(including supervisory goodwill), plus qualifying PMSRs valued at the
amount includable in core capital.
- 19 -
The risk-based capital requirements issued by the OTS provide that the
capital ratio applicable to an asset is adjusted to reflect the degree of
credit risk associated with that asset and that the asset base for
computing a savings institution's capital requirement includes
off-balance-sheet assets. Capital must be maintained against the full
amount of assets sold with recourse despite the fact that the assets are
treated as having been sold under GAAP. However, the amount of capital
required need not exceed the amount of recourse retained.
There are currently four categories of risk-weightings: 0% for cash
and similar assets, 20% for qualifying mortgage-backed securities, 50% for
qualifying residential permanent real estate loans and 100% for other
loans, including credit card loans, commercial real estate loans and loans
more than 90 days past due and for real estate acquired in settlement of
loans. Savings institutions generally are required to 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.
A savings institution's supplementary capital may be used to satisfy
the risk-based capital requirement only to the extent of the institution's
core capital. Supplementary capital includes cumulative perpetual preferred
stock, qualifying non-perpetual preferred stock, qualifying subordinated
debt, nonwithdrawable accounts and pledged deposits, and general loan and
lease loss reserves (up to a maximum of 1.25% of risk-weighted assets). At
September 30, 1993, the Bank had $60.5 million in general reserves on loans
and leases, $44.7 million 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 term to maturity. The
phase-out established for such maturing capital instruments by the OTS
permits an institution to include such instruments in supplementary capital
under one of two phase-out options: (i) at the beginning of each of the
last five years prior to the maturity date of the instrument, the
institution may reduce the amount eligible to be included by 20% of the
original amount or (ii) the institution may include only the aggregate
amount of maturing capital instruments that mature in any one year during
the seven years immediately prior to an instrument's maturity that does not
exceed 20% of the institution's capital. Once an institution selects either
the first or second option, it must continue to select the same option for
all subsequent issuances of maturing capital instruments as long as there
is any outstanding balance of such instruments for which an option has been
selected. Maturing capital instruments issued before November 7, 1989 may
be treated according to the rule stated above or the rule in effect at that
date. At September 30, 1993, the Bank had $138.5 million in maturing
capital instruments, of which $132.8 million was includable as
supplementary capital. See "Deposits and Other Sources - Borrowings."
Effective January 1, 1994, the OTS's risk-based capital requirements were
amended to incorporate interest-rate risk measures to complement those already
established for credit risk. Under the amendments, an institution that would
experience a change in "portfolio equity" in an amount in excess of 2.0% of
the market value of the institution's assets as a result of an increase or
decrease in the general level of interest rates of as much as 200 basis points
is required to maintain additional amounts of risk-based capital. Additional
capital will have to be maintained by affected institutions beginning July 1,
- 20 -
1994 based on interest rate exposure as of December 31, 1993. Although the
analysis of the Bank's interest rate exposure at December 31, 1993 is not yet
available, based upon an OTS analysis of the Bank's exposure at September 30,
1993, management believes that the Bank would not experience a change in
"portfolio equity" in an amount in excess of 2.0% of its assets under this
test and therefore believes that the Bank will not be required to maintain
additional amounts of risk-based capital beginning July 1, 1994.
OTS regulations contain special rules affecting savings institutions
with certain kinds of subsidiaries. For purposes of determining compliance
with each of the capital standards, a savings institution's investments in,
and extensions of credit to, subsidiaries engaged in activities not
permissible for a national bank ("non-includable subsidiaries") are, with
certain exceptions, deducted from the savings institution's capital. At
September 30, 1993, investments in non-includable subsidiaries are subject
to a 25% phase-out from all three FIRREA capital requirements. Such
phase-out will gradually increase to 100% on July 1, 1996 in accordance
with a delayed phase-in period approved by the OTS pursuant to legislation
enacted in October 1992.
All or a portion of the assets of each of a savings institution's
subsidiaries are generally consolidated with the assets of the savings
institution for regulatory capital purposes unless all of the savings
institution's investments in, and extensions of credit to, such subsidiary
are deducted from capital. Chevy Chase's real estate development
subsidiaries are its only subsidiaries engaged in activities not
permissible for a national bank. At September 30, 1993, the Bank's
investments in, and extensions of credit to, its non-includable
subsidiaries totaled approximately $30.6 million, which was $40.9 million
less than the level of such investments in, and extensions of credit to,
its non-includable subsidiaries as of April 12, 1989. Of the $30.6 million,
$6.5 million constituted a deduction from tangible capital. Chevy Chase
currently intends to continue to operate its non-includable subsidiaries,
but to reduce gradually its aggregate investments in, and extensions of
credit to, such subsidiaries.
OTS capital regulations also require the deduction from total capital
of all equity investments that are not permissible for national banks and
the portion of land loans and non-residential construction loans in excess
of an 80% loan-to-value ratio. The deduction from total capital is on a
specified phase-in basis identical to the phase-in of the deduction from
core capital of investments in non-includable subsidiaries discussed above,
except that the delayed phase-in schedule is not applicable. In April 1993,
the OTS adopted a rule that eliminated the capital deduction for equity
investments permissible for national banks. Based on the April 1993 rule,
the Bank's only equity investment at September 30, 1993 is a property
classified as real estate held for sale that the Bank agreed with OTS in
1991 to treat as an equity investment for regulatory capital purposes. At
September 30, 1993, the book value of that property, after subsequent
valuation allowances, amounted to $43.3 million of which $20.6 million was
required to be deducted from total capital.
OTS capital regulations provide a five-year holding period (or such
longer period as may be approved by the OTS) for real estate acquired in
settlement of loans ("REO" or "real estate held for sale") to qualify for an
- 21 -
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 at the then-current phase-in percentage.
Accordingly, if the Bank is unable to dispose of its REO property (through
bulk sales or otherwise) prior to the end of the applicable five-year
holding period and is unable to obtain an extension of such five-year
holding period from the OTS, the Bank would be required to deduct the
then-current book value of such REO property from risk-based capital.
The Bank is actively managing its levels of investments in, and loans
to, non-includable subsidiaries and equity investments to minimize the
impact of the deductions from capital for these investments as the
deductions continue to increase. The Bank's ability to implement
successfully these and other strategies for maintaining capital compliance
is dependent on a number of factors, including, for example, general
economic conditions and the continued recovery of local real estate
markets. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Financial Condition - Banking - Capital -
Capital Maintenance Strategies."
In July 1993, the OTS released the Bank from a capital plan to which
the Bank had been subject as a result of its failure to meet all applicable
regulatory capital requirements in prior periods. In connection with the
release of the Bank from its capital plan, the OTS also released the Bank
from a related capital directive which had imposed certain restrictions on
the Bank's operations and required the Bank to achieve compliance with
applicable capital requirements by June 30, 1992 (which deadline was
subsequently extended by the OTS until December 31, 1992). The Bank was in
compliance with all of its regulatory capital requirements under FIRREA at
September 30, 1993.
In October 1993, the Bank and the OTS amended a written agreement
dated September 30, 1991 that imposed certain restrictions on the Bank. As
amended, the agreement continues to address transactions with affiliates,
reduction of real estate acquired in settlement of loans, and asset
quality. Specifically, the Bank has agreed that it will not, without
receiving the prior approval of the OTS, (i) increase its investment in
certain of its planned unit developments ("Communities"), including the
four active Communities, beyond specified levels, (ii) make any additional
tax sharing payments to B. F. Saul Real Estate Investment Trust (the
"Trust"), which owns 80% of the Bank's common stock, or (iii) engage in any
other transaction with the Trust. In addition, the Bank must (i) provide
the OTS with 15 days notice prior to selling any asset with a value over
$20 million, (ii) make every effort to reduce its exposure in certain of
its Communities, including the four active Communities, (iii) notify the
OTS 15 days prior to rejecting any purchase offers for those properties and
(iv) sell any single-family permanent loans for purchases of homes in those
properties if the terms of those loans are more favorable to the borrowers
than terms prevailing in the general market. The amended agreement also
requires the Bank to submit various periodic reports to the OTS. A material
violation of the agreement could subject the Bank to additional regulatory
sanctions. Management believes the Bank is in material compliance with the
agreement.
- 22 -
The October 1993 amendment eliminated among other things, provisions
that required the Bank to (i) provide the OTS with 15 days notice prior to
selling certain significant assets with a value over $5 million, (ii) adopt
a formal expense reduction plan, (iii) make every effort to convert its
outstanding subordinated debentures to another form of capital (although no
deadline for achieving such a conversion was specified in the agreement),
(iv) review the pricing of its major products and fees, (v) review certain
compensation arrangements with the original developers of certain of its
large REO projects, (vi) obtain the prior written approval of the OTS to
pay dividends on its common stock or to increase senior executive
compensation beyond specified levels and (vii) make every effort to obtain
an infusion of capital in an amount sufficient to meet its fully phased-in
capital requirements by June 30, 1992, and, if necessary, to seek a merger
or acquisition partner.
The OTS has the authority to require an institution to maintain
capital at levels above the minimum levels generally required, but has not
indicated to the Bank any intention to exercise its authority to do so with
respect to the Bank.
PROMPT CORRECTIVE ACTION. Pursuant to FDICIA, the OTS and the other
federal agencies regulating financial institutions have adopted regulations
which, effective December 19, 1992, 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 to which institutions are assigned for purposes of
determining their 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
OTS to meet and maintain a specific capital level. An institution is
considered "adequately capitalized" if such capital ratios are at least
4.0% (3.0% if rated in the highest rating category), 4.0% and 8.0%,
respectively. 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" and an institution with ratios under 3.0%,
3.0% or 6.0%, respectively, 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" (generally defined by the OTS as core
capital plus cumulative perpetual preferred stock) to total assets is 2.0%
or less. An institution's classification category could be downgraded 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.
At September 30, 1993, the Bank's leverage, tier 1 risk-based and total
risk-based regulatory capital ratios were 5.35%, 7.29% and 11.70%,
- 23 -
respectively, which exceeded the corresponding ratios of 5.0%, 6.0% and
10.0% established under the prompt corrective action regulations for "well
capitalized" institutions.
GROWTH RESTRICTIONS. Primarily because of its level of non-performing
assets, the Bank remains subject to restrictions on asset growth. Under the
applicable OTS requirements, the Bank may not increase its total assets
during any calendar quarter in excess of an amount equal to net interest
credited on deposit liabilities during the quarter without prior written
approval from OTS. The OTS notified the Bank on September 10, 1993 that OTS
would waive this restriction for the period from July 1, 1993 through June
30, 1994 to allow for an increase in total assets of up to $500 million,
subject to the conditions, among others, that the Bank's regulatory capital
ratios increase with asset growth and that the Bank maintain sufficient
capital to meet the "well capitalized" ratios under the OTS's prompt
corrective action regulations.
The Bank's ability to increase its regulatory capital ratios to
support additional asset growth and to remain "well capitalized" is
dependent on a number of factors, including, for example, general economic
conditions and the continued recovery of local real estate markets.
QUALIFIED THRIFT LENDER ("QTL") TEST. Insured savings institutions
like the Bank must meet a QTL test to avoid imposition of certain
restrictions. Legislation enacted in 1991 and 1992 significantly changed
the QTL test. Under the modified requirements, thrifts must maintain a
"thrift investment percentage" equal to a minimum of 65%. The numerator of
such percentage is the thrift's "qualified thrift investments"; the
denominator is the thrift's "portfolio assets." "Portfolio assets" is
defined as total assets minus (i) the thrift's premises and equipment used
to conduct its business, (ii) liquid assets, as defined, and (iii)
intangible assets, including goodwill and purchased residential mortgage
loan servicing rights. The QTL test must be met on a monthly average basis
in nine out of every 12 months.
At September 30, 1993, the Bank had 84.4% of its portfolio assets
invested in qualified thrift investments. Additionally, the Bank met the
QTL test in each of the previous 12 months.
Assets that may be included in a thrift's "qualified thrift
investments" without limit include: residential housing loans (including
home equity loans and manufactured housing loans), mortgage-backed
securities and FHLB stock. 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: 50% of residential housing loans
originated and sold within 90 days; investments in real estate-oriented
service corporations; 200% of mortgage loans for residences, churches,
schools, nursing homes and small businesses in areas with unmet credit
needs (low or moderate income areas where credit demand exceeds supply);
loans for personal, family household or educational purposes (which may not
exceed 10% of portfolio assets); 200% of certain "starter" home loans; FNMA
stock; and FHLMC stock. Intangible assets, including goodwill, are
specifically excluded from qualified thrift investments.
- 24 -
An institution which fails to meet the QTL test is subject to
significant penalties. Immediately after an institution ceases to be a QTL,
it (i) may not 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, (ii) may not establish any new branch
office at any location at which a national bank could not establish a
branch office, (iii) may not obtain new advances from the applicable FHLB
and (iv) may not 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
remain a QTL, an institution may not retain any investments or engage in
any activities that would be impermissible for a national bank, and must
repay any outstanding FHLB advances as promptly as possible consistent with
the safe and sound operation of the institution.
Because Chevy Chase is engaged in activities that are not permissible
for national banks (most significantly, its investments in subsidiaries
that engage in real estate development activities), failure to satisfy the
QTL test would require a significant change in Chevy Chase's current
activities and would require a divestiture of any prohibited assets held at
such time. Depending on the level of such activities at the time,
compliance with these restrictions could have a significant adverse effect
on the Bank. In addition, because the Trust is engaged in real estate
ownership and development, which are activities that are currently
prohibited for bank holding companies, failure by Chevy Chase to remain a
QTL, in the absence of a significant restructuring of the Trust's
operations, would, in effect, require the Trust to reduce its ownership of
Chevy Chase 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. The Bank's credit card loan and automobile
loan securitization and sales activity to date have been undertaken, in
part, to meet these objectives.
DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS. Under OTS regulations, the
ability of thrift institutions such as the Bank to make "capital
distributions" (defined to include payment of dividends, stock repurchases,
cash-out mergers and other distributions charged against the capital
accounts of an institution) varies depending primarily on the institution's
regulatory capital level. The regulations do not apply to interest or
principal payments on debt, including interest or principal payments on the
Bank's outstanding subordinated debentures.
Institutions are divided into three tiers for purposes of these
regulations. Tier 1 institutions are those in compliance with their "fully
phased-in" capital requirements and which have not been notified by the OTS
that they are "in need of more than normal supervision." Tier 1
institutions may make capital distributions without regulatory approval in
amounts up to the greater of (i) 100% of net income for the calendar year
to date, plus up to one-half of the institution's surplus capital ratio
(i.e., the excess of capital over
- 25 -
the fully phased-in requirement) at the beginning of the calendar year in
which the distribution is made or (ii) 75% of net income for the most
recent four quarters.
Tier 2 institutions are those in compliance with their current, but
not their fully phased-in, capital requirements. Tier 2 institutions may
make distributions without regulatory approval of up to 75% of their net
income for the most recent four quarters. Tier 1 and Tier 2 institutions
that make capital distributions under the foregoing rules must continue to
meet the applicable capital requirements on a pro forma basis after giving
effect to such distributions. Tier 1 and Tier 2 institutions may seek OTS
approval to pay dividends beyond these amounts.
Tier 3 institutions have capital levels below their current required
minimum levels and may not make any capital distributions without the prior
written approval of the OTS.
The OTS retains general discretion to prohibit any otherwise permitted
capital distributions on general safety and soundness grounds and must be
given 30 days advance notice of all capital distributions. The OTS has
approved the payment of dividends on the Bank's outstanding 13%
Noncumulative Perpetual Preferred Stock, Series A (the "Preferred Stock"),
provided that (i) immediately after giving effect to the dividend payment,
the Bank's core and risk-based regulatory capital ratios would be not less
than 4.0% and 8.0%, respectively, (ii) dividends are earned and payable in
accordance with OTS a capital distribution regulation and (iii) the Bank
continues to make progress in the disposition and reduction of its
non-performing loans and real estate owned.
At September 30, 1993, the Bank had sufficient levels of capital to be
a Tier 1 institution. However, the OTS retains discretion under its capital
distribution regulation to treat an institution that is in need of more
than normal supervision (after written notice) as a Tier 2 or Tier 3
institution. As discussed in the following paragraph, the Bank also is
subject to contractual limitations on its ability to pay dividends. 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 deemed relevant by the Board
of Directors, including applicable government regulations and policies.
The indenture pursuant to which $150 million of the Bank's 9 1/4%
Subordinated Debentures due 2005 were sold in November 1993 (the
"Indenture") provides that the Bank may not pay a dividend on its capital
stock unless, after giving effect to the dividend, no default or event of
default shall have occurred and be continuing and the Bank shall be in
compliance with its regulatory capital requirements. In addition, the
amount of the proposed dividend may not exceed the sum of (i) $15 million,
(ii) 66-2/3% of the Bank's consolidated net income (as defined) 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
- 26 -
securities. Notwithstanding these restrictions on dividends, provided no
default or event of default has occurred and is continuing under the
Indenture, the Indenture does not restrict either the payment of dividends
on the Preferred Stock 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. See Note 24 to the Consolidated Financial
Statements in this report.
LENDING LIMITS. FIRREA generally subjects thrift institutions to the
same loans-to-one-borrower limits that apply to national banks. These
limits, which became effective August 9, 1989, were substantially more
restrictive than the previous limits applicable to thrift institutions.
With certain exceptions, the limits prohibit an institution from lending to
one borrower (including certain related entities of the borrower) in an
amount in excess of 15% of the institution's unimpaired capital and
unimpaired surplus, plus an additional 10% for loans fully secured by
readily marketable collateral. The Bank's loans-to-one-borrower limit was
approximately $72.6 million at September 30, 1993, and no group
relationships exceeded this limit at that date.
SAFETY AND SOUNDNESS STANDARDS. FDICIA requires the Bank's regulators
to devise standards to evaluate the operations of depository institutions,
as well as standards relating to asset quality, earnings and compensation.
The operational standards must cover internal controls, loan documentation,
credit underwriting, interest rate exposure, asset growth and employee
compensation. The asset quality and earnings standards must specify a
maximum ratio of classified assets to capital and minimum earnings
sufficient to absorb losses. Any institution that fails to meet these
standards must 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 restrict its rate of
asset growth, prohibit asset growth entirely, require the institution to
increase its ratio of tangible equity to assets, restrict the interest rate
paid on deposits to the prevailing rates of interest on deposits of
comparable amounts and maturities or require the institution to take any
other action that 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.
In November 1993, the OTS and the other federal bank regulators
published a joint notice of proposed rulemaking that solicited comment on
proposed standards in these areas. Among other things, the proposed
regulation's asset quality standards specify that the ratio of an
institution's assets classified as substandard or doubtful to the sum of
its total capital plus any allowances for loan losses not included in total
capital should not exceed 100%. Based on its preliminary review of the
proposed regulation, management does not believe that these new
requirements, if adopted substantially in the form proposed, would have a
material adverse effect on the Bank's operations.
- 27 -
DISPOSITION OF ADC INVESTMENTS. The Bank was advised in October 1989
by the Atlanta District of the OTS that ADC loans classified as investments
in real estate for accounting purposes must be considered as ownership
interests in real estate and, therefore, are not authorized investments for
the Bank to hold directly. The OTS directed the Bank to refrain from
entering into additional transactions of this nature in the future and to
seek opportunities to remove existing ADC transactions that constitute real
estate investments from its books as quickly as possible without material
loss.
At September 30, 1993, the Bank had only one ADC loan, with a book
value of $8.9 million, before all valuation allowances of $2.0 million,
classified as an investment in real estate. The Bank's levels of ADC loans
have declined significantly in recent years as a result of the Bank's
acquisition of title to the properties following the default of borrowers.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Banking - Asset Quality."
REGULATORY ASSESSMENTS. FIRREA contained provisions authorizing the
OTS to assess fees to fund its operations. Pursuant to that authority, the
OTS has adopted the following fees: (i) asset-based assessments for all
savings institutions, (ii) examination fees for certain affiliates of
savings associations, (iii) application fees, (iv) securities filing fees
and (v) publication fees. Of these fees, the asset-based assessments are
the most significant. Such assessments, which are paid semi-annually every
January 31 and July 31, incorporate a "general assessment" which varies
depending on the asset size of the institution and an additional "premium
assessment" for certain institutions requiring increased supervision. The
Bank was subject to this 50% "premium assessment" effective October 1,
1991. As a result, the semi-annual assessment paid on July 31, 1993 for the
six-month period ending December 31, 1993 was $507,891, comprising a
general assessment of $338,594 and a premium assessment of $169,297.
OTHER REGULATIONS AND LEGISLATION. As a thrift institution, Chevy
Chase continues to be subject to a requirement that it obtain prior
approval of the OTS before merging with another institution or before
increasing its insured accounts through merger, consolidation, purchase of
assets or assumption of liabilities. In addition, FIRREA contains
provisions that (i) impose a five-year moratorium on conversions from SAIF
insurance; (ii) permit a savings institution to convert to a commercial
bank charter if it retains SAIF insurance; (iii) permit bank holding
companies to acquire healthy as well as failing thrifts; (iv) substantially
strengthen the enforcement powers of the federal agencies regulating
financial institutions and increase the maximum penalties for violations of
laws and regulations to as much as $1 million per day; and (v) place new
restrictions on transactions between thrift institutions and their
affiliates and insiders.
In addition to the provisions noted above, FDICIA, among other things,
(i) requires regulators to revise their risk-based capital standards to
take into account interest-rate risk, concentration of credit risk and the
risks of non-traditional activities; (ii) requires annual on-site
regulatory examinations of institutions; (iii) requires management to
prepare annual reports on
- 28 -
the financial condition of the institution; (iv) requires independent audit
committees for all insured depository institutions; (v) mandates certain
accounting reforms, including the development of methods to disclose the
estimated fair market value of assets and liabilities; (vi) requires the
regulators to adopt uniform regulations prescribing standards for loans
that are secured by real estate or that are made for the purpose of
constructing a building or improving real estate; (vii) imposes limits on
the ability of the Federal Reserve Banks to lend to undercapitalized
institutions; and (viii) permits banks and thrifts to combine and to be
controlled by the same holding company. FDICIA also contains a number of
consumer-oriented provisions that (i) reduce deposit insurance assessments
for institutions offering "lifeline accounts" and/or loans to low- and
moderate-income persons in distressed communities; (ii) require uniform
disclosures regarding deposit accounts; and (iii) require advance
notification to customers and regulators of branch closings.
Under amendments to OTS regulations adopted in 1992, federally
chartered thrifts like Chevy Chase were permitted, for the first time, to
establish branches anywhere in the United States, provided they meet their
regulatory capital requirements and are "qualifying institutions" that meet
the domestic building and loan test of section 7701(a)(19) of the Internal
Revenue Code or the asset composition test of subparagraph (c) of that
section and if, with respect to each state outside of its home state where
the association has established branches, the branches, taken alone, also
satisfy the building and loan test.
Under legislation adopted in 1993, 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: (i)
administrative expenses of the receiver, (ii) any deposit liability of the
institution, (iii) any other general or senior liability of the institution
(which is not an obligation described in clause (iv) or (v)), (iv) any
obligation subordinated to depositors or general creditors (which is not an
obligation described in clause (v)) and (v) any obligation to stockholders
arising as a result of their status as stockholders.
FEDERAL RESERVE SYSTEM. The Federal Reserve Board ("FRB") requires
depository institutions, including federal savings banks, to maintain
reserves against their 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 earning asset base. FRB regulations generally require
that reserves be maintained against net transaction accounts. Effective
December 22, 1992, the first $3.8 million of a depository institution's
transaction accounts were subject to a 0% reserve requirement. The next
$43.0 million in net transaction accounts were subject to a 3.0% reserve
requirement and any net transaction accounts over $46.8 million were
subject to a 10.0% reserve requirement. The reserve requirement ratios for
certain non-personal time deposits and "Eurocurrency liabilities" are 0%.
The Bank met its reserve requirements for each period during the year ended
September 30, 1993. The balances maintained
- 29 -
to meet the reserve requirements imposed by the FRB also may be used to
satisfy liquidity requirements which are imposed by the OTS.
Savings institutions may borrow from the FRB "discount window,"
although FRB regulations require these institutions to exhaust all
reasonable alternate sources of funds, including FHLB sources, before
borrowing from the FRB. FDICIA imposes additional limitations on the
ability of the FRB to lend to undercapitalized institutions through the
discount window. See "Other Regulations and Legislation."
COMMUNITY REINVESTMENT ACT. Under the Community Reinvestment Act (the
"CRA") and the OTS's implementing regulations, a savings association has a
continuing and affirmative obligation to help meet the credit needs of its
local communities, including low- and moderate-income neighborhoods,
consistent with the safe and sound operation of the institution. The CRA
requires the board of directors of each savings association to adopt a CRA
statement for each delineated local community that describes, among other
things, its efforts to help meet community credit needs and the specific
types of credit that the institution is willing to extend. In connection
with its examination of a savings association, the OTS is required to
assess the institution's record in satisfying the intent of the CRA. In
addition, the OTS is required to take into account the institution's record
of meeting the credit needs of its community in determining whether to
grant approval for certain types of applications.
OTHER ASPECTS OF FEDERAL LAW. The Bank is also subject to federal
statutory provisions covering other items, including security procedures,
currency transactions reporting, insider and affiliated party transactions,
management interlocks, truth-in-lending, electronic funds transfers, funds
availability and equal credit opportunity.
RECENT ACCOUNTING PRONOUNCEMENTS. Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"), was issued
in February 1992 and changes the manner in which companies record deferred
tax liabilities or assets and requires ongoing adjustments for enacted
changes in tax rates and regulations. The Bank currently plans to adopt
SFAS 109 in the first quarter of fiscal 1994 on a prospective basis, with
the cumulative effect of this accounting change amounting to an increase in
the Bank's deferred tax asset of approximately $5.0 million.
In May 1993, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 114, "Accounting by Creditors for
Impairment of a Loan" ("SFAS 114"), and Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"). SFAS 114 defines impaired loans and requires such
loans to be measured based on the present value of expected future cash
flows or the fair value of the collateral if the loan is
collateral-dependent. SFAS 114 is effective for fiscal years beginning
after December 15, 1994. The Bank has not yet determined the effect that
implementation of SFAS 114 will have on its financial statements, but
believes that such effect will not be material.
- 30 -
SFAS 115 establishes accounting standards for investments in equity
securities that have readily determinable fair values and for all
investments in debt securities. SFAS 115 requires companies to classify
such equity and debt securities into one of three categories on the date of
acquisition and the date of all subsequent financial statements. Under SFAS
115, securities that are categorized either as "available for sale" or
"trading" are reported at fair value, and securities classified as
"held-to-maturity" are reported at amortized cost. SFAS 115 is effective
for fiscal years beginning after December 15, 1993, and may be applied at
the end of earlier fiscal years for which annual financial statements have
not been issued. The Bank is currently evaluating SFAS 115 and has not yet
determined the effect that the implementation of SFAS 115 will have on its
financial statements.
See Summary of Significant Accounting Policies in the Consolidated
Financial Statements in this report.
MARKET AREA
The Bank's principal deposit and lending markets are located in the
Washington, D.C. metropolitan area. Service industries and federal, state
and local governments employ a significant portion of the Washington, D.C.
area labor force, while a substantial number of the nation's 500 largest
corporations have some presence in the area. The Washington, D.C. area's
seasonally unadjusted unemployment rate is generally below the national
rate and was 4.5% in September 1993, compared to the national rate of 6.7%.
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, to a lesser
extent, Fairfax County in Virginia. Approximately 25.4% of the Bank's
deposits at September 30, 1993 were obtained from depositors residing
outside of Maryland, primarily in Northern Virginia. Chevy Chase and a
commercial bank had the largest market shares of consumer deposits in
Montgomery County at June 30, 1992, according to published industry
statistics. The per capita income of Montgomery and Fairfax Counties ranks
among the highest of counties and equivalent jurisdictions nationally.
These two counties are also the Washington, D.C. 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.
Unemployment in both Montgomery and Fairfax Counties in September 1993
(3.6% and 3.4%, respectively) was below the national and state rates for
the same month.
The Bank historically has concentrated its lending activities in the
Washington, D.C. metropolitan area. See "Lending Activities."
INVESTMENTS AND OTHER SECURITIES
The Bank is required by OTS regulations to maintain a specific minimum
amount of liquid assets and short-term liquid assets invested in certain
- 31 -
qualifying types of investments. See "Regulation - Liquidity
Requirements." To meet these requirements, the Bank maintains a portfolio
of cash, federal funds and Agency mortgage-backed securities with final
maturities of five years or less. The balance of investments in excess of
regulatory requirements reflects management's objective of maintaining
liquidity at a level sufficient to assure adequate funds to meet expected
and unexpected balance sheet fluctuations.
Investment and mortgage-backed securities held for investment are
stated at cost, adjusted for amortization of premiums and accretion of
discounts. These securities are carried at amortized cost because
management has the intent and ability to hold such securities until
maturity. Securities to be held for indefinite periods of time, including
securities that management intends to use as part of its asset-liability
strategy, or that may be sold in response to changes in interest rates,
changes in prepayment risks, the need to increase regulatory capital or
other similar factors, are classified as held for sale and are carried at
the lower of cost or market value.
The OTS has adopted guidelines governing investment securities held by
SAIF-insured institutions. The guidelines require that investments in
securities be accounted for in accordance with GAAP, summarize the
applicable accounting principles and provide guidance regarding the
application of GAAP in determining whether securities are properly
classified as held for investment, held for sale or trading.
LENDING ACTIVITIES
LOAN PORTFOLIO COMPOSITION. At September 30, 1993, the Bank's loan
portfolio totaled $2.3 billion, which represented 48.0% of its total
assets. (All references in this report to the Bank's loan portfolio refer
to loans, whether they are held for sale and/or securitization or for
investment, unless the context otherwise indicates.) Loans collateralized
by single-family residences constituted 56.1% of the loan portfolio at that
date.
The following table sets forth information concerning the Bank's loan
portfolio (net of unfunded commitments) for the periods indicated.
- 32 -
LOAN PORTFOLIO
(Dollars in thousands)
September 30,
-----------------------------------------------------------------------------------------------------
1993 1992 1991 1990 1989
------------------ ------------------- ----------------- ------------------- ------------------
% of % of % of % of % of
Balance Total Balance Total Balance Total Balance Total Balance Total
----------- ----- ------------ ----- ----------- ----- ------------ ----- ----------- -----
Residential (1) $ 1,287,333 53.6% $ 933,867 41.6% $ 1,345,409 41.7% $ 1,031,628 32.2% $ 900,528 27.1%
Home equity (1) 60,549 2.5 223,148 9.9 289,976 9.0 711,363 22.2 602,447 18.1
Commercial
and multifamily 94,079 3.9 61,522 2.7 69,097 2.1 89,759 2.8 103,413 3.1
Real estate
construction
and ground 62,637 2.6 92,215 4.1 133,852 4.2 277,061 8.6 312,958 9.4
Credit card (1) 754,520 31.4 872,672 38.9 1,302,008 40.4 883,722 27.6 1,262,388 37.9
Automobile 104,703 4.4 18,524 0.8 13,801 0.4 112,268 3.5 59,302 1.8
Other 40,070 1.6 43,405 2.0 70,782 2.2 99,291 3.1 86,000 2.6
----------- ------ ----------- ------ ----------- ------ ----------- ------ ----------- ------
2,403,891 100.0% 2,245,353 100.0% 3,224,925 100.0% 3,205,092 100.0% 3,327,036 100.0%
----------- ====== ----------- ====== ----------- ====== ----------- ====== ----------- ======
Less:
Unearned premiums
and discounts 1,543 2,589 6,002 7,037 9,354
Deferred loan
origination
fees (costs) (3,472) 1,889 6,612 7,721 13,534
Reserve for
loan losses 68,040 78,818 89,745 58,339 41,934
------------ ------------ ------------ ------------ -----------
66,111 83,296 102,359 73,097 64,822
------------ ------------ ------------ ------------ -----------
Total loans
receivable $ 2,337,780 $ 2,162,057 $ 3,122,566 $ 3,131,995 $ 3,262,214
=========== =========== =========== =========== ===========
<FN>
- ---------------------------------------------------------------------------------------------------------------------------
(1) Includes loans held for sale and/or securitization.
-33-
The Bank will continue to adjust the composition of its loan portfolio
in response to regulatory capital and qualified thrift lender requirements.
See "Regulation - Regulatory Capital" and "- Qualified Thrift Lender
("QTL") Test" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Banking - Asset
and Liability Management."
CONTRACTUAL PRINCIPAL REPAYMENTS OF LOANS. The following table shows
the scheduled contractual principal repayments of the Bank's loans at
September 30, 1993. The entire balance of loans held for sale and/or
Securitization is shown in the year ending September 30, 1994, because such
loans are expected to be sold in less than one year.
- 34 -
CONTRACTUAL PRINCIPAL REPAYMENTS
(In thousands)
Principal Approximate Principal Repayments
Balance Due in Years Ending September 30,
Outstanding at --------------------------------------------------------------------------------
September 30, 2009 and
1993 (1) 1994 1995 1996 1997-1998 1999-2003 2004-2008 Thereafter
-------------- ----------- ---------- --------- --------- ---------- ---------- ----------
Residential $ 1,111,306 $ 16,271 $ 25,756 $ 28,912 $ 55,125 $ 150,179 $ 138,564 $ 696,499
Home equity 60,549 2,277 1,045 3,296 9,370 274 10,631 33,656
Commercial
and multifamily 94,079 71,655 3,328 3,064 3,555 6,022 6,455 --
Real estate
construction
and ground 62,637 33,842 27,610 1,185 -- -- -- --
Credit card (2) 454,520 82,442 67,489 59,372 83,607 103,181 36,949 21,480
Other 144,773 44,651 34,427 35,092 23,453 2 2 7,146
Loans held for sale 176,027 176,027 -- -- -- -- -- --
Loans held for
securitization and sale 300,000 300,000 -- -- -- -- -- --
------------ ---------- --------- ---------- --------- ---------- ---------- ----------
Total loans
receivable (3) $ 2,403,891 $ 727,165 $ 159,655 $ 130,921 $ 175,110 $ 259,658 $ 192,601 $ 758,781
============ ========== ========= ========== ========= ========== ========== ==========
Fixed-rate loans $ 308,389 $ 43,374 $ 40,045 $ 44,931 $ 47,028 $ 64,054 $ 17,557 $ 51,400
Adjustable-rate loans 1,619,475 207,764 119,610 85,990 128,082 195,604 175,044 707,381
Loans held for sale 176,027 176,027 -- -- -- -- -- --
Loans held for
securitization and sale 300,000 300,000 -- -- -- -- -- --
------------ ----------- --------- ---------- --------- ---------- ---------- ----------
Total loans
receivable $ 2,403,891 $ 727,165 $ 159,655 $ 130,921 $ 175,110 $ 259,658 $ 192,601 $ 758,781
============ =========== ========= ========== ========= ========== ========== ==========
<FN>
- ------------------------------------------------------------------------------------------------------------------------------
(1) Of the total amount of loans outstanding at September 30, 1993 which were due after one year, an aggregate principal
balance of approximately $265.0 million had fixed interest rates and an aggregate principal balance of approximately
$1.4 billion had adjustable interest rates.
(2) Estimated repayments of credit card loans reflect the required minimum payments.
(3) Before deduction of reserve for loan losses, unearned discounts and deferred loan origination fees (costs).
-35-
Actual payments may not reflect scheduled contractual principal
repayments due to the effect of loan refinancings, prepayments and
enforcement of due-on-sale clauses, which give the Bank the right to
declare a "conventional loan," one that is neither insured by the Federal
Housing Administration ("FHA") nor partially guaranteed by the Veterans'
Administration ("VA"), immediately due and payable in the event, among
other things, that the borrower sells the real property subject to the
mortgage and the loan is not repaid. 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, 1993, $43.4
million of fixed-rate loans and $207.8 million of adjustable-rate loans
were contractually due to be repaid within one year.
ORIGINATION, PURCHASE AND SALE OF REAL ESTATE LOANS. The following
table shows changes in the composition of the Bank's real estate loan
portfolio and the net change in mortgage-backed securities.
- 36 -
ORIGINATION, PURCHASE AND SALE OF REAL ESTATE LOANS
(In thousands)
For the Year Ended September 30,
------------------------------------------------
1993 1992 1991
------------ ------------ ------------
Real estate loan originations and purchases: (1)
Residential and home equity $ 1,758,484 $ 1,246,367 $ 1,120,461
Commercial and multifamily 42,718 5,350 -
Real estate construction and ground 41,675 40,943 44,302
------------ ------------- -------------
Total originations and purchases 1,842,877 1,292,660 1,164,763
------------ ------------- -------------
Principal repayments (346,645) (251,865) (284,519)
Sales (2) (785,255) (568,955) (795,993)
Loans transferred to real estate acquired in
settlement of loans or in - substance foreclosures (23,158) (43,046) (177,582)
Other - (1,809) (2,685)
---------- ------------ -----------
(1,155,058) (865,675) (1,260,779)
Transfers to mortgage-backed securities (3) (493,973) (954,567) (175,461)
Increase (decrease) in real estate loans $ 193,846 $ (527,582) $ (271,477)
========== =========== ===========
<FN>
- ------------------------------------------------------------------------------------------------------------
(1) Excludes unfunded commitments.
(2) Includes securitization and sale of home equity credit line receivables of $340.4 million, $253.6 million
and $600.1 million for the years ended September 30, 1993, 1992 and 1991, respectively.
(3) Represents real estate loans which were pooled and exchanged for FHLMC, FNMA, GNMA and private label,
AA-rated mortgage-backed securities.
- 37 -
As a federally chartered savings institution, the Bank has general
authority to make loans secured by real estate located throughout the
United States. Although in the past the Bank has made loans secured by
properties located outside of its primary market area, approximately 93.0%
of the Bank's real estate loans at September 30, 1993 by principal balance
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. Commercial, real estate
construction and ground and home equity credit line loans are originated
directly by the Bank.
In the latter part of fiscal 1990, the Bank began developing a
wholesale network of correspondents, including loan brokers and financial
institutions, in order to supplement its direct origination of
single-family adjustable-rate residential mortgage loans in the Washington,
D.C. metropolitan area. The loans are originated or purchased on a "flow"
basis, with some loans settling directly in the Bank's name and some loans
purchased by the Bank after settlement in the name of the correspondents.
The Bank determines the specific loan products and rates under which the
correspondents originate the loans, and subjects the loans to the Bank's
underwriting criteria and review. During the year ended September 30, 1993,
approximately $259.8 million of loans settled under the correspondent
program. The Bank intends to continue to develop its wholesale network.
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, and in recent periods have
produced additional non-interest income in the form of gains on sales of
loans. In fiscal 1993, sales of mortgage loans originated or purchased for
sale by the Bank totaled $853.0 million. 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 originates fixed-rate,
single-family, long-term loans on terms which conform to the Federal Home
Loan Mortgage Corporation ("FHLMC") and the Federal National Mortgage
Association ("FNMA") guidelines in order to ensure their saleability in the
public secondary mortgage market. In order to manage its interest-rate
exposure, the Bank hedges its fixed-rate 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, 1993, the Bank had $176.0 million of
single-family residential loans held for sale to investors.
When the Bank sells a whole loan or loan participation and retains
servicing, or purchases mortgage servicing rights from third parties, it
continues to collect and remit loan payments, inspect the properties, make
certain insurance and tax payments on behalf of borrowers and otherwise
service the loans. The normal servicing fee, generally ranging from 0.25%
to 0.50% of the outstanding loan principal amount per annum, 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
- 38 -
participation or whole loan purchaser. At September 30, 1993, the Bank was
servicing residential permanent loans totaling $2.0 billion for other
investors.
SALES OF MORTGAGE-BACKED SECURITIES. A significant portion of the
Bank's sales of mortgage-backed securities involve sales pursuant to the
Bank's normal mortgage banking operations. Generally, the Bank's policy is
to sell its fixed-rate mortgage production which, in the case of most
conforming fixed-rate loans, is accomplished by first pooling such loans
into mortgage-backed securities. The mortgage-backed securities sold as
part of the Bank's mortgage banking operations are generally issued in the
same month as the sale of such securities. The securities are formed from
conforming fixed-rate loans originated for sale or from fixed-rate loans
resulting from the borrower's election to convert from a variable-rate loan
to a fixed-rate loan. As a result, the Consolidated Statements of Cash
Flows in this report reflect significant proceeds from the sales of
mortgage-backed securities even though there are no balances of
mortgage-backed securities to report as held for sale. Instead, these
fixed-rate loans are designated as held for sale in the Consolidated
Balance Sheets in this report.
Sales of mortgage-backed securities from the Bank's investment
portfolio during fiscal years 1991, 1992 and 1993 generally were effected
in connection with the Bank's restructuring of its balance sheet in
response to a variety of factors. In March 1991, the Bank sold $323.3
million of variable-rate mortgage-backed securities, which constituted all
variable-rate mortgage-backed securities then owned by the Bank. The sale
of these securities occurred primarily to offset the regulatory capital
impact of the Bank's decision to increase its reserves for losses by $29.9
million in the March 1991 quarter and to permit the Bank to remain in
compliance with its minimum risk-based capital requirement.
In September 1991, the Bank sold $303.3 million of mortgage-backed
securities acquired in June 1991. The securities had been acquired with
borrowed funds in anticipation of a contemplated sale of assets designed to
improve the Bank's regulatory capital levels. The contemplated sale
subsequently was determined not to be in the best long-term interests of
the Bank.
In the June 1992 quarter, the Bank sold its remaining $438.4 million
of long-term fixed-rate mortgage-backed securities. The sale was designed
to mitigate the effects on the Bank's capital levels of an increase in the
Bank's reserves for losses on real estate and real estate-related
charge-offs taken in the same quarter. The Bank subsequently classified the
securities sold in June 1992 as held for sale as of March 31, 1992.
In the second quarter of fiscal 1993, the Bank sold its entire
portfolio of seven-year balloon fixed-rate mortgage-backed securities,
totaling $127.8 million, primarily to provide the Bank with flexibility
under the Bank's previous asset growth limitations imposed by its various
agreements with the OTS to permit increased mortgage loan origination
activity resulting from low market interest rates and in order to reduce
its exposure to possible future
- 39 -
increases in long-term interest rates. The Bank subsequently classified
such mortgage-backed securities as held for sale as of December 31, 1992.
At September 30, 1993, it was management's intent to hold all
mortgage-backed securities until maturity. The earlier sales of
mortgage-backed securities from the Bank's investment portfolio were for
reasons related to its capital position and growth limitations and in
furtherance of its asset and liability management objectives. As a result
of the prior restructuring of the Bank's balance sheet and the improvement
in the Bank's regulatory capital ratios following the sale of the Preferred
Stock in April 1993, as well as the OTS's partial waiver in September 1993 of
applicable growth restrictions, the Bank does not currently contemplate any
additional sales of mortgage-backed securities from its investment portfolio.
SINGLE-FAMILY RESIDENTIAL REAL ESTATE LENDING. The Bank originates a
variety of loans secured by single-family residential structures, which are
structures consisting of up to four separate dwelling units. At September
30, 1993, $1.3 billion (or 56.1%) of the Bank's loan portfolio consisted of
loans secured by first or second mortgages on such properties, including
$49.0 million of FHA-insured or VA-guaranteed loans.
Chevy Chase currently offers fixed-rate loans with maturities of 15 to
30 years and adjustable-rate residential mortgage loans ("ARMs"),
principally with maturities of 30 years. At September 30, 1993, 17.9% of
the Bank's loans consisted of ARMs scheduled to have interest rate
adjustments within one year. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition -
Banking - Asset and Liability Management." The interest rates on these
loans (other than the interest rates on home equity credit line loans)
generally are adjusted annually based on changes in the applicable interest
rate index. Interest rates on the majority of the Bank's ARMs are adjusted
based on changes in yields on U.S. Treasury securities of varying
maturities, primarily one year. The interest rate adjustment provisions of
the Bank's ARMs contain limitations on the frequency and maximum amount of
interest rate adjustments, although such limitations are not required by
law. These limitations are determined by a variety of factors, including
mortgage loan competition in the Bank's markets. The ARMs currently offered
by the Bank are generally subject to a limitation on the annual increase in
the interest rate of 2.0% and a limitation on the increase over the term of
the loan of from 6.0% to 9.0%.
In the past, the Bank has originated six-month ARMs with a negative
amortization feature. Interest is accrued at the coupon rate (which adjusts
every six months), with differences between interest computed at the coupon
rate and interest computed at the payment rate capitalized to the loan
balance. At September 30, 1993, the balance of such loans was $84.7
million, of which $2.3 million represented deferred interest capitalized to
the loan balance. The Bank does not currently originate loans which have a
negative amortization feature.
Consistent with its commitment to serve local communities, the Bank
established the Chevy Chase Community Development Loan Fund in March 1993.
The fund provided $25.0 million of below-market rate mortgage financing to
- 40 -
low-income and moderate-income families in the Washington, D.C.
metropolitan area. In October 1993, the Bank committed $1.0 million to the
Prince George's County Revitalization Fund, a fund dedicated to providing
assistance to small businesses located inside the Washington, D.C. Beltway.
The Bank's home equity credit line loan provides revolving credit
secured principally by a second mortgage on the borrower's home. Home
equity credit line loans bear interest at a variable rate that adjusts
quarterly 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%. In order to promote its home equity credit line loan program,
the Bank currently offers prospective borrowers a below-market interest
rate for an introductory period and settlement without closing costs.
Securitizations of home equity credit line receivables have been an
integral element of the Bank's strategies to enhance liquidity, to further
asset and liability management objectives and to maintain compliance with
regulatory capital requirements. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Financial Condition -
Banking." The Bank transferred $340.4 million, $253.6 million and $600.1
million of home equity credit line receivables in fiscal 1993, fiscal 1992
and fiscal 1991, respectively, to trusts for securitization and sale to
investors. Gains of $16.8 million, $15.1 million and $25.8 were recognized
by the Bank as a result of these transactions. The Bank continues to
service the underlying accounts.
COMMERCIAL REAL ESTATE AND CONSTRUCTION LENDING. In its past four
fiscal years, the Bank has deemphasized permanent commercial real estate
loans, land acquisition and land development loans, and loans for
construction of commercial income-producing properties. This type of
lending generally is considered to involve a higher level of risk than
single-family mortgages or other consumer lending due to the concentration
of principal in a limited number of loans and borrowers. However, in fiscal
1993, the Bank provided financing generally at market rates, to certain
purchasers of its commercial REO. Additionally, the Bank continues to
finance the construction of residential real estate, principally
single-family detached homes and townhouses, but generally only after a
home is sold by the builder to a consumer.
Aggregate balances of residential construction, commercial
construction, ground and commercial and multifamily loans increased 2.0% in
fiscal 1993 to $156.7 million at September 30, 1993 from $153.7 million at
September 30, 1992.
CREDIT CARD LENDING. Since June 1985, Chevy Chase has been providing
retail credit through its credit card program, which offers VISA-TM- and
MasterCard-TM- credit cards and the related Gold Cards. Chevy Chase issues
the credit cards and receives interest income on credit extended, a fee
based on a percentage of credit sales paid by merchants accepting card
purchases, and an annual membership fee for use of the cards. Chevy Chase's
credit card loan portfolio accounted for 31.4% of Chevy Chase's total loans
at September 30, 1993. According to statistics published in American
Banker, Chevy Chase is
- 41 -
the third largest issuers of credit cards among thrift institutions, based
on total credit card loans outstanding. At September 30, 1993, credit card
loans outstanding totaled $754.5 million and managed credit card
receivables, including receivables owned by the Bank and receivables
securitized, sold and serviced by the Bank, totaled $1.6 billion.
The Bank has emphasized credit card lending in recent years because the
shorter term and normally higher interest rates on such loans help it
maintain a profitable spread between its average loan yield and its cost of
funds. In addition, credit card accounts typically may be sold at a premium
over their receivables balances, thus further enhancing their potential
value to the Bank. Chevy Chase also believes its credit card program
contributes to market share growth in its local markets by attracting
new depositors, promoting a high degree of customer loyalty and providing
opportunities to cross-market other products of the Bank. For this reason,
the Bank has not sold any credit card accounts maintained by cardholders
having addresses in Maryland, Virginia or the District of Columbia, the
Bank's primary market area.
The Bank historically has obtained new credit card accounts through
direct mailings and telemarketing. In November 1990, the Bank ceased active
national solicitation of new credit card accounts due in part to the
significant initial cost of acquiring accounts and the Bank's desire
to enhance its capital position. As a result of the improvement in the
Bank's regulatory capital ratios, in June 1993 the Bank reinstated the
active national solicitation of new credit card accounts in markets which
the Bank considers to have favorable demographic characteristics.
Chevy Chase's internal data processing systems are capable of handling
a broad range of credit card program operations, including processing of
credit applications and collection functions. Until May 1993, certain
data processing and administrative functions associated with the servicing of
the credit card accounts were performed on behalf of the Bank by the
Atlantic States Bankcard Association ("ASBA") from its facilities in
Raleigh, North Carolina. In May 1993, ASBA was acquired by First
Data Resources Incorporated ("First Data Resources"). In October 1993, the
Bank converted its credit card processing to First Data Resources, which
provides a variety of data processing and administrative services to the
Bank, including processing and settlement of transactions, maintenance
of individual cardholder accounts, processing of cardholder statements and
issuance of plastic cards. The fee per account charged by First Data
Resources to perform such services on behalf of the Bank will generally be
less than the fee per account formerly charged by ASBA for comparable
services.
Changes in credit card use and payment patterns by cardholders,
including increased defaults, may result from a variety of social, legal and
economic factors. Economic factors affecting credit card use include the
rate of inflation and relative interest rates offered for various types of
loans. Adverse changes in economic conditions could have a direct impact
on the timing and amount of payments by borrowers. During times of
economic recession, default rates on credit card loans generally may be
expected to exceed default rates on residential mortgage loans. See
"Management's Discussion and
- 42 -
Analysis of Financial Condition and Results of Operations - Financial
Condition -Banking - Asset Quality - Delinquent Loans" and "- Reserves for
Losses."
Certain issuers of credit cards adjust their pricing to provide for
the different credit risks among customers based upon card usage, repayment
habits and other criteria. The Bank has implemented such risk-based
pricing by increasing the interest rates charged to high-risk customers and
by continuing to allow premium-credit customers a more favorable rate. The
Bank recently has offered premium-credit customers the option to convert to
a variable-rate product which currently provides the cardholder with a lower
interest rate than the Bank's fixed-rate product. Periodically, the Bank
offers promotional discounts to certain customers to encourage increased
usage of the Bank's credit cards.
Securitizations of credit card receivables and, in prior years, sales
of credit card relationships have been integral elements of the Bank's
strategies to enhance liquidity, to further asset and liability management
objectives and to maintain compliance with regulatory capital and
"qualified thrift lender" requirements. The Bank transferred $350.0
million, $280.0 million and $450.0 million of credit card receivables in
fiscal 1993, fiscal 1992 and fiscal 1990, respectively, to trusts for
securitization and sale to investors. No gain or loss was recognized by
the Bank as a result of these transactions; however, the Bank continues to
service the underlying accounts, and excess servicing fees are recognized
over the related lives of the transactions. These excess servicing fees
represent the contractual interest and fees paid by the cardholders less
certificate interest paid to the certificateholders and administrative fees
paid to providers of services to the trusts. In fiscal 1992, 1991 and
1990, the Bank sold, at a premium over their receivables balances of $14.9
million, $273.4 million and $646.0 million, respectively, 367,897 credit
card relationships. No such sales occurred during fiscal 1993.
From time to time, regulation of credit card interest rates has been
the subject of legislative debate and concern among various consumer
interest groups. Although no interest rate caps have been enacted into law,
publicity resulting from these congressional actions could lead to
increased consumer demand for reduced credit card interest rates and
interest rate regulation provisions could be enacted in future legislation.
The credit card industry is highly competitive and characterized by
increasing use of advertising, target marketing, pricing competition in
interest rates and annual membership fees, and other features (such as
buyer protection plans), as both established and new credit card issuers
seek to expand or to enter the market. Management anticipates that
competitive pressures will continue to require adjustments from time to
time to the pricing of the Bank's credit card products.
Credit card loans are not subject to those provisions of federal laws
and regulations that limit to 35% of an institution's total assets the
amount of consumer loans that a federally chartered savings institution may
make.
- 43 -
CONSUMER AND OTHER LENDING. Federal laws and regulations permit a
federally chartered savings institution to make secured and unsecured
consumer loans up to 35% of the institution's total assets. In addition, a
federally chartered savings institution has lending authority above the 35%
limit for certain consumer loans which include, in addition to credit card
loans, home improvement, secured deposit account and educational loans.
Chevy Chase currently offers a variety of consumer loans other than
credit card loans, including automobile loans, overdraft lines of credit and
unsecured loans for traditional consumer purchases and needs. The
Bank's portfolio of such consumer loans totaled $144.8 million at September
30, 1993. Consumer and other loans (other than credit card loans)
accounted for 6.0% of total loans at September 30, 1993.
REAL ESTATE LOAN UNDERWRITING. In the loan approval process, Chevy
Chase assesses both the borrower's ability to repay the loan and, in
appropriate cases, the adequacy of the proposed security. Credit approval
is vested with the Board of Directors and delegated to the Executive Loan
Committee and certain senior officers in accordance with the credit
authorizations approved by the Board of Directors. 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 loans of $15 million or more are presented to the
Board of Directors for final approval.
The approval process for all types of real estate loans includes
on-site appraisals 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. Appraisals supporting major
construction and commercial loans are generally performed by independent
appraisers selected by the Bank.
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 up to 95% of the appraised value of
single-family residential dwellings to be owner-occupied. The Bank also
lends up to 85% of the appraised value of the completed project to finance
the construction of such dwellings, and, on a case-by-case basis, the Bank
may, on occasion, lend up to 90% of such appraised value when such financing
is limited to pre-sold units. 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. In December
1992, the Bank reduced its acceptable loan-to-value ratios for many types
of commercial real estate
- 44 -
loans and increased the required preleasing levels and equity investment by
the developer. Currently, the Bank generally does not originate a second
mortgage loan (including a home equity credit line loan) if the aggregate
loan-to-value ratio of the second loan and the related first mortgage loan
exceeds 80% of the appraised value of the property. Loan-to-value ratios
are determined at the time a loan is originated. Consequently, subsequent
declines in the values of the security properties could expose the Bank to
losses.
Pursuant to FDICIA, the OTS issued final regulations requiring
institutions to adopt internal real estate lending policies, including
loan-to-value limitations conforming to specific guidelines established by
the OTS. The Bank's current lending policies conform to these new
regulations.
Under current OTS regulations, certain "high ratio" land loans and
non-residential construction loans are considered "equity investments." The
amount of the loan which exceeds an 80% loan-to-value ratio must be
deducted from capital. See "Regulation - Regulatory Capital."
On all loans secured by real estate (other than 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 placed with four carriers.
Substantially all fixed-rate mortgage loans originated by the Bank
contain a "due on sale" clause providing 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.
CREDIT CARD LOAN UNDERWRITING. Prior to February 1993, the Bank
generally did not pre-approve accounts for its credit card loans. However,
beginning with the resumption of active solicitation of new accounts in
February 1993, the Bank generates new accounts through direct-mail and
telemarketing solicitation campaigns directed at individuals who have been
preapproved. The Bank identifies potential cardholders for preapproved
solicitations by supplying a list of credit criteria to a credit bureau,
which generates a list of individuals who meet such criteria. When the
Bank receives an acceptance certificate from an individual that received a
preapproved solicitation, the Bank obtains a credit report on such
individual issued by an independent credit reporting agency, and the credit
limit and terms of the account are subject to certain post-screening
underwriting reviews performed by the Bank.
- 45 -
The Bank's underwriting approach to account approval supplements a
computerized credit scoring system with an individual evaluation of each
completed application for creditworthiness. In the underwriting process,
the Bank considers the prospective cardholder's income, credit history,
outstanding debt as a percentage of gross income and other factors intended
to provide a general indication of the applicant's willingness and ability
to repay his obligations. The Bank also reviews a credit report on each
applicant issued by an independent credit reporting agency and, for certain
applicants, independently verifies employment, income or other information
contained in the credit application.
If an application is approved, the Bank establishes an initial credit
limit on the cardholder's account based on the limit requested in the credit
application and the Bank's evaluation of the cardholder's credit worthiness.
This credit limit is adjusted from time to time based on the Bank's
continuing evaluation of the cardholder's repayment ability as evidenced by
the cardholder's payment history and other factors. The Bank also may
increase the credit limit at the cardholder's request after completion of
an evaluation comparable to that performed during the initial underwriting.
Management reviews credit losses on a monthly basis and adjusts its
underwriting standards as appropriate.
LOAN SERVICING. In addition to interest earned on loans, the Bank
receives income through servicing of loans and fees in connection with loan
origination, loan modification, late payments, changes of property
ownership and for miscellaneous services related to its loans. Loan
servicing income, principally servicing income earned on the Bank's
securitized credit card, home equity credit line and other consumer
receivables portfolios, has been a source of substantial earnings for the
Bank in recent periods. At September 30, 1993, the Bank serviced $841.8
million, $530.1 million and $29.6 million of securitized credit card, home
equity credit line and automobile loan receivables, respectively. Income
from these activities varies with the volume and type of loans made and
sold.
The following table sets forth certain information relating to the
Bank's servicing income as of or for the periods indicated.
- 46 -
As of or For the Year Ended September 30,
-----------------------------------------
1993 1992 1991
-------- ----------- ----------
(In thousands)
Amounts of loans serviced
for others at end of
year (1) ............ $3,423,578 $2,379,095 $2,771,534
Loan servicing fee
income (2) ............ $ 46,083 $ 39,924 $ 47,632
__________________
<FN>
(1) The Bank's basis in its servicing rights at September 30, 1993, 1992 and
1991 was $47.9 million, $42.3 million and $44.3 million, respectively.
(2) In each of the years ended September 30, 1993, 1992 and 1991, loan
servicing fee income as a percentage of net interest income before
provision for loan losses was 25.4%, 21.2% and 29.4%, respectively.
The Bank earns fees in connection with the servicing of home equity
credit line loans, credit card loans, automobile loans and single-family
residential mortgage loans. The Bank's level of servicing fee income
increases or decreases with increases or decreases in securitized balances
of these loan types. The Bank's level of servicing income for the fiscal
year ended September 30, 1992 reflected a decrease of $8.3 million related
to a change in the method of amortizing gains previously recognized on the
securitization and sale of home equity credit line receivables. The Bank's
level of servicing fee income declines upon repayment of assets previously
securitized and sold and repayment of mortgage loans serviced for others.
As the Bank securitizes and sells assets, purchases mortgage servicing
rights, or sells mortgage loans and retains the servicing rights on those
loans, the level of servicing fee income increases. During fiscal 1993, the
Bank securitized and sold $340.4 million of home equity credit line
receivables and $350.0 million of credit card receivables. Pursuant to
these transactions, the Bank will continue to service the underlying loans.
In fiscal 1993, the Bank acquired the rights to service approximately
$1.2 billion principal amount of fixed-rate FHLMC and FNMA mortgages.
During fiscal 1993, the Bank sold approximately $1.2 million of rights to
service mortgage loans with an aggregate principal balance of approximately
$76.1 million. In addition, the Bank sold the rights to service mortgage
loans with an aggregate principal balance of $476.1 million, which were
originated by the Bank in connection with its mortgage banking activities.
The Bank's investment in loan servicing rights (including purchased
mortgage servicing rights and excess loan servicing assets), and the
amortization of such rights, are evaluated quarterly based on the
discounted value of estimated future net cash flows to be generated by
- 47 -
the underlying loans. Changes in the discounted value are recorded as
amortization expense (in the case of purchased mortgage servicing rights)
or as a reduction of fee income (in the case of excess loan servicing
assets) in the period in which the change occurs. Several estimates are
used when determining the discounted value, the most significant of which
is the estimated rate of repayment of the underlying loans.
Interest rates charged on new mortgage loans have declined in recent
years, resulting in high levels of mortgage refinance activity. This
activity has caused significant declines in loans serviced by the Bank as
well as increases in the estimated rates at which loans will repay in the
future. As a result, the rate of amortization of these rights was
accelerated in fiscal 1993.
In addition to the Bank's acquisition of $1.2 billion principal
amount of mortgage loans, the Bank securitized and sold $340.4 million of
home equity credit lines during fiscal 1993. Because of these transactions
and also because of the increased repayment activity referred to above,
during fiscal 1993, purchased mortgage servicing rights amortization
expense increased $10.5 million and home equity credit line receivable
servicing income decreased $3.8 million. While management believes that its
estimates of future repayment rates are reasonable, there can be no
assurance that future adjustments to the rate of amortization will not be
necessary.
The Bank's current origination fees on its single-family mortgage
loans generally range from 1.0% to 3.0% of the principal amount of the
loan. Its current origination fees on construction and multifamily
residential and commercial real estate loans generally range from 0.5% to
2.0% of the principal amount of the loan.
Loan origination and commitment fees, and the related costs
associated with making the loans, are deferred in accordance with Statement
of Financial Accounting Standards No. 91, "Accounting for Nonrefundable
Fees Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases." For fully amortizing loans originated for the Bank's
portfolio, the net deferred fees are accreted to interest income over the
estimated life of the loans using the level-yield method. Fees deferred on
revolving credit lines or loans which have no scheduled amortization
originated for the Bank's portfolio are accreted to income over the
estimated lives of the underlying loans using the straight-line method,
which is not materially different from the level-yield method.
Fees deferred on loans originated and held for sale are not accreted
to income but instead are used in determining the gain or loss on the sale
of the loans.
- 48 -
DELINQUENCIES, FORECLOSURES AND RESERVES 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, such acquired property is listed
in the Bank's account for real estate acquired in settlement of loans until
the property 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.
The total outstanding balances of credit card loans (the largest
category of the Bank's consumer loans) are contractually delinquent if the
minimum payment indicated on the cardholder's statement is not received by
the due date indicated on such statement. Efforts to collect contractually
delinquent credit card receivables currently are made by the Bank's service
center personnel or the Bank's designees. Collection activities include
statement messages, formal collection letters and telephone calls. The Bank
may, at its option, enter into arrangements with cardholders to extend or
otherwise change payment schedules. Delinquency levels are monitored by
collection managers and information is reported regularly to senior
management. Accounts are charged off when they become 180 days
contractually delinquent, although the Bank continues to attempt to collect
balances due and, in some cases, may refer the accounts to outside
collection agencies.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Banking - Asset Quality -
Delinquent Loans" for a discussion of the Bank's delinquent loan portfolio
at September 30, 1993.
RESERVES FOR LOSSES. It is the Bank's policy to maintain adequate
reserves for estimated losses on loans and real estate. Generally, the
reserves are based on, among other things, historical loan loss experience,
evaluation of economic conditions in general and in various sectors of the
Bank's customer base, and periodic reviews of loan portfolio quality by
Bank personnel. Reserves for losses on loans and real estate are based on
estimates of future losses. Actual losses may vary from current estimates.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Banking - Asset Quality -
Reserves for Losses."
The Bank's specific methods for establishing the appropriate levels
of reserves vary depending upon the assets involved. The Bank's
- 49 -
reserve for credit card loans is based on a number of factors, including
historical charge-off and repayment experience and the age of the
portfolio. The Bank has developed a static pool model to extrapolate its
reserve needs based on an analysis of the characteristics of the portfolio
and trends at any particular time. In this regard, the Bank considers
historical charge-off information relative to origination date, borrower
profiles, age of accounts, delinquencies, bankruptcies and other factors.
Although industry standards are considered, they are given comparatively
less weight due to management's belief that comparisons among different
institutions' portfolios are potentially misleading because of significant
differences in underwriting standards, curing and re-aging procedures and
charge-off policies. Chevy Chase's policy is to charge off credit card
receivables when they become 180 days contractually delinquent. The Bank's
actual charge-off experience for credit card loans may vary from the levels
forecasted by the Bank's static pool model because credit card loans
typically are more sensitive to general economic conditions than certain
other types of loans. For example, an unforeseen decline in economic
activity may result in increased bankruptcy losses which the model is
unable to forecast. Nevertheless, because the Bank's model employs a
rolling 12-month base, such unforeseen losses are incorporated into the
model as they occur and reserves are adjusted accordingly. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Banking - Asset Quality - Reserves for
Losses."
The Bank's methods for determining the reserve for loans secured by
real estate vary depending on whether the loans are secured by residential
homes or by other real estate. For residential mortgage loans, management
computes the reserve by stratifying residential permanent loans on a state
by state and ownership (i.e., investor or homeowner) basis. After the
residential permanent portfolio has been stratified by state, historical
loss ratios (as adjusted for predictable or quantifiable trends, if known)
for the specific states are applied to delinquent loans. The sum of these
calculations is the component assigned to residential permanent loans. In
the Bank's experience, this approach has resulted in timely recognition of
necessary reserves, which has been supported by the Bank's favorable
results on the ultimate disposition of the underlying collateral.
The Bank assesses the adequacy of its general reserves for
non-residential (i.e., other than single-family residential) mortgage
loans, real estate acquired in settlement of loans ("REO") and real estate
held for investment based primarily on an ongoing evaluation of individual
assets. This evaluation takes into consideration a variety of factors,
including cash flow analyses, independent appraisals, market studies,
economic trends and management's knowledge of the market and experience
with particular borrowers. The Bank obtains current appraisals when
properties are classified as REO. The Bank periodically reviews appraisals
and orders new appraisals as appropriate based on a number of factors,
including the date of the previous appraisal, changes in market conditions
and regulatory requirements.
- 50 -
The Bank regularly reviews its overall loan portfolio consisting of
performing non-classified assets and, based on such review, establishes
additional reserves for losses.
In addition to the general reserves described above, valuation
allowances are provided for individual loans where the ultimate collection
is considered questionable by management after reviewing the current status
of loans which are contractually past due and considering the net
realizable value of the security of the loan or guarantees, if applicable.
To date, sales of REO, non-residential mortgage 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 reserves.
The Bank's individualized asset review takes place within its Loan
Review Group and the Asset Classification Committee (the "Committee"). The
Loan Review Group is part of the Credit Department and accumulates and
analyzes data relating to assets of $1.0 million or more and makes
appropriate recommendations regarding asset classifications to the
Committee. The Committee meets on a regular basis to discuss
classifications of such assets and to review the reserves for losses. The
Committee generally reviews the status of various projects, including, for
example, data on recent lot sales for residential development projects and
leasing activity on commercial projects. Actual progress is compared to pro
forma projections made when the related loan was underwritten. Local
economic conditions and known trends are also reviewed. The Committee also
considers steps being taken by borrowers to address problems, and reviews
financial information relating to borrowers and guarantors as well as
reports by loan officers who are responsible for continually evaluating the
projects. The actions of the Committee are reported to the Board of
Directors.
REO is carried at the lower of cost or fair value.
In-substance foreclosures include those loans and investments for
which the Bank has determined that (i) the borrower has little or no equity
in the collateral, (ii) the proceeds for repayment are expected to come
only from the operation or sale of the collateral and (iii) the borrower
either has abandoned control of the collateral or, based on the borrower's
financial condition or the economic prospects for the borrower and/or the
collateral, is unlikely to rebuild the equity in the collateral or
otherwise repay the loan in the foreseeable future. In-substance
foreclosures are carried at the lower of cost or fair value.
In January 1993, the OTS adopted a rule effective December 31, 1992
which required savings associations to use fair value, rather than net
realizable value, in determining appropriate write-downs of foreclosed
assets (including in-substance foreclosures) and permitted
- 51 -
savings associations to reduce the risk-weighting for all repossessed
assets, equity investments and assets more than 90 days past due from 200%
to 100%, thus reducing the amount of capital that an association was
required to maintain against such assets. The effect of this change was to
conform OTS policy to Statement of Position 92-3, "Accounting for
Foreclosed Assets," issued by the American Institute of Certified Public
Accountants ("SOP 92-3"). See Summary of Significant Accounting Policies in
the Consolidated Financial Statements in this report. In connection with
this rule and the Bank's adoption of SOP 92-3, the Bank recorded valuation
allowances against its foreclosed assets of $40.5 million for the quarter
ended December 31, 1992, of which $21.5 million had been previously
provided during the year ended September 30, 1992. In August 1993, the OTS
adopted a new policy, effective September 30, 1993, for the valuation and
classification of troubled, collateral-dependent loans. The impact of the
new policy on the Bank is not material.
The OTS has issued for comment proposed guidelines regarding the
appropriate levels of general reserves that savings associations should
maintain. Although the proposed guidelines generally provide that examiners
will rely on management's evaluation of the adequacy of general reserves if
the association's process for such an evaluation is "sound," the guidelines
nevertheless set forth quantitative and qualitative factors for reviewing
management's analysis and calculating the appropriate level of general
reserves. Based on its review of the proposed guidelines, the Bank believes
that its evaluation of the adequacy of the general reserves complies with
the proposed guidelines and that its levels of general reserves at
September 30, 1993 generally meet the proposed guidelines, although there
can be no assurances that the OTS will not seek to require the Bank to
increase its levels of general reserves.
The Bank's assets are also subject to review and classification by
the OTS and the FDIC upon examination. Based on such examinations, the
Bank could be required to establish additional reserves 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.
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. Its deposit programs
- 52 -
include 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. All
jumbo certificates of deposit are sold directly by the Bank to depositors,
either through its branches or through its money desk operation.
Chevy Chase attracts deposits through its branch network and
advertisements, and offers depositors access to their accounts through 284
ATMs, including 104 ATMs located in Safeway Inc. stores. The Bank is a
member of the regional "MOST" ATM network which offers over 2500
locations. The Bank is also a member of the "PLUS" ATM network, which
offers over 50,000 locations worldwide. In addition, the Bank has the right
to install ATMs in Safeway stores in the greater Washington,
D.C./Baltimore/Richmond area which do not currently have ATM service. The
acquisition of these ATMs and installation rights significantly expands
both the number of ATMs and the number of locations in the Bank's ATM
network and enhances the Bank's position as a leading provider of
convenient ATM service in its primary market area.
The Bank obtains deposits primarily from customers residing in
Montgomery and Prince George's Counties in Maryland and Northern Virginia.
Approximately 25.4% of the Bank's deposits at September 30, 1993 were
obtained from depositors residing outside of Maryland, with approximately
10.8% of the Bank's deposits being obtained 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.
- 53 -
DEPOSIT ANALYSIS
(Dollars in thousands)
September 30,
-----------------------------------------------------------------------------------------------
1993 1992 1991 1990 1989
------------------ ----------------- ---------------- ---------------- -----------------
% of % of % of % of % of
Balance Total Balance Total Balance Total Balance Total Balance Total
- -------------------------------------------------------------------------------------------------------------------------------
Demand and NOW accounts $ 835,084 21.6% $ 743,214 19.0% $ 729,559 17.1% $ 574,016 13.1% $ 511,160 12.0%
Money market deposit accounts 1,196,690 30.9 1,292,779 33.0 1,364,390 32.0 1,702,699 38.9 1,686,304 39.5
Statement savings accounts 941,289 24.3 690,328 17.6 595,181 14.0 390,710 8.9 459,405 10.8
Jumbo certificate accounts 56,218 1.5 42,423 1.1 128,288 3.0 206,496 4.7 197,210 4.6
Other certificate accounts 790,465 20.4 1,099,833 28.1 1,400,853 32.9 1,461,632 33.4 1,371,244 32.1
Other deposit accounts 50,277 1.3 47,381 1.2 44,759 1.0 43,034 1.0 42,862 1.0
------------------ ----------------- ----------------- ---------------- -----------------
Total deposits 3,870,023 100.0% 3,915,958 100.0% 4,263,030 100.0% 4,378,587 100.0% 4,268,185 100.0%
====== ====== ====== ====== ======
Deferred premium on
certificate accounts -- -- 3 7 20
---------- ---------- ---------- ---------- ----------
Total $3,870,023 $3,915,958 $4,263,033 $4,378,594 $4,268,205
========== ========== ========== ========== ==========
- -------------------------------------------------------------------------------------------------------------------------------
Average Cost of Deposits
- -------------------------------------------------------------------------------------------------------------------------------
Year Ended September 30,
--------------------------------------------------
1993 1992 1991
- ---------------------------------------------------------------------------------------------------------------------------
Demand and NOW accounts 2.47% 3.15% 5.16%
Money market accounts 3.17% 4.16% 6.19%
Statement savings and
other deposit accounts 3.25% 4.03% 5.64%
Certificate accounts 4.33% 5.63% 7.22%
Total deposit accounts 3.35% 4.45% 6.36%
====== ====== ======
- 54 -
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 become increasingly responsive to changes in
interest rates and the Bank has become relatively more conservative in its
pricing, the Bank has experienced a net outflow of deposit balances. 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 Bank does not solicit brokered deposits.
The following table sets forth Chevy Chase's deposit flows during the
periods indicated.
Deposit Flows
Year Ended September 30,
-------------------------------------------
1993 1992 1991
----------- ----------- -----------
(In thousands)
Deposits ............... $10,801,085 $11,173,419 $13,544,669
Withdrawals from
accounts ............. (10,985,541) (11,721,253) (13,959,696)
----------- ----------- -----------
Net cash from
accounts ............. (184,456) (547,834) (415,027)
Interest credited to
accounts ............. 138,521 200,759 299,466
----------- ----------- -----------
Net decrease in deposit
balances ............. $ (45,935) $ (347,075) $ (115,561)
============ ============ ============
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, 1993 maturing during
the fiscal years indicated.
- 55 -
WEIGHTED AVERAGE INTEREST RATES OF DEPOSITS
AS OF SEPTEMBER 30, 1993
Demand,NOW
and Money Market Statement Passbook and Other Certificate
Deposit Accounts Savings Account Core Accounts Accounts Total
-------------------- -------------------- -------------------- -------------------- -------------------
Maturing During Weighted Weighted Weighted Weighted Weighted
Period Ending Average Average Average Average Average
September 30, Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
- --------------- ----------- -------- ----------- -------- ----------- -------- ----------- -------- ---------- --------
(Dollars in thousands)
1994 $2,031,774 3.02 % $ 941,289 3.48 % $ 50,277 2.99 % $ 639,808 4.20 % $3,663,148 3.34 %
1995 -- -- -- -- -- -- 121,497 4.23 121,497 4.23
1996 -- -- -- -- -- -- 27,794 5.12 27,794 5.12
1997 -- -- -- -- -- -- 21,757 5.74 21,757 5.74
1998 -- -- -- -- -- -- 35,827 5.44 35,827 5.44
---------- ---------- --------- ---------- ----------
Total $2,031,774 3.02 % $ 941,289 3.48 % $ 50,277 2.99 % $ 846,683 4.33 % $3,870,023 3.42 %
========== ========== ========= ========== ==========
- 56 -
The following table summarizes maturities of certificate accounts in
amounts of $100,000 or greater as of September 30, 1993.
Year Ending September 30, Amount Weighted Average Rate
- ------------------------- ------ ---------------------
(Dollars in thousands)
1994....................... $ 44,445 3.97%
1995....................... 4,988 4.36
1996....................... 1,414 5.33
1997....................... 1,356 5.96
1998....................... 3,674 5.41
--------
Total ................... $ 55,877 4.18%
======== =====
The following table represents the amounts of deposits by various
interest rate categories as of September 30, 1993 maturing during the
fiscal years indicated.
- 57 -
MATURITIES OF DEPOSITS BY INTEREST RATES
AS OF SEPTEMBER 30, 1993
(In thousands)
Accounts Maturing During Year Ending September 30,
--------------------------------------------------------------------------------
Interest Rates 1994 1995 1996 1997 1998 Total
- -------------------- ------------ ----------- ------------ ------------ ------------ -----------
Demand deposits (0%) $ 72,518 $ 0 $ 0 $ 0 $ 0 $ 72,518
0.00% to 1.99% 862 0 0 0 0 862
2.00% to 2.99% 166,348 0 0 0 0 166,348
3.00% to 3.99% 3,151,626 63,577 1 0 41 3,215,245
4.00% to 4.99% 83,199 38,184 15,438 179 0 137,000
5.00% to 5.99% 126,346 17,004 2,212 10,686 35,737 191,985
6.00% to 7.99% 52,260 2,165 10,136 10,892 4 75,457
8.00% to 9.99% 9,989 567 7 0 45 10,608
----------- ---------- ----------- ----------- ----------- -----------
Total $ 3,663,148 $ 121,497 $ 27,794 $ 21,757 $ 35,827 $ 3,870,023
=========== =========== =========== =========== =========== ===========
- 58 -
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 such
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. Advances are made pursuant to several different credit programs, and
the granting of advances is subject to the discretion of the FHLB of
Atlanta.
Each credit program has its own interest rate and range of
maturities. The FHLB of Atlanta prescribes the acceptable uses for the
funds advanced pursuant to each program, as well as limitations on the
amount of advances. Limitations on the amount of advances generally are
based on the FHLB's assessment of the institution's creditworthiness. The
Bank had outstanding FHLB advances of $412.0 million at September 30, 1993.
From time to time, the Bank enters into repurchase agreements, which
are treated as financings. The Bank sells securities (usually U.S.
Government or mortgage-backed securities) to a dealer and agrees to buy
back the same securities at a specified time (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 $83.2 million of repurchase
agreements outstanding at September 30, 1993.
- 59 -
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,
--------------------------
1993 1992
----------- ---------
Securities sold under repurchase agreements: (Dollars in thousands)
Balance at year-end . . . . . . . . . . $ 83,151 $ 446,367
Average amount outstanding during
the year . . . . . . . . . . . . . . 265,176 123,480
Maximum amount outstanding at any month-
end . . . . . . . . . . . . . . . . . 478,534 485,067
Weighted average interest rate during
year (1). . . . . . . . . . . . . . . 3.28% 3.64%
Weighted average interest rate on year-end
balances . . . . . . . . . . . . . . 3.23% 3.36%
_____________________
<FN>
(1) The weighted average interest rate during the year is computed daily
using a daily rate and balance.
In November 1988, the Bank issued $50 million principal amount of 15%
Subordinated Capital Debentures due November 15, 2003 (the "1988
Debentures"). Interest on the issue is payable semi-annually on May 15 and
November 15 in each year. As of November 15, 1993, the 1988 Debentures are
redeemable, in whole or in part, at the option of the Bank. The Bank may
not redeem any portion of the 1988 Debentures unless its outstanding 13 1/2%
Subordinated Capital Debentures due July 15, 2002 have been paid in
full.
In July 1987, the Bank issued $80.5 million principal amount of 13 1/2%
Subordinated Capital Debentures due July 15, 2002 (the "1987
Debentures"). Interest on the issue is payable semi-annually on January 15
and July 15 in each year. As of July 15, 1992, the 1987 Debentures are
redeemable, in whole or in part, at the option of the Bank. Mandatory
annual sinking fund payments on July 15, 2000 and July 15, 2001, each in
the amount of 25% of the original principal amount of the 1987 Debentures,
will retire 50% of the issue prior to maturity at a redemption price equal
to 100% of the principal amount redeemed, plus accrued interest.
On November 23, 1993, the Bank sold $150 million 9 1/4% Subordinated
Debentures due 2005 (the "1993 Debentures") and received net proceeds of
$143.6 million from the sale. On that date, the Bank also issued a notice
that it would redeem the Bank's outstanding 1987 Debentures on December 23,
1993 and a notice that it would redeem the Bank's outstanding 1988
Debentures on December 24, 1993. The Bank will use approximately $134.2
million of the proceeds from the sale of the 1993 Debentures to redeem the
1987 Debentures and the 1988 Debentures. The Bank expects to incur a loss
of approximately $6.5 million, after related income taxes, in connection
with the redemption of the 1987 Debentures
- 60 -
and the 1988 Debentures. The OTS has approved the inclusion of the
principal amount of the 1993 Debentures in the Bank's supplementary capital
for regulatory capital purposes.
In December 1986, the Bank issued an unsecured ten-year subordinated
capital note in the original principal amount of $10.0 million to BACOB
Savings Bank, s.c., a foreign private savings bank. Unless the note is
earlier redeemed, the note principal is payable in one payment on December
31, 1996. Interest is payable in arrears on May 15 and November 15 of each
year at a variable rate of 3% over the six-month London Interbank Offered
Rate ("LIBOR"). The note may be redeemed at the Bank's option, at par,
without premium or penalty, together with accrued interest.
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.
Such regulations also permit the Bank to make "conforming loans" to such
subsidiaries and joint ventures in an amount not to exceed 50% of the
Bank's regulatory capital. At September 30, 1993, 2.0% and 3.0% of the
Bank's assets was equal to $97.6 million and $146.3 million, respectively,
and the Bank had $55.2 million invested in its subsidiaries, $36.3 million
of which was in the form of conforming loans. The Bank may establish
operating subsidiaries to engage in any activities that the Bank may engage
in directly.
Chevy Chase engages in significant activities through B. F. Saul
Mortgage Company. See "Lending Activities." The Bank engages in other
activities through its subsidiaries, including those described below.
REAL ESTATE DEVELOPMENT ACTIVITIES. Manor Investment Company
("Manor") is in the business of real estate development. In the past, its
real estate development activities consisted of the construction of
income-producing properties, the purchase, and in some cases, improvement
of land for resale without project construction and participation in joint
ventures with other developers. 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 activities.
SECURITIES BROKERAGE SERVICES. Chevy Chase Securities, Inc., a
licensed broker-dealer, is in the business of selling securities on a
retail basis to the general public, including customers and depositors of
the Bank.
INSURANCE SERVICES. Chevy Chase Insurance Agency, Inc. is a licensed
insurance broker offering a variety of "personal line"
- 61 -
insurance programs in the property and casualty field (primarily homeowner
and automobile insurance) and in the life insurance field (primarily
mortgage and credit card life and disability programs).
SPECIAL PURPOSE SUBSIDIARIES. At September 30, 1993, Chevy Chase
owned 27 active subsidiaries that 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 active
subsidiaries was $346.5 million at September 30, 1993. The Bank's
investments in these subsidiaries are not subject to the 3.0% service
corporation investment limit discussed above. See "Regulation - Regulatory
Capital." FIRREA generally requires the Bank 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.
EMPLOYEES
The Bank and its subsidiaries had 2,009 full-time and 416 part-time
employees at September 30, 1993. The Bank provides its employees with a
comprehensive range of employee benefit programs, including group health
benefits, life insurance, disability insurance, paid sick leave and an
employee loan program. The Bank offers home mortgage and credit card loans
to employees at prevailing market rates, but waives up to one point of any
loan origination fees on home mortgage and the annual fee on credit card
loans, and provides a yearly rebate equal to 0.5% of the outstanding loan
balance of home mortgage loans at calendar year-end. The Bank also offers
employees a one percent discount on the interest rate on overdraft lines of
credit. 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 real estate and other loans in its markets. The Bank's most
direct competition for deposits has come from other thrift institutions,
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 historically has come from local
depository institutions, but deregulation of the financial services
industry and changing market demands in recent years have eroded
distinctions between providers of financial services. In addition, both
depository and non-depository institutions have greater nationwide
- 62 -
access to attractive markets, such as the Washington, D.C. area, than they
have had in past years. Chevy Chase now competes with regional financial
institutions and national providers of investment alternatives, as well as
a number of large money center and regional banks that have acquired
subsidiary institutions in the area.
The Bank estimates that it competes principally with approximately 15
depository institutions in its deposit-taking activities, with
approximately seven institutions in the origination of single-family
residential mortgage loans (other than home equity credit line loans) and
with approximately ten depository institutions in the origination of home
equity credit line loans. At June 30, 1992, according to published industry
statistics, Chevy Chase, together with a commercial bank, had the largest
market share (approximately 19.0%) of deposits in Montgomery County,
Maryland, and Chevy Chase ranked third in market share of deposits in
Prince George's County, Maryland. Based on publicly available information,
Chevy Chase estimates that, in the Washington, D.C. metropolitan area, it
maintains a significant market share of single-family residential mortgage
loans and the leading market share of home equity credit line loans.
Interstate banking laws enacted by state legislatures have
intensified the competition faced by the Bank in attracting deposits and
making loans. A number of large out-of-state financial institutions have
established or acquired banking operations in Maryland, Virginia and the
District of Columbia pursuant to these provisions.
- 63 -
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 "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial
Statements included elsewhere in this report.
- 64 -
SELECTED FINANCIAL DATA
Year Ended September 30,
------------------------------------------------------------
(In thousands, except per share amounts) 1993 1992* 1991* 1990* 1989*
- ---------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
REAL ESTATE
Total income $93,245 $100,179 $102,013 $104,299 $99,076
Real estate operating loss (44,495) (28,511) (20,035) (39,262) (35,925)
- ---------------------------------------------------------------------------------------------------------------------------
BANKING
Interest income $348,814 $403,033 $487,572 $503,507 $500,998
Interest expense 167,518 214,761 325,711 361,418 361,636
Net interest income 181,296 188,272 161,861 142,089 139,362
Provision for loan losses (62,513) (89,062) (147,141) (78,300) (70,331)
Net interest income after provision for loan losses 118,783 99,210 14,720 63,789 69,031
Other income:
Credit card, loan servicing and deposit service fees 91,063 92,291 105,441 134,166 102,775
Earnings (loss) on real estate held for investment (12,722) (50,649) (47,495) (53,290) 9,490
Gain (loss) on sales of assets 40,270 44,259 81,927 99,028 42,520
Gain on sale of mortgage servicing rights 4,828 3,750 9,137 0 0
Other 7,314 10,766 12,133 9,725 8,025
Total other income 130,753 100,417 161,143 189,629 162,810
Operating expenses 185,687 156,218 181,975 200,367 181,736
Banking operating income (loss) 63,849 43,409 (6,112) 53,051 50,105
- --------------------------------------------------------------------------------------------------------------------------
TOTAL COMPANY
Operating income (loss) $19,354 $14,898 ($26,147) $13,789 $14,180
Income (loss) before minority interest 15,389 11,198 (29,372) 91 1,448
Total company net income (loss) 4,473 5,937 (27,259) (5,922) (6,036)
Net income (loss) per common share (0.20) 0.11 (6.77) (1.51) (1.25)
- ---------------------------------------------------------------------------------------------------------------------------
CASH DIVIDENDS DECLARED PER COMMON SHARE $0 $0 $0 $0.15 $0.20
- ---------------------------------------------------------------------------------------------------------------------------
CASH FLOW ITEMS
Net cash flows provided by (used in) operating activities
Real estate ($3,149) ($884) ($16,374) ($17,381) ($19,956)
Banking 1,157,157 1,043,648 1,521,024 (296,840) 59,196
Total company 1,154,008 1,042,764 1,504,650 (314,221) 39,240
Net cash flows provided by (used in) investing activities
Real estate (2,999) (1,333) 25,731 (11,409) (14,443)
Banking (898,649) (1,241,043) (1,183,033) (16,611) (697,227)
Total Company (901,648) (1,242,376) (1,157,302) (28,020) (711,670)
Net cash flows provided by (used in) financing activities
Real estate 3,230 169 (41,709) 12,016 32,206
Banking (190,850) 157,183 (348,624) 413,957 554,758
Total Company (187,620) 157,352 (390,333) 425,973 586,964
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET ITEMS
REAL ESTATE
ASSETS:
Total assets $220,556 $334,378 $346,088 $370,564 $366,688
Income-producing properties
Commercial 109,513 231,315 232,390 239,277 227,304
Hotels 111,484 111,662 113,217 111,672 105,633
Other 3,985 7,189 6,779 6,779 6,750
Accumulated depreciation (62,626) (95,466) (90,564) (86,655) (74,836)
Total income-producing properties 162,356 254,700 261,822 271,073 264,851
Land parcels 38,411 50,981 56,353 58,900 54,877
LIABILITIES:
Total liabilities 450,153 522,760 505,793 538,577 509,458
Mortgage notes payable 264,776 429,968 350,693 369,134 347,919
Notes payable - unsecured 38,661 50,417 86,532 108,512 113,513
Bank borrowings 0 0 38,273 36,645 25,594
- --------------------------------------------------------------------------------------------------------------------------
BANKING
ASSETS:
Total assets $4,872,771 $4,998,756 $4,821,407 $5,219,018 $4,753,667
Mortgage-backed securities 1,501,192 1,599,653 439,767 702,110 768,911
Loans receivable, net 1,861,753 1,636,359 2,537,204 2,504,619 2,790,390
Real estate held for investment 388,459 521,927 564,137 421,211 286,358
Purchased mortgage servicing rights, net 20,472 13,007 14,222 22,874 26,392
LIABILITIES:
Total liabilities 4,634,001 4,885,189 4,747,715 5,106,446 4,659,915
Deposit accounts 3,870,023 3,915,958 4,263,033 4,378,594 4,268,205
Bonds payable 24,605 25,130 25,605 26,050 26,455
Securities sold under repurchase agreements and
other short-term borrowings 88,266 450,321 3,459 403,947 78,559
Federal Home Loan Bank advances 412,000 275,000 200,000 0 20,000
Capital notes -- subordinated 138,500 138,500 138,500 138,500 138,500
- --------------------------------------------------------------------------------------------------------------------------
TOTAL COMPANY
Total assets $5,093,327 $5,333,134 $5,167,495 $5,589,582 $5,120,355
Total liabilities before minority interest 5,084,154 5,407,949 5,253,508 5,645,023 5,169,373
Minority interest held by affiliates 34,495 27,912 22,651 24,764 18,750
Minority interest - other 74,307 0 0 0 0
Shareholders' equity (deficit) (99,629) (102,727) (108,664) (80,205) (67,768)
Shareholders' equity (deficit) per common share (20.64) (21.28) (22.51) (16.62) (14.04)
- ---------------------------------------------------------------------------------------------------------------------------
<FN>
* Some amounts have been reclassified for comparative purposes.
- 65 -
The following table sets forth certain additional financial data with
respect to the Bank.
At or for Year Ended
September 30,
-------------------------------------------------
1993 1992 1991 1990 1989
SELECTED RATIOS: ------ ------ ------ ------ ------
Return on average assets. . . . 0.77% 0.55% (0.20)% 0.61% 0.79%
Return on average stockholders'
equity. . . . . . . . . 19.31% 19.33% (7.57)% 25.26% 73.91%
Average stockholders' equity
to average assets . . . 3.98% 2.84% 2.69% 2.41% 1.07%
Net yield on interest-earning
assets. . . . . . . . . 4.59% 4.98% 3.81% 3.30% 3.31%
Net loan charge-offs to average
loans . . . . . . . . . 3.43% 4.15% 3.72% 1.86% 1.60%
Non-performing assets to total
assets. . . . . . . . . 7.63% 10.36% 12.32% 8.75% 1.28%
Average interest-earning
assets to average interest-
bearing liabilities . . 86.44% 82.76% 85.64% 91.35% 92.16%
REGULATORY CAPITAL RATIOS:
Tangible . . . . . . . . 4.60% 2.22% 1.58% 1.81% N/A
Core (or leverage). . . . 5.35% 3.22% 2.82% 3.03% N/A
Tier 1 risk-based . . . . . 7.29% N/A N/A N/A N/A
Total risk-based. . . . . 11.70% 7.72% 5.51% 6.52% N/A
- 66-
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
fully consolidated basis. The term "Trust" used in the text and the financial
statements included herein refers to the combined entity, which includes the
parent company and its wholly-owned subsidiaries, as well as Chevy Chase, Chevy
Chase's subsidiaries and the parent company's other majority-owned subsidiaries.
"Real Estate Trust" refers to the parent company and its wholly-owned and
majority-owned subsidiaries, excluding Chevy Chase and Chevy Chase's
subsidiaries. The business conducted by the Bank and its subsidiaries is
identified by the term "Banking," while the operations conducted by the Real
Estate Trust are designated as "Real Estate."
The financial data on Banking reflect certain purchase accounting
adjustments made by the Trust in connection with its acquisition of the Bank and
therefore differ in certain respects from the comparable financial data set
forth in the unconsolidated financial statements of the Bank.
FINANCIAL CONDITION
REAL ESTATE
The Real Estate Trust's investment portfolio at September 30, 1993
consisted of office and industrial projects, hotels and land parcels. See
"Business - Real Estate - Real Estate Investments." In August 1993, the Real
Estate Trust transferred its 22 shopping center properties and one of its office
properties, together with the debt associated with such properties, to Saul
Holdings Partnership and a subsidiary limited partnership of Saul Holdings
Partnership in exchange for securities representing a 21.5% limited partnership
interest in Saul Holdings Partnership. See "Business - Real Estate - Investment
in Saul Holdings Limited Partnership."
Office space in the Real Estate Trust's office property portfolio was 77%
leased at September 30, 1993, compared to a lease rate of 81% at September 30,
1992. At September 30, 1993, the Real Estate Trust's office property portfolio
had a total gross leasable area of approximately 1.36 million square feet. Of
the office space that was leased at September 30, 1993, 179,000 square feet
(13%) is subject to leases whose terms expire in fiscal 1994. Due to a decline
in market lease rates for office space over the past several years, the terms of
certain of the new leases are expected to be less favorable to the Real Estate
Trust than the terms of the expiring leases.
For the fiscal year ended September 30, 1993, the nine hotel properties
owned by the Real Estate Trust achieved a 63% occupancy rate, compared to an
average rate of 68% in fiscal 1992. Five of the hotels experienced an increase
in occupancy rates during fiscal 1993, while three hotels registered lower
occupancy rates. The ninth property reported a significant decline in occupancy
as a result of adverse local business conditions.
- 67 -
BANKING
GENERAL. In April 1993, the Bank sold for $75.0 million 3,000,000 shares
of its Preferred Stock. The $71.9 million of net proceeds from the sale are
fully includable as tier 1 or core capital for purposes of determining the
Bank's regulatory capital ratios under the FIRREA and OTS prompt corrective
action regulations. See Note 24 to the Consolidated Financial Statements in
this report.
At September 30, 1993, the Bank remained in compliance with all of its
regulatory capital requirements under FIRREA. The Bank's tangible, core (or
leverage) and risk-based regulatory capital ratios were 4.60%, 5.35% and 11.70%,
respectively, compared to the requirements of 1.5%, 3.0% and 8.0%, respectively.
Additionally, at September 30, 1993, the Bank's leverage, tier 1 risk-based and
total risk-based capital ratios of 5.35%, 7.29% and 11.70%, respectively,
exceeded the corresponding ratios of 5.0%, 6.0% and 10.0% established under the
prompt corrective action regulations for "well capitalized" institutions. On the
basis of its balance sheet at September 30, 1993, the Bank met the
FIRREA-mandated fully phased-in capital requirements.
On July 26, 1993, the OTS released the Bank from its capital plan and
capital directive following the Bank's return to full regulatory capital
compliance as a result of its operating performance and the sale of the
Preferred Stock. The Bank is subject to various restrictions and requirements
contained in a written agreement with the OTS as modified on October 29, 1993.
See "Business - Banking - Regulation."
In September 1993, the OTS notified the Bank that, subject to certain
conditions, the OTS would waive growth restrictions otherwise applicable to the
Bank for the period from July 1, 1993 through June 30, 1994 to allow for an
increase in total assets of up to $500 million. See "Business - Banking -
Regulation - Growth Restrictions."
On November 23, 1993, the Bank sold $150.0 million 9 1/4% Subordinated
Debentures due 2005. Also on that date, the Bank issued a notice that it would
redeem the Bank's outstanding 1987 Debentures on December 23, 1993 and a notice
that it would redeem the Bank's outstanding 1988 Debentures on December 24,
1993. The Bank received net proceeds of $143.6 million from the sale of the
1993 Debentures, of which approximately $134.2 million will be used to redeem
the 1987 Debentures and the 1988 Debentures. The remaining net proceeds will be
used for general corporate purposes. The Bank expects to incur a loss of
approximately $6.5 million, after related income taxes, in connection with the
redemption of the 1987 Debentures and the 1988 Debentures. The OTS has approved
the inclusion of the principal amount of the 1993 Debentures in the Bank's
supplementary capital for regulatory capital purposes.
The Bank's assets are subject to review and classification by the OTS and
the FDIC upon examination. The OTS and the FDIC concluded concurrent
examinations of the Bank in October 1993. The Bank's results of operations for
the fiscal year ended September 30, 1993 reflect certain adjustments made by the
Bank in the fourth quarter as a result of such examinations. See
- 68 -
"Results of Operations - Fiscal Year 1993 Compared to Fiscal Year 1992 -
Banking."
ASSET QUALITY. The Bank's asset quality has improved in recent periods as
a result of a number of significant actions taken by management to resolve
problem real estate assets and enhance risk management efforts. The Bank has
committed substantial resources to problem asset resolution and has reorganized
its staff in order to facilitate the resolution and workout of problem real
estate assets.
NON-PERFORMING ASSETS. 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, all valuation allowances.
- 69 -
NON-PERFORMING ASSETS
(Dollars in thousands)
September 30,
----------------------------------------------------------------------
1993 1992 1991 1990 1989
------------ ------------ ------------ ------------ ------------
Non-performing assets:
Non-accrual loans:
Residential $ 9,108 $ 12,865 $ 17,913 $ 8,119 $ 5,945
Commercial and multifamily -- 3,694 -- -- --
Residential construction and ground -- 1,196 30,469 45,622 --
Commercial construction and ground -- 3,413 15,629 31,661 16,663
------------ ------------ ------------ ------------ ------------
Total non-accrual real estate loans 9,108 21,168 64,011 85,402 22,608
Credit card 20,557 26,780 33,682 23,798 21,761
Consumer and other 314 3,572 3,331 1,207 145
------------ ------------ ------------ ------------ ------------
Total non-accrual loans (1) 29,979 51,520 101,024 110,407 44,514
------------ ------------ ------------ ------------ ------------
Non-accrual real estate held for investment (1) 8,898 8,892 8,892 17,236 --
------------ ------------ ------------ ------------ -----------
Real estate acquired in settlement of loans 434,616 541,352 537,490 339,034 16,367
Reserve for losses on real estate
acquired in settlement of loans (101,462) (94,125) (53,337) (10,078) --
------------ ------------ ------------ ------------ -----------
Real estate acquired in settlement
of loans, net 333,154 447,227 484,153 328,956 16,367
------------ ------------ ------------ ------------ ------------
Total non-performing assets $ 372,031 $ 507,639 $ 594,069 $ 456,599 $ 60,881
============ ============ ============ ============ ============
Reserve for losses on loans $ 68,040 $ 78,818 $ 89,745 $ 58,339 $ 41,934
Reserve for losses on real estate
held for investment (2) 10,182 14,919 4,161 2,800 --
Reserve for losses on real estate
acquired in settlement of loans (2) 101,462 94,125 53,337 10,078 --
------------ ------------ ------------ ------------ ------------
Total reserves for losses $ 179,684 $ 187,862 $ 147,243 $ 71,217 $ 41,934
============ ============ ============ ============ ============
<FN>
-------------------------------------------------------------------------------------------------------------------------
(1) Before deduction of reserves for losses.
(2) The Bank initially established its reserve for losses on real estate held for investment or sale in fiscal year 1990.
- 70 -
NON-PERFORMING ASSETS (CONTINUED)
(Dollars in thousands)
September 30,
--------------------------------------------------------------
1993 1992 1991 1990 1989
---------- ---------- ---------- ---------- ----------
Ratios:
Non-performing assets to total assets (4) 7.63% 10.36% 12.32% 8.75% 1.28%
Reserve for losses on real estate loans to non-accrual
real estate loans (1) 219.29% 53.16% 23.72% 22.38% 6.62%
Reserve for losses on credit card loans to non-accrual
credit card loans (1) 228.08% 214.96% 209.73% 151.03% 185.63%
Reserve for losses on consumer and other loans to
non-accrual consumer and other loans (1) 376.11% 131.10% 117.68% 272.08% 28.97%
Reserve for losses on loans to non-accrual loans (1) 226.96% 128.12% 88.84% 52.84% 94.20%
Reserve for losses on real estate held for investment
to non-accrual real estate held for investment (1)(2) 114.43% 167.78% 46.79% 16.25% --
Reserve for losses on real estate held for investment or sale
to non-performing real estate held for investment or sale (1)(2) 25.17% 19.82% 10.52% 3.61% --
Reserve for losses on loans to total loans receivable (3) 2.83% 3.52% 2.79% 1.83% 1.27%
Reserve for losses on real estate held for investment to
real estate held for investment (1)(2) 15.55% 16.65% 4.95% 2.95% --
<FN>
- -----------------------------------------------------------------------------------------------------------------------------------
(1) Before deduction of reserves for losses.
(2) The Bank initially established its reserve for losses on real estate held for investment or sale in fiscal year 1990.
(3) Includes loans receivable and loans held for sale and/or securitization, before deduction of reserve for losses.
(4) Non-performing assets is presented after valuation allowances on real estate acquired in settlement of loans but before
reserves for losses on non-accrual loans and non-accrual real estate held for investment.
- 71 -
Non-performing assets include non-accrual loans (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-accrual real estate held for
investment ("non-accrual REI"), and real estate acquired in settlement of loans,
either through foreclosure or deed-in-lieu of foreclosure, or pursuant to
in-substance foreclosure.
Non-performing assets totaled $372.0 million, after valuation allowances
on REO of $101.5 million, or 7.6% of total assets at September 30, 1993,
compared to $517.6 million, after valuation allowances on REO of $94.1 million,
or 10.4% of total assets at September 30, 1992. In addition to the valuation
allowances on REO, the Bank maintained $5.5 million and $13.4 million of
valuation allowances on its non-accrual loans and non-accrual real estate held
for investment at September 30, 1993 and September 30, 1992, respectively. The
decrease in non-performing assets was attributable to declines in non-accrual
loans and REO of $31.5 million and $114.1 million, respectively, during the year
ended September 30, 1993.
The Bank's non-performing real estate assets, which include non-accrual
real estate loans, non-accrual real estate held for investment and REO, totaled
$351.2 million at September 30, 1993 or 94.4% of total non-performing assets at
that date. As shown in the following table, the Bank's non-performing real
estate assets, after valuation allowances on such assets, have declined from
their peak of $567.6 million in February 1992 to $348.7 million at September 30,
1993, reflecting both additional write-downs on non-performing assets during
that period and, in more recent periods, asset sales.
DECLINE IN NON-PERFORMING REAL ESTATE ASSETS
Total
Valuation Cumulative
Total Allowances on Total Decline from
Non-Performing Non-Accrual Real Non-Performing February 29, 1992
Real Estate Estate Loans and Real Estate -----------------
Assets (1) Non-Accrual REI(2) Assets, net Amount Percent
-------------- ------------------ -------------- ------ -------
(Dollars in thousands)
December 31, 1991 .. $559,665 $ 6,692 $552,973 - -
February 29, 1992 .. 574,321 6,712 567,609 - -
March 31, 1992 ..... 551,960 5,490 546,470 ($21,139) -3.7%
June 30, 1992 ...... 512,729 10,224 502,505 (65,104) -11.5%
September 30, 1992 . 487,287 7,147 480,140 (87,469) -15.4%
December 31, 1992 .. 427,113 2,332 424,781 (142,828) -25.2%
March 31, 1993 ..... 394,672 2,635 392,037 (175,572) -30.9%
June 30, 1993 ...... 382,657 2,634 380,023 (187,586) -33.1%
September 30, 1993 . 351,160 2,427 348,733 (218,876) -38.6%
- 72 -
- -------------------------
(1) Represents total non-accrual real estate loans and non-accrual REI before
deduction of valuation allowances and REO, after valuation allowances.
(2) Represents valuation allowances on non-accrual real estate loans and
non-accrual REI. At September 30, 1993, valuation allowances on non-accrual real
estate loans and non-accrual REI were $0.4 million and $2.0 million,
respectively.
A larger portion of the affected properties financed by the Bank involves
residential rather than commercial properties. In general, the residential real
estate market has been less significantly affected by the downturn in recent
years than the commercial real estate market. At September 30, 1993, $297.9
million or 84.8% of the Bank's total non-performing real estate assets related
to residential real estate properties.
NON-ACCRUAL LOANS. The Bank's non-accrual loans totaled $30.0 million at
September 30, 1993, a decrease of $31.5 million from $61.5 million at September
30, 1992. At September 30, 1993, non-accrual loans consisted primarily of $9.1
million of non-accrual real estate loans and $20.6 million of non-accrual credit
card loans. Non-accrual loans decreased primarily because of the
reclassification from non-accrual to REO of four loans with aggregate principal
balances of $15.9 million, charge-offs of $3.2 million on three commercial
loans, the reclassification of a residential construction loan with a principal
balance of $1.9 million from a non-accrual loan to a non-classified asset
because the loan became current during the period, net principal repayments and
reductions of non-accrual residential loans of $4.3 million, and net principal
repayments and reductions of non-accrual credit card loans of $6.2 million. The
reduction in non-accrual credit card loans reflects improved economic conditions
and continued maturation of the Bank's credit card portfolio.
At September 30, 1993, the Bank had $20.6 million of credit card loans
which were classified for regulatory purposes as substandard and disclosed as
non-performing assets because they were 90 days or more past due. At that date,
the Bank also had $6.5 million of credit card loans classified for regulatory
purposes as substandard and $119.5 million of credit card loans classified for
regulatory purposes as special mention which were not disclosed as either
non-performing assets (i.e., credit card loans which are 90 days or more past
due) or potential problem assets. The amount classified as substandard but not
disclosed as non-performing assets ($6.5 million) primarily related to accounts
for which the customers have agreed to modified payment terms, but which were
60-89 days past due. Of the $6.5 million, $0.5 million was current, $0.2 million
was 30-59 days past due and $5.8 million was 60-89 days past due at September
30, 1993. The amount classified as special mention ($119.5 million) primarily
related to accounts which have had purchasing privileges suspended, including
accounts for which the
- 73 -
customers have agreed to modified payment terms and which were less than 60 days
past due. Of the $119.5 million reported as special mention, $93.3 million was
current, $16.8 million was 30-59 days past due and $9.4 million was 60-89 days
past due at September 30, 1993. All delinquent amounts are included in the table
of delinquent loans. See "Delinquent Loans."
The Bank would have recorded interest income of $10.4 million for the year
ended September 30, 1993 if non-accrual assets and restructured loans had been
current in accordance with their original terms. Interest income of $3.0 million
was actually recorded on non-accrual assets and restructured loans during the
fiscal year. The Bank's net interest income in future periods will continue to
be adversely affected by the Bank's non-performing assets.
NON-ACCRUAL REAL ESTATE HELD FOR INVESTMENT. At September 30, 1993 and
September 30, 1992, a participating loan to a developer with a balance of $8.9
million, before valuation allowances of $2.0 million, was non-performing.
REO. In the past, the Bank was an active lender on residential real estate
development projects and, to a lesser extent, commercial buildings and land. The
majority of the amount of loans originated were to developers for the
acquisition and development of residential planned unit developments. The
majority of the loans contained provisions that entitled the Bank to a portion
of the profits generated by the underlying properties. Beginning in mid-1990 and
extending through 1992, as a result of the slowdown in the Washington, D.C. area
economy, the Bank took active control, either through foreclosure or
deed-in-lieu of foreclosure, of most of the properties securing these loans. The
Bank decided that completing the infrastructure of the properties, implementing
an aggressive marketing program, and then selling building lots to home builders
represented the most effective method of recovering the Bank's investment in
these properties.
At September 30, 1993, the Bank's REO totaled $333.1 million, after
valuation allowances on such assets of $101.5 million. The principal component
of REO is five planned unit developments ("Communities") with an aggregate book
value of $240.9 million at that date. Four of the Communities are under active
development. During the year ended September 30, 1993, REO decreased $114.1
million primarily due to the sale of eleven properties with an aggregate book
value of $97.1 million after valuation allowances.
The Bank capitalizes costs relating to development and improvement of REO.
Interest costs are capitalized on real estate properties under development. See
"Disposition of REO." The Bank capitalized interest in the amount of $10.2
million in the year ended September 30, 1993, of which $9.6 million related to
the Bank's four active Communities.
- 74 -
DISPOSITION OF REO. During the year ended September 30, 1993, the Bank
received proceeds of approximately $187.5 million upon the disposition of REO
consisting of three office buildings ($50.9 million), 1,302 residential lots or
units in the Communities and other smaller residential properties ($89.4
million), one apartment building ($13.3 million), various single-family
residential properties ($11.4 million), three retail centers ($9.4 million), one
industrial building ($3.0 million), 34.25 acres of land in one of its
Communities ($8.9 million) and 32.44 acres of land in other smaller residential
properties ($1.2 million).
The Bank's objective with respect to its REO is to sell such properties as
expeditiously as possible and in an orderly manner which 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, including
continued improvement in general economic conditions in the Washington, D.C.
metropolitan area and increased availability of financing for the potential
purchasers of these properties. In addition, under its written agreement with
OTS, the Bank is required to make every effort to reduce its exposure in certain
of its real estate development properties, including the four active
Communities. In accordance with this requirement, management of the Bank is
pursuing several strategies. First, the Bank has focused its efforts on
marketing building lots directly to home builders. The Bank is proceeding with
lot finishing to meet the requirements of existing and new contracts with
builders and is accelerating the record plat process so that individual lots can
be sold at the earliest possible time. Second, the Bank continues to seek and
negotiate with potential purchasers of retail and commercial ground in the
Communities. Finally, the Bank continues to seek and engage in discussions with
potential investors concerning the possibility of larger scale or bulk purchases
of ground at the Communities.
The following table sets forth the Bank's REO at September 30, 1993.
- 75 -
Balance Balance
Before All After
Valuation Valuation Valuation
Allowances Allowances Allowances
---------- ---------- ----------
(In thousands)
Communities . . . . . . . . . $311,844 $ 70,945 $240,899
Residential ground and
construction. . . . . . . . 64,302 19,370 44,932
Retail centers. . . . . . . . 17,655 1,571 16,084
Commercial land . . . . . . . 21,051 4,927 16,124
Office buildings. . . . . . . 7,142 446 6,696
Industrial buildings. . . . . 9,519 4,048 5,471
Single-family residential
properties. . . . . . . . . 3,103 155 2,948
-------- -------- --------
Total REO. . . . . . . . . $434,616 $101,462 $333,154
======== ======== ========
Approximately $240.9 million (or 72.3%), after valuation allowances, of
the Bank's aggregate book value of REO at September 30, 1993 was attributable to
the five Communities. At September 30, 1993, the Bank's remaining 27.7% of REO
consisted of various types of properties, including residential ground and
construction (13.5%), retail centers (4.8%), commercial land (4.8%), office
buildings (2.0%), industrial buildings (1.7%) and single-family residential
properties (0.9%). These properties had an aggregate book value of $92.2
million, after valuation allowances, at September 30, 1993. At September 30,
1993, the Bank had executed contracts to sell five of these properties at their
aggregate book value of $7.2 million at that date.
The four active Communities consist primarily of 13,425 residential lots
or units and 172.5 acres of land designated for retail use. At September 30,
1993, 8,033 residential units (59.8%) had been sold to builders, consisting of
5,885 units (43.8%) which had been settled and 2,148 units (16.0%) which were
under contract and pending settlement, and approximately 85.5 acres (49.5%) of
retail land had been sold to developers, including 20.0 acres which were under
contract and pending settlement. In addition, at September 30, 1993, the Bank
was engaged in discussions with potential purchasers regarding the sale of
additional residential units and retail land.
The rate of home sales at the Bank's four active Communities has increased
in recent periods. Home sales at these Communities increased from 1,061 units
during the year ended September 30, 1992 to 1,535 units during the year ended
September 30, 1993, which represents a 44.7% increase. Management believes that
the positive trend in home sales activity indicates that the demand for the
Bank's lots will increase, because builders generally will not purchase a lot
from the Bank until the home is under contract with the home purchaser and
because inventories of lots previously purchased by builders are being depleted.
There
- 76 -
can be no assurance, however, that home sales will remain at these levels in
future periods.
The Bank in some cases has made financing available in an attempt to
facilitate sales of lots in the four Communities under active development. The
following table presents, at the periods indicated, the outstanding balances of
loans provided by the Bank (subsequent to its acquisition of title to the
properties) to facilitate sales of lots in such Communities.
September 30,
-------------------------------------------
1993 1992 1991
---------- ---------- ----------
(In thousands)
Residential construction loans . . . . . . . . . . $10,386 $ 3,138 $ 899
Single-family permanent loans (1). . . . . . . . . 79,104 93,856 43,772
------- ------- -------
Total. . . . . . . . . . . . . . . . . . . . . . $89,490 $96,994 $44,671
======= ======= =======
<FN>
- ---------------------
(1) Includes $8.8 million and $13.3 million of loans classified as held for
sale at September 30, 1993 and September 30, 1992, respectively, in the
Consolidated Financial Statements in this report.
The Bank anticipates that it will provide construction financing for
approximately 20% of the remaining unsold lot inventory in the Communities. The
Bank also anticipates that it will provide permanent financing for approximately
25% of the homes to be sold in the Communities. The Bank's policy is to sell all
such single-family permanent loans for which the date of initial application is
subsequent to September 30, 1991. At September 30, 1993, the Bank had originated
$108.2 million and sold $99.4 million of such loans. The remaining $8.8 million
of such loans are classified as held for sale and generally are expected to be
sold in the first quarter of fiscal 1994. The total pre-tax cost to the Bank of
granting more favorable terms to the borrowers was approximately $1.7 million,
or 1.5% of the $108.2 million principal amount of the loans made. The estimated
cost is generally recognized by the Bank as a cost of sale at the time that the
Bank sells building lots to developers.
In furtherance of its objective of facilitating sales, the Bank in the
past has elected to use its own funds to continue development of some of the
Communities to the extent proceeds generated by sales of lots or housing units
at the Communities have been insufficient to fund development costs, and may do
so again in the future. The following table presents net funds provided or used
by the Bank to continue development at the four active Communities for the years
indicated.
- 77 -
Year Ended September 30,
--------------------------------------
1993 1992 1991
------- ------- --------
(In thousands)
Sales proceeds . . . . . . . $66,291 $39,594 $ 6,318
Development costs. . . . . . 51,649 35,803 30,204
------- ------- --------
Net funds provided by
(used for) development . . $14,642 $ 3,791 $(23,886)
======= ======= ========
The Bank currently anticipates that sales proceeds will continue to exceed
development costs in future periods. In the event development costs exceed sales
proceeds in future periods, the Bank believes that adequate funds will be
available from its primary liquidity sources to fund such costs. See "Liquidity
- - Banking."
In addition to the four active Communities, REO includes a fifth
Community, consisting of approximately 2,900 acres in Loudoun County, Virginia,
which is in the pre-development stage. At September 30, 1993, this property had
a book value of $37.9 million, after valuation allowances. The Bank continues to
assess various strategies for the ultimate disposition of the property.
Under its written agreement with the OTS, the Bank may not increase its
investments in certain of its large REO properties beyond levels existing at
September 30, 1991 without OTS approval. The Bank has submitted to the OTS
budgets through September 30, 1993 for additional investments in these
properties, and the OTS has not objected to the implementation of those budgets.
The Bank's aggregate investment for those properties at September 30, 1993,
calculated in accordance with the Bank's discussions with the OTS, was $279.2
million, compared to $281.4 million at September 30, 1992. The aggregate
investment at September 30, 1993 of $279.2 million does not reflect valuation
allowances of $38.3 million.
The Bank will continue 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 in resolving these problem
assets as expeditiously as possible. While the Bank does not anticipate any
significant increases in non-performing and potential problem assets, additional
charge-offs or reserves could be required absent a continued recovery of the
local real estate markets.
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. The
majority of the Bank's potential problem assets involve borrowers or properties
experiencing cash flow problems
- 78 -
due primarily to the downturn in recent years of the real estate markets in
which the properties are located.
At September 30, 1993, potential problem assets totaled $73.6 million
before valuation allowances of $15.4 million, as compared to $109.0 million,
before valuation allowances of $10.1 million at September 30, 1992. The $35.4
million decrease in potential problem assets is primarily attributable to $31.4
million of loans in which the borrowers' financial condition have improved such
that management no longer has serious doubts as to the borrowers' ability to
comply with present repayment terms. In addition, the decrease was the result of
the transfer of one residential construction loan with a principal balance of
$0.7 million to REO and net paydowns of $8.3 million. The decrease was partially
offset by the addition to potential problem assets of four loans with an
aggregate principal balance of $5.0 million.
DELINQUENT LOANS. At September 30, 1993, delinquent loans totaled $49.1
million or 2.0% of gross loans compared to $77.9 million or 3.5% of gross loans
at September 30, 1992. The following table sets forth information regarding the
Bank's delinquent loans at September 30, 1993.
Principal Balance Total as a
--------------------------------- Percentage
Mortgage Non-Mortgage of Gross
Loans Loans Total Loans (1)
--------- ------------ ----- ----------
(Dollars in thousands)
Loans delinquent for:
30-59 days . . . . . $ 7,606 $25,498 $33,104 1.4%
60-89 days . . . . . 1,280 14,736 16,016 0.6%
------- ------- ------- ----
Total. . . . . . . $ 8,886 $40,234 $49,120 2.0%
======= ======= ======= ====
<FN>
- --------------------
(1) Includes loans held for sale and/or securitization, before deduction of
reserves.
Mortgage loans classified as delinquent 30-89 days consists entirely of
single-family permanent residential mortgage loans and home equity credit line
loans. Total delinquent mortgage loans decreased to $8.9 million at September
30, 1993 from $28.9 million at September 30, 1992. The $20.0 million decrease
was primarily attributable to the return to current status of loans previously
delinquent 30-59 days, including the restructuring of a residential ground loan
with a principal balance of $9.9 million, as well as an improvement in general
economic conditions.
Non-mortgage loans (principally credit card loans) delinquent 30-89 days
decreased to $40.2 million at September 30, 1993 from $49.0 million at September
30, 1992, primarily as a result of an improvement
- 79 -
in general economic conditions. Non-mortgage loans delinquent 30-89 days as a
percentage of total non-mortgage loans outstanding decreased to 4.5% at
September 30, 1993 from 5.3% at September 30, 1992, as a result of the decline
in the Bank's portfolio of non-mortgage loans delinquent during the period.
TROUBLED DEBT RESTRUCTURINGS. A troubled debt restructuring occurs when
the Bank agrees to modify significant terms of a loan in favor of the borrower,
when the borrower is experiencing financial difficulties. The following table
sets forth loans accounted for as troubled debt restructurings, before deduction
of valuation allowances, at the dates indicated.
September 30,
-------------------------------------------------
1993 1992 1991 1990 1989
------- ------- ------- ------ ------
(In thousands)
Troubled debt
restructurings. . . . . . $36,729 $31,688 $19,961 $5,675 $4,150
======= ======= ======= ====== ======
At September 30, 1993, loans accounted for as troubled debt restructurings
included three commercial permanent loans with principal balances totaling $17.2
million, two residential construction loans with principal balances totaling
$10.6 million and a residential ground loan with a principal balance of $8.9
million. Since becoming restructured, all such loans are paying principal and
interest in accordance with their present repayment terms. Loans accounted for
as troubled debt restructurings with principal balances totaling $35.8 million
were classified as potential problem assets at September 30, 1993; the remaining
$0.9 million represents the principal balance of one residential construction
loan which, other than an extension of its maturity date, was performing in
accordance with its original terms. At September 30, 1993, the Bank had
commitments to lend $4.6 million of additional funds on loans that have been
restructured.
REAL ESTATE HELD FOR INVESTMENT. At September 30, 1993, real estate held
for investment consisted of ten properties with an aggregate book value of $55.3
million, net of accumulated depreciation of $11.1 million and valuation
allowances of $10.2 million. This category includes one office building (which
was approximately 88% leased at such date) and two apartment buildings (which
were fully leased at such date and are financed with bonds issued by a local
housing finance agency). These properties are owned and operated by subsidiaries
of the Bank. Also included is a loan to a developer with a book value of $8.9
million at September 30, 1993, before valuation allowances of $2.0 million,
which has a profit participation feature. The loan, which is secured by
commercial land, is included in non-performing assets. In August 1993, the Bank
sold a retail center at the Bank's book value. The Bank has discussions from
time to time with potential investors concerning the possible sale of certain of
its real estate.
- 80 -
RESERVES FOR LOSSES. The following tables show loss experience by asset
type and the components of the reserve for losses on loans and the reserve 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.
- 81 -
ANALYSIS OF RESERVE BALANCES ON AND CHARGE-OFFS OF LOANS
(Dollars in thousands)
September 30,
--------------------------------------------------------------------
1993 1992 1991 1990 1989
----------- ----------- ----------- ----------- -----------
Balance at beginning of year $ 78,818 $ 89,745 $ 58,339 $ 41,934 $ 26,189
----------- ----------- ----------- ----------- ----------
Provision for loan losses 62,513 89,062 147,141 78,300 70,331
----------- ----------- ----------- ----------- -----------
Charge-offs:
Residential 45 581 78 -- --
Commercial and multifamily 766 1,855 1,500 1,622 --
Ground 4,274 1,650 16,899 2,375 --
Residential construction -- 1,971 3,564 517 --
Commercial construction -- 1,431 13,421 1,944 --
Credit card 78,445 103,158 89,294 64,493 59,586
Consumer and other 3,664 1,898 1,695 560 284
----------- ----------- ----------- ----------- -----------
Total charge-offs 87,194 112,544 126,451 71,511 59,870
----------- ----------- ----------- ----------- -----------
Recoveries:
Ground -- -- -- 120 20
Credit card 13,601 12,196 10,618 8,732 4,939
Other 302 359 98 764 325
----------- ----------- ----------- ----------- -----------
Total recoveries 13,903 12,555 10,716 9,616 5,284
----------- ----------- ----------- ----------- -----------
Charge-offs, net of recoveries 73,291 99,989 115,735 61,895 54,586
----------- ----------- ----------- ----------- -----------
Balance at end of year $ 68,040 $ 78,818 $ 89,745 $ 58,339 $ 41,934
=========== =========== =========== =========== =========
Provision for loan losses to average loans (1) 2.93% 3.69% 4.72% 2.36% 2.06%
Net loan charge-offs to average loans (1) 3.43% 4.15% 3.72% 1.86% 1.60%
Ending reserve for losses on loans to total loans (1) (2) 2.83% 3.52% 2.79% 1.83% 1.27%
<FN>
- -----------------------------------------------------------------------------------------------------------------------------------
(1) Includes loans held for sale and/or securitization.
(2) Before deduction of reserves.
- 82 -
COMPONENTS OF RESERVE FOR LOSSES ON LOANS BY TYPE
(Dollars in thousands)
September 30,
--------------------------------------------------------------------------------------------------------------------
1993 1992 1991 1990 1989
---------------------- ---------------------- ---------------------- ---------------------- ------------------------
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 period
allocated to:
Residential
permanent $ 4,235 53.6 % $ 2,335 41.6 % $ 2,326 41.7 % $ 1,263 32.2 % $ 1,155 27.1 %
Home equity 250 2.5 504 9.9 597 9.0 470 22.2 -- --
Commercial and
multifamily 9,606 3.9 5,907 2.7 4,655 2.1 3,960 2.8 -- --
Residential
construction 4,125 1.5 4,470 2.6 3,683 2.2 1,708 2.2 -- --
Commercial
construction 345 0.4 729 0.5 1,754 0.7 1,407 1.9 341 9.4
Ground 1,412 0.7 2,624 1.0 2,168 1.3 10,305 4.5 -- --
Credit card 46,886 31.4 57,566 38.9 70,642 40.4 35,942 27.6 40,396 37.9
Consumer and
other 1,181 6.0 4,683 2.8 2,997 2.6 1,132 6.6 42 4.4
--------- -------- -------- -------- --------
Subtotal 68,040 78,818 88,822 56,187 41,934
Unallocated -- -- 923 2,152 --
-------- -------- --------- --------- ---------
Total $68,040 $ 78,818 89,745 $ 58,339 $ 41,934
======== ========= ========= ========= =========
- ----------------------------------------------------------------------------------------------------------------------------------
- 83 -
ANALYSIS OF RESERVE BALANCES ON AND CHARGE-OFFS OF
REAL ESTATE HELD FOR INVESTMENT OR SALE
(In thousands)
Year Ended September 30,
--------------------------------------------
1993 1992 1991 1990 (1)
- ---------------------------------- --------- --------- --------- ---------
Balance at beginning of year:
Real estate held for investment $ 14,919 $ 4,161 $ 2,800 $ -
Real estate held for sale 94,125 53,337 10,078 -
--------- --------- --------- ---------
Total 109,044 57,498 12,878 -
--------- --------- --------- ---------
Provision for real estate losses:
Real estate held for investment 1,470 12,673 4,724 45,586
Real estate held for sale 28,945 47,923 43,259 10,078
--------- --------- --------- ---------
Total 30,415 60,596 47,983 55,664
--------- --------- --------- ---------
Charge-offs:
Real estate held for investment:
Residential construction - - - 117
Residential ground - - - 41,585
Commercial ground - 1,550 3,363 1,084
Commercial permanent - 365 - -
Commercial construction 6,207 - - -
--------- --------- --------- ---------
Total 6,207 1,915 3,363 42,786
--------- --------- --------- ---------
Real estate held for sale:
Residential - 3,002 - -
Residential construction 79 - - -
Residential ground 259 348 - -
Commercial ground 1,353 3,785 - -
Commercial permanent 761 - - -
Commercial construction 19,156 - - -
--------- --------- --------- ---------
Total 21,608 7,135 - -
--------- --------- --------- ---------
Total charge-offs on real estate
held for investment or sale 27,815 9,050 3,363 42,786
--------- --------- --------- ---------
Balance at end of year:
Real estate held for investment 10,182 14,919 4,161 2,800
Real estate held for sale 101,462 94,125 53,337 10,078
--------- --------- --------- ---------
Total $111,644 $109,044 $ 57,498 $ 12,878
========= ========= ========= =========
- -------------------------------------------------------------------------------
<FN>
(1) The Bank initially established its reserve for losses on real estate held
for investment or sale in fiscal year 1990.
- 84 -
COMPONENTS OF RESERVE FOR LOSSES
ON REAL ESTATE HELD FOR INVESTMENT OR SALE
(In thousands)
September 30,
--------------------------------------------
1993 1992 1991 1990
- ----------------------------------------- --------- --------- --------- ---------
Reserve for losses on real estate
held for investment:
Commercial and multifamily $ 7,945 $ 8,037 $ 2,389 $ 839
Commercial construction - 4,995 506 506
Ground 1,972 1,682 1,266 1,455
Other 265 205 - -
--------- --------- --------- ---------
Total 10,182 14,919 4,161 2,800
--------- --------- --------- ---------
Reserve for losses on real estate
held for sale:
Residential 102 447 2,813 1,906
Home equity 53 21 4 3
Commercial and multifamily 4,678 1,705 1,564 96
Commercial construction 1,387 15,439 6,899 2,115
Residential construction 2,924 2,294 1,664 307
Ground 92,318 74,219 40,393 5,651
Unallocated - - - -
--------- --------- --------- ---------
Total 101,462 94,125 53,337 10,078
--------- --------- --------- ---------
Total reserve for losses on real
estate held for investment or sale $111,644 $109,044 $ 57,498 $ 12,878
========= ========= ========= =========
- 85 -
The Bank maintains reserves for estimated losses on loans and real estate. See
"Business - Banking - Delinquencies, Foreclosures and Reserves for Losses -
Reserves for Losses." The Bank's total reserves for losses on loans and real
estate held for investment or sale decreased by $8.2 million from the level at
September 30, 1992 to $179.7 million at September 30, 1993. The $8.2 million
decrease was primarily attributable to decreased reserves on credit card loans
resulting partially from the securitization and sale of $350.0 million of such
loans during fiscal 1993 and a decline in the ratio of credit card charge-offs
to outstanding credit card loans, and decreased reserves on other loans. The
decreased reserves on credit card loans were partially offset by increased
reserves on real estate assets as a result of the adoption of SOP 92-3. See
Summary of Significant Accounting Policies in the Consolidated Financial
Statements in this report. During the year ended September 30, 1993, the Bank
recorded net charge-offs of $32.9 million on loans secured by real estate and
real estate held for investment or sale and provided an additional $38.9 million
in valuation allowances on these assets.
The following table shows reserves for losses on performing and
non-performing assets at the dates indicated.
- 86 -
September 30, 1993
---------------------------------
Performing Non-performing Total
---------- -------------- -----
(In thousands)
Reserves for losses on:
Loans:
Real estate. . . . . . . . $19,518 $ 455 $ 19,973
Credit card. . . . . . . . 44,830 2,056 46,886
Consumer and other . . . . 1,125 56 1,181
------- -------- --------
Total reserve for
losses on loans. . . . . 65,473 2,567 68,040
------- -------- --------
Real estate held for
investment . . . . . . . . 8,210 1,972 10,182
Real estate held for sale . - 101,462 101,462
------- -------- --------
Total reserve for losses on
real estate held for
investment or sale. . . . 8,210 103,434 111,644
------- -------- --------
Total reserves for losses . $73,683 $106,001 $179,684
======= ======== ========
September 30, 1992
---------------------------------
Performing Non-performing Total
---------- -------------- -----
(In thousands)
Reserves for losses on:
Loans:
Real estate. . . . . . . . $11,104 $ 5,465 $ 16,569
Credit card. . . . . . . . 54,888 2,678 57,566
Consumer and other . . . . 1,148 3,535 4,683
------- -------- --------
Total reserve for
losses on loans. . . . . 67,140 11,678 78,818
------- -------- --------
Real estate held for
investment . . . . . . . . 13,237 1,682 14,919
Real estate held for sale . - 94,125 94,125
------- -------- --------
Total reserve for losses on
real estate held for
investment or sale. . . . 13,237 95,807 109,044
------- -------- --------
Total reserves for losses. . $80,377 $107,485 $187,862
======= ======== ========
- 87 -
Reserves for losses on loans secured by real estate and real estate held
for investment or sale totaled $131.6 million at September 30, 1993, which
constituted 29.1% of total non-performing real estate assets. This amount
represented a $6.0 million increase over the September 30, 1992 level of $125.6
million, or 21.6% of total non-performing real estate assets at that date.
When real estate collateral securing an extension of credit is initially
recorded as REO, it is written down to fair value on the basis of an appraisal.
Such initial write-downs represent management's best estimate of exposure to the
Bank at the time that the collateral becomes REO and in effect substitutes for
reserves that would otherwise be recorded if the collateral had not become REO.
As circumstances change, it may be necessary to provide additional reserves
based on new information. Depending on the nature of the information, these new
reserves may be valuation allowances, which reflect additional impairment with
respect to a specific asset, or may be unallocated reserves, which provide
protection against changes in management's perception of overall economic
factors. Accordingly, the Bank believes that relatively lower levels of reserves
are initially required for REO because of the Bank's policy of adjusting the
book basis of its REO to reflect the fair value of the collateral. Reserves for
losses on real estate held for sale at September 30, 1993 are net of
approximately $66.2 million of cumulative charge-offs against assets remaining
in the Bank's portfolio at September 30, 1993.
The Bank from time to time obtains updated appraisals on its real estate
acquired in settlement of loans. As a result of such updated appraisals, the
Bank could be required to increase its reserves.
Net charge-offs of credit card loans for the year ended September 30, 1993
were $64.8 million, compared to $91.0 million for the year ended September 30,
1992. The decrease in net charge-offs resulted primarily from a $259.5 million
decrease in average credit card balances and a decline in payment defaults. The
allowance at any balance sheet date relates only to receivable balances that
exist as of that date. Because of the nature of a revolving credit card account,
however, the cardholder may enter into transactions (such as retail purchases
and cash advances) subsequent to a balance sheet date, which increases the
outstanding balance of the account. Accordingly, charge-offs in any fiscal
period relate both to balances that existed at the beginning of the period and
to balances created during the period and may therefore exceed the levels of
reserves established at the beginning of the fiscal period.
The reserve for losses on credit card loans decreased to $46.9 million at
September 30, 1993 from $57.6 million at September 30, 1992 primarily because of
a decline in the Bank's reserve ratio resulting from a decline in the ratio of
credit card charge-offs to outstanding credit card loans. The ratios of the
reserve for such losses to non-
- 88 -
performing credit card loans and to outstanding credit card loans changed from
215.0% and 6.6%, respectively, at September 30, 1992 to 228.1% and 6.2%,
respectively, at September 30, 1993.
The reserve for losses on consumer and other loans decreased to $1.2
million at September 30, 1993 from $4.7 million at September 30, 1992, primarily
because of the charge-off of two loans against the reserve. The ratios of the
reserves for losses on consumer and other loans to non-performing consumer and
other loans and to outstanding consumer and other loans changed from 131.1% and
7.6%, respectively, at September 30, 1992 to 376.1% and 0.8%, respectively, at
September 30, 1993.
In November 1990, the SEC initiated an informal investigation concerning
the Bank's reserves for losses and related matters and has requested documents
from the Bank covering the period since October 1, 1988. See "Legal
Proceedings." Based upon the information available to it at this time,
management believes that the matter should be resolved in a manner that will not
result in a material adverse financial impact on the Bank.
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 mixes, volumes and maturities 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 is pursuing an asset-liability management strategy to control its
risk from changes in market interest rates principally by originating
interest-sensitive loans for its portfolio. In furtherance of this strategy, the
Bank emphasizes origination and retention of ARMs, adjustable-rate home equity
credit line loans and credit card loans, which generally have shorter terms and
higher yields than mortgage loans. At September 30, 1993, ARMs and home equity
credit line loans with rates adjustable in one year or less accounted for 17.9%
of total loans, and credit card loans accounted for 31.4% of total loans.
In recent periods, the Bank's policy has generally been to sell most of
its long-term fixed-rate mortgage production, thereby avoiding the exposure to
market interest rate fluctuations typically associated with long-term fixed-rate
lending. The Bank retains in its portfolio the majority of its variable-rate
mortgage production.
Also in furtherance of asset and liability management objectives, the Bank
has engaged, and may continue to engage in the future, in securitization
transactions with respect to credit card and home equity credit line receivables
depending on its need for additional funds, market conditions and related
factors. During fiscal 1993, the Bank
- 89 -
securitized and sold $350.0 million of credit card receivables and $340.4
million of home equity credit line receivables.
During the June 1993 quarter, the Bank sold its entire portfolio of
five-year U.S. Government securities, totaling $172.9 million, primarily to
provide flexibility under previous regulatory growth limits for increased
mortgage loan origination activity. The Bank also sold $127.8 million of
seven-year balloon mortgage-backed securities during the second quarter of
fiscal 1993 for similar reasons and in order to reduce its exposure to possible
future increases in long-term interest rates.
A traditional measure of interest-rate risk within the savings industry is
the interest sensitivity "gap," which is the sum of all interest-earning assets
minus all interest-bearing liabilities to be repriced within the same period. A
negative gap like that shown below for the Bank implies that, if market interest
rates rise, the Bank's average cost of funds will increase more rapidly than the
concurrent increase in the average yield on interest-earning assets. In a period
of rising market interest rates, the differential effect on the average yield on
interest-earning assets and the average cost of interest-bearing liabilities
will decrease the Bank's net interest spread and thereby adversely affect the
Bank's operating results. Conversely, in a period of declining interest rates, a
negative gap would result in an increase in the Bank's net interest spread.
The Bank views control over interest rate sensitivity as a key element in
its financial planning process and monitors its interest rate sensitivity
through its forecasting system. The Bank manages its 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 contractual maturities of the Bank's
interest-earning assets and interest-bearing liabilities at September 30, 1993,
as adjusted for estimated prepayments and amortization and provisions for
adjustable interest rates. Adjustable and floating rate loans are included in
the period in which their interest
- 90 -
rates are next scheduled to adjust, and the prepayment rates assumed in each
period for the Bank's loans are those rates published most recently by the FHLB
of Atlanta. 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.
- 91 -
REIT
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, 1993
Mortgage loans:
Adjustable-rate $ 432,730 $ 153,883 $ 232,352 $ 251,434 $ 23,311 $ 1,093,710
Fixed-rate 13,309 8,320 33,447 32,963 83,350 171,389
Loans held for sale 176,027 - - - - 176,027
Home equity credit lines
and second mortgages 66,191 49 14 - - 66,254
Credit card and other 486,286 19,042 69,554 23,514 - 598,396
Loans held for securitization and sale 300,000 - - - - 300,000
Mortgage-backed securities 198,198 350,034 223,393 714,451 15,116 1,501,192
Other investments 157,567 - 8,779 103 - 166,449
------------- ------------- ------------- ------------- ------------- -------------
Total interest-earning assets 1,830,308 531,328 567,539 1,022,465 121,777 4,073,417
Total non-interest earning assets - - - - 799,354 799,354
------------- ------------- ------------- ------------- ------------- -------------
Total assets $ 1,830,308 $ 531,328 $ 567,539 $ 1,022,465 $ 921,131 $ 4,872,771
============= ============= ============= ============= ============= =============
Deposits:
Fixed maturity deposits $ 486,834 $ 152,974 $ 149,291 $ 57,584 $ - $ 846,683
NOW, statement and passbook accounts 1,336,414 36,550 121,736 82,856 176,576 1,754,132
Money market deposit accounts 1,196,690 - - - - 1,196,690
Borrowings:
Capital notes - subordinated 10,000 - - - 128,500 138,500
Other 350,647 75,390 76,766 2,136 27,857 532,796
------------- ------------- ------------- ------------- ------------- -------------
Total interest-bearing liabilities 3,380,585 264,914 347,793 142,576 332,933 4,468,801
Total non-interest bearing liabilities - - - - 165,200 165,200
Stockholders' equity - - - - 238,770 238,770
Total liabilities & stockholders' ------------- ------------- ------------- ------------- ------------- -------------
equity $ 3,380,585 $ 264,914 $ 347,793 $ 142,576 $ 736,903 $ 4,872,771
============= ============= ============= ============= ============= =============
Gap ($1,550,277) $266,414 $219,746 $879,889 ($211,156)
Cumulative gap ($1,550,277) ($1,283,863) ($1,064,117) ($184,228) ($395,384)
Cumulative gap as a percentage
of total assets (31.8)% (26.3)% (21.8)% (3.8)% (8.1)%
- 92 -
The one-year gap, as a percentage of total assets, was a negative 26.3% at
September 30, 1993, compared to a negative 24.9% at September 30, 1992. As noted
above, the Bank's negative one-year gap would adversely affect the Bank's net
interest spread and earnings if interest rates rise and the Bank is unable to
take steps to reduce its gap.
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 13. On August 31,
1993, the OTS incorporated an interest-rate risk measure into its capital
rules. Management does not believe that the new OTS interest-rate risk measure
will require the Bank to hold additional capital against interest-rate risk. See
"Business - Banking - Regulation - Regulatory Capital."
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 TAX ASSET. At September 30, 1993, the Bank recorded a net
deferred tax asset of $44.8 million, which generally represents the cumulative
excess of the Bank's actual income tax liability over its income tax expense for
financial reporting purposes. This net deferred tax asset is reported on the
Bank's financial statements in accordance with Accounting Principles Board
Opinion No. 11.
In January 1993, the OTS issued Thrift Bulletin 56 ("TB 56") setting forth
additional guidance regarding the treatment of net deferred tax assets for
regulatory reporting and capital purposes. For purposes of the Reports of
Condition and Income and the Thrift Financial Reports and other regulatory
reporting, TB 56 provides that thrift institutions are required to report their
net deferred tax assets in accordance with the Statement of Financial Accounting
Standards No. 109 ("SFAS No. 109") as of January 1, 1993, or the beginning of
their first fiscal year thereafter, if later (although early adoption of SFAS
No. 109 is permitted). Management does not believe that reporting the Bank's net
deferred tax asset under SFAS No. 109 will have a material effect on the asset
for regulatory reporting purposes.
- 93 -
For regulatory capital purposes, TB 56 generally sets forth a limitation
on the amount of a thrift's net deferred tax asset reported under SFAS No. 109
that can be included in a thrift's regulatory capital. However, TB 56 provides a
transition rule under which net deferred tax assets reportable as of December
31, 1992 under the standards of APB No. 11 are not subject to this limitation.
Thus, the inclusion in regulatory capital of such deferred tax assets is not
limited under TB 56 to the extent the assets remain unamortized. Although the
OTS did not define the term "unamortized" in TB 56, the Bank believes that the
term refers to that portion of a financial institution's net deferred tax asset
which has not yet been reduced by the reversal of timing differences. Because
the Bank's net deferred tax asset of $55.1 million at December 31, 1992 was
reported under APB No. 11, the entire amount of the Bank's current net deferred
tax asset is grandfathered under this transition rule. This grandfathering of
the Bank's net deferred tax asset will not prevent or otherwise affect future
reductions in the asset due to a reversal of timing differences. TB 56 also
provides that net deferred tax assets reported under the transition rule remain
subject to previously existing rules and supervisory policy, including periodic
evaluation as to realizability.
LIQUIDITY AND CAPITAL RESOURCES
REAL ESTATE
GENERAL. The Real Estate Trust's primary cash requirements fall into four
categories: operating expenses (exclusive of interest on outstanding debt),
capital improvements, interest on outstanding debt and repayment of outstanding
debt.
Historically, the Real Estate Trust's total cash requirements have
exceeded the cash generated by its operations. This condition is currently the
case and is expected to continue to be so for the foreseeable future. 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 ("Notes") sold to the public, and the payment of
capital improvement costs. In the past, the Real Estate Trust has funded such
shortfalls through a combination of external funding sources, primarily new
financings (including the sale of Notes), refinancings of maturing mortgage
debt, asset sales and tax sharing payments from the Bank. See the Consolidated
Statements of Cash Flows included in the Consolidated Financial Statements in
this report.
The Real Estate Trust's liquidity position was constrained in the last
three fiscal years, primarily because of the persistence of recessionary
conditions in the Real Estate Trust's major real estate markets. Those
conditions have significantly curtailed the availability of long-term fixed-rate
mortgage financing on satisfactory terms. The Real Estate Trust refinanced
$350.0 million of mortgage debt in the
- 94 -
first quarter of fiscal 1992. See Note 3 to the Consolidated Financial
Statements in this report.
The Real Estate Trust's current program of public Note sales was initiated
in the 1970's as a vehicle for supplementing other external funding sources.
Note sales were suspended in June 1990, but resumed in November 1992. During the
period from the date of resumption of Note sales through November 30, 1993, the
Real Estate Trust sold $14.5 million of Notes. The table under "Recent Liquidity
Trends" below provides information at September 30, 1993 with respect to the
maturities of Notes outstanding at such date.
The Real Estate Trust has actively pursued a number of strategies to
improve its ability to meet its cash requirements.
RECENT LIQUIDITY TRENDS. The Real Estate Trust's liquidity position was
positively affected by two developments in fiscal 1993. Short-term liquidity
constraints were eased as a result of OTS approval of the resumption of tax
sharing payments by the Bank to the Real Estate Trust following a significant
improvement in the Bank's regulatory capital ratios and overall financial
condition. See "Banking - Capital." The Real Estate Trust's long-term liquidity
prospects improved as a result of the transfer to Saul Holdings Partnership and
a subsidiary limited partnership of the mortgage debt encumbering the 22
shopping centers and one office property transferred by the Real Estate Trust to
such partnerships in August 1993. A substantial portion of such mortgage debt
was scheduled to mature in fiscal years 1993 to 1997. See "Business - Real
Estate - Investment in Saul Holdings Limited Partnership" and Note 1 to the
Consolidated Financial Statements in this report.
The maturity schedule for the Real Estate Trust's outstanding mortgage and
Note debt at September 30, 1993 for the fiscal years commencing October 1, 1993
is set forth in the following table:
DEBT MATURITY SCHEDULE
(In thousands)
Notes
Fiscal Payable -
Year Mortgage Notes Unsecured Total
- --------------------------------------------------------------
1994 $ 8,538 $14,044 $ 22,582
1995 7,342 6,784 14,126
1996 4,494 5,223 9,717
1997 185,028 (1)(2) 1,735 186,763 (1)(2)
1998 16,024 7,777 23,801
Thereafter 43,350 3,098 46,448
- 95 -
<FN>
- ---------------------
(1) The Real Estate Trust has five one-year options to extend $146 million of
this amount upon payment of $9 million in reduction of principal in fiscal
1997 and $8 million in reduction of principal each year thereafter.
(2) Balance does not include deferred interest, which amounted to
approximately $14.5 million at September 30, 1993 and is payable at
maturity.
Of the $264.8 million of mortgage debt outstanding at September 30, 1993, $163.0
million was nonrecourse to the Real Estate Trust.
The Real Estate Trust believes that capital improvement costs in the next
several fiscal years will be in the range of $2 to $3 million per year.
In order to meet its debt amortization and capital improvement costs in
fiscal 1994 and future years, the Real Estate Trust will be required to raise
substantial amounts of cash primarily from a combination of mortgage loan
refinancings, sales of Notes, and tax sharing payments and cash dividends from
the Bank.
The Real Estate Trust is currently selling Notes principally to pay
outstanding Notes as they mature. In paying maturing Notes with proceeds of Note
sales, the Real Estate Trust effectively is refinancing its outstanding Notes
with similar new unsecured debt at the lower interest rates currently prevailing
in today's market. To the degree that the Real Estate Trust does not sell new
Notes in an amount sufficient to finance completely the scheduled repayment of
outstanding Notes as they mature, which was the case in fiscal 1993, it will
finance such repayments from other sources of funds.
In April 1993, the Bank received net proceeds of $71.9 million from its
sale of the Preferred Stock, which significantly strengthened the Bank's
regulatory capital ratios. See "Banking - Capital." This capital infusion,
together with the Bank's improved operating results, should enhance the
prospects of the Real Estate Trust to receive tax sharing payments and dividends
from the Bank. In June 1993, after receiving approval of the OTS, the Bank made
a $5.0 million payment to the Real Estate Trust pursuant to the Tax Sharing
Agreement between the Bank and the Trust. OTS approval of this payment was
conditioned on a pledge by the Real Estate Trust of certain assets to secure
certain of the Trust's obligations under the Tax Sharing Agreement. Following
execution of the pledge, the OTS approved, and the Bank made subsequent to
September 30, 1993, additional tax sharing payments of $4.6 million to the Real
Estate Trust. Under the terms of the Bank's written agreement with the OTS, any
additional tax sharing payments by the Bank must be approved by the OTS.
The Real Estate Trust to date has not relied on cash dividends from Chevy
Chase to meet its cash needs. In October 1993, the Bank's written agreement with
the OTS was amended to eliminate the requirement that the Bank obtain the
written approval of the OTS prior to declaring or paying dividends
- 96 -
on its common stock. OTS regulations tie Chevy Chase's ability to pay dividends
to specific levels of regulatory capital and earnings. See "Business - Banking -
Regulation - Dividends and Other Capital Distributions."
As the owner, directly and through a wholly-owned subsidiary, of a 21.5%
limited partnership interest in Saul Holdings Partnership, the Real Estate Trust
will share in cash distributions from operations and from capital transactions
involving the sale or refinancing of the properties of Saul Holdings
Partnership. The partnership agreement of Saul Holdings Partnership provides for
quarterly cash distributions to the partners out of net cash flow. See "Business
- - Real Estate - Investment in Saul Holdings Limited Partnership." In October
1993, the Real Estate Trust received its first cash distribution, in the amount
of $524,000, from Saul Holdings Partnership.
BANKING
LIQUIDITY. The 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.
The OTS has established a minimum liquidity requirement, which may vary
from time to time depending upon economic conditions and deposit flows. The
required liquidity level is currently 5.0%. The Bank's liquidity ratio at
September 30, 1993 was 24.3%, compared to 17.2% at September 30, 1992. The
increase over the prior period is primarily attributable to an increase in the
five-year balloon mortgage-backed securities portfolio and to a decrease in
outstanding borrowings primarily as a result of the securitization and sale of
$146.2 million of home equity credit line receivables during September 1993.
The Bank's primary sources of funds historically have consisted of (i)
principal and interest payments on loans and mortgage-backed securities, (ii)
savings deposits, (iii) sales of loans, mortgage-backed securities and
investments and (iv) borrowed funds. The Bank's holdings of readily marketable
securities constitute another important source of liquidity. At September 30,
1993, the Bank's portfolio included mortgage loans, U.S. Government securities
and mortgage-backed securities with outstanding principal balances of $593.2
million, $4.7 million and $1.4 billion, respectively, which could be used as
collateral for borrowings from the FHLB of Atlanta and various securities
brokers. The amount which the Bank could have borrowed against its unpledged
mortgage loans, U.S. Government securities and mortgage-backed securities
totaled $1.3 billion at September 30, 1993, after market-value and broker
adjustments of the collateral.
In recent periods, the proceeds from sales of credit card relationships
and other assets and securitization and sale of credit card, home equity credit
line and automobile loan receivables have been significant sources of liquidity
for the Bank. The Bank securitized and sold $194.2 million of home equity credit
line receivables and $150.0 million of credit card receivables in the first and
second quarters of fiscal 1993, respectively. In addition, during the fourth
quarter of fiscal 1993, the Bank securitized and sold $200.0 million of credit
card receivables and $146.2 million of home equity credit
- 97 -
line receivables. As part of its operating strategy, the Bank will continue to
explore opportunities to sell assets and to securitize and sell credit card and
home equity credit line receivables to meet liquidity and other balance sheet
objectives.
The ability of the Bank to securitize and sell assets in the future will
depend on a number of factors, including conditions in the market for
asset-backed securities and competitive pressures in the credit card industry.
The Bank does not currently anticipate relying upon securitizations of
receivables other than credit card and home equity credit line receivables. The
Bank's currently projected levels of securitization of credit card and home
equity credit line receivables reflect in part a reduction in the pool of
receivables eligible for such securitizations. The reduction in the amount of
eligible receivables has resulted from prior securitization and sales
activities. Management believes that to support future securitization activity,
a sufficient pool of eligible receivables will be provided by the existing
portfolio of receivables, the amortization of existing credit card and home
equity credit line trusts, increased usage of existing accounts and originations
of new accounts.
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. For
the year ended September 30, 1993, the Bank used the cash provided by operating,
investing and financing activities primarily to meet its commitments to fund
maturing savings certificates and deposit withdrawals of $10.8 billion, repay
borrowings of $11.8 billion, fund existing and continuing loan commitments
(including real estate held for investment or sale) of $1.8 billion, purchase
investments and loans of $928.7 million and meet operating expenses, before
depreciation and amortization, of $133.1 million. These commitments were funded
primarily through proceeds from customer deposits and sales of certificates of
deposit of $10.8 billion, proceeds from borrowings of $11.6 billion, proceeds
from sales of loans, securities and real estate of $2.2 billion, and principal
and interest collected on investments, loans and mortgage-backed securities of
$1.1 billion.
The Bank is obligated under various recourse provisions related to the
securitization and sale of credit card, home equity credit line and automobile
loan receivables. See Note 28 to the Consolidated Financial Statements in this
report. Of the $1.4 billion of outstanding trust certificate balances at
September 30, 1993, the primary recourse to the Bank was approximately $74.8
million.
The Bank also is obligated under various recourse provisions related to
the swap of single-family residential loans for participation certificates and
mortgage-backed securities issued to the Bank by FHLMC and FNMA. At September
30, 1993, recourse to the Bank under these arrangements was approximately $6.1
million. See Note 28 to the Consolidated Financial Statements in this report.
- 98 -
The Bank's commitments at September 30, 1993 are set forth in the
following table:
(In thousands)
Commitments to originate loans $ 96,423
----------
Loans in process (collateralized loans):
Home equity. . . . . . . . . . . . . . . . . . . 538,362
Real estate construction . . . . . . . . . . . . 23,099
Commercial and multifamily . . . . . . . . . . . 1,532
Residential ground . . . . . . . . . . . . . . . 3,544
----------
566,537
----------
Loans in process (unsecured loans):
Credit cards . . . . . . . . . . . . . . . . . . 2,602,097
Overdraft lines. . . . . . . . . . . . . . . . . 35,032
Commercial . . . . . . . . . . . . . . . . . . . 413
----------
2,637,542
----------
Total commitments to extend credit . . . . . 3,300,502
Letters of credit. . . . . . . . . . . . . . . . . 73,270
Recourse arrangements on asset-backed
securitizations. . . . . . . . . . . . . . . . . 74,830
Recourse arrangements on mortgage-backed
securities . . . . . . . . . . . . . . . . . . . 6,054
----------
Total commitments. . . . . . . . . . . . . . $3,454,656
==========
Based on historical experience, the Bank expects to fund substantially
less than the total amount of its outstanding credit card and home equity credit
line commitments, which together accounted for 90.9% of commitments at September
30, 1993.
At September 30, 1993, repayments of borrowed money scheduled to occur
during the next 12 months were $395.9 million. Certificates of deposit maturing
during the next 12 months amounted to $639.8 million, of which a substantial
portion is expected to remain with the Bank.
There were no material commitments for capital expenditures at September
30, 1993.
The Bank's liquidity requirements in years subsequent to fiscal 1993 will
continue to be affected both by the asset size of the Bank, the growth of which
will be constrained by capital and other regulatory requirements, and the
composition of the asset portfolio. Management believes that the Bank's primary
sources of funds, described above, will
- 99 -
be sufficient to meet the Bank's foreseeable long-term liquidity needs. The mix
of funding sources utilized from time to time will be determined by a number of
factors, including capital planning objectives, lending and investment
strategies and market conditions.
CAPITAL. At September 30, 1993, the Bank was in compliance with all of its
regulatory capital requirements under FIRREA, including FIRREA-mandated fully
phased-in capital requirements, 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, 1993, 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.
- 100 -
REGULATORY CAPITAL
(Dollars in thousands)
Actual Capital Required
---------------------- ----------------------
As a % As a % Excess
Amount of Assets Amount of Assets Capital
- ------------------------------------------ --------- --------- --------- --------- ---------
Capital per financial statements $284,794
Adjustments for tangible and core capital:
Intangible assets (55,270)
Non-includable subsidiaries (1) (6,458)
---------
Total tangible capital 223,066 4.60% $ 72,665 1.50% $150,401
Supervisory goodwill 36,333 ========= ========= ========= =========
---------
Total core capital (2) 259,399 5.35% $145,330 3.00% $114,069
--------- ========= ========= ========= =========
Total tier 1 risk-based capital (2) 259,399 7.29% N/A N/A N/A
--------- ========= ========= ========= =========
Adjustments for risk-based capital:
Subordinated capital debentures 132,800
Reserve for general loan losses 60,548
---------
Total supplementary capital 193,348
Excess loan loss reserves (15,892)
---------
Adjusted supplementary capital 177,456
---------
Total available capital 436,855
Equity investments (1) (20,568)
---------
Total risk-based capital (2) $416,287 11.70% $284,528 8.00% $131,759
========= ========= ========= ========= =========
- -----------------------------------------------------------------------------------------------------------
<FN>
(1) Reflects an aggregate offset of $6.6 million representing the amount of general reserves 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.
(2) 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%.
- 101 -
In April 1993, the Bank sold 3,000,000 shares of its Preferred Stock. See
Note 24 to the Consolidated Financial Statements in this report. The $71.9
million of net proceeds from the sale are fully includable in tier 1 or core
capital for regulatory capital purposes.
REGULATORY ACTION AND REQUIREMENTS. At September 30, 1993, the Bank was in
compliance with all of its regulatory capital requirements under FIRREA.
However, because the Bank did not meet its risk-based capital requirement at
June 30, 1991, the Bank is subject to a written agreement, as amended in October
1993, with the OTS which imposes certain restrictions on the Bank's operations
and requires certain affirmative actions by the Bank. Primarily because of its
level of non-performing assets, the Bank is subject to restrictions on asset
growth. Under the applicable OTS requirements, the Bank may not increase its
total assets during any calendar quarter in excess of an amount equal to net
interest credited on deposit liabilities during the quarter without prior
written approval from OTS. In September 1993, the Bank received OTS approval,
subject to certain conditions, to increase incrementally its total assets during
the period from July 1, 1993 through June 30, 1994 by an amount of up to $500
million. The Bank is also subject to a requirement to obtain OTS approval for
changes in directors and senior executive officers and the imposition of
increased OTS assessments and FDIC insurance premiums. The OTS has approved the
payment of dividends on the Preferred Stock provided certain conditions are met.
See "Business - Banking - Regulation - Dividends and Other Capital
Distributions." In the future, if the Bank is unable to maintain capital
compliance, the Bank could be subject to additional regulatory sanctions.
In July 1993, the OTS released the Bank from a capital plan and capital
directive because of the Bank's return to full regulatory capital compliance as
a result of its operating performance and the sale of the Preferred Stock.
CAPITAL MAINTENANCE STRATEGIES. The Bank's return to capital compliance
was due in large part to successful implementation of a number of capital
enhancement strategies. These included the elimination of certain unprofitable
lines of business, implementation of a program to achieve significant reductions
in operating expenses, re-pricing of certain product offerings and the sale of
the Preferred Stock in April 1993. The Bank's capital plan called for an orderly
disposition of several large real estate developments designed to protect and to
return the capital invested in these properties to the Bank in a safe and
expeditious manner. The Bank may continue to consider further steps to attract
additional outside capital.
During fiscal 1993, the Bank securitized and sold $350.0 million of credit
card receivables and $340.4 million of home equity credit line receivables. The
Bank recognized an aggregate gain of $16.8 million in connection with the home
equity credit line transactions. No gains or losses were recognized as a result
of the credit card receivables transactions, but, excess servicing fees will be
recognized over the related
- 102 -
life of the transactions. The Bank expects to continue to securitize various
loan receivables in the future to meet various objectives.
The regulatory capital requirements applicable to the Bank will continue
to increase over time as a result of the gradual phase-out of various assets
from regulatory capital. On the basis of its balance sheet at September 30,
1993, the Bank met the FIRREA-mandated fully phased-in capital requirements. On
a fully phased-in basis, at September 30, 1993 the Bank's tangible, core (or
leverage), and total risk-based capital ratios were 4.17%, 4.17% and 9.80%,
respectively, compared with the requirements of 1.5%, 3.0% and 8.0%,
respectively. At September 30, 1993, the Bank had $30.6 million, after
subsequent valuation allowances, of investments in subsidiaries engaged in
activities impermissible for national banks ("non-includable subsidiaries")
which are currently subject to a 25% phase-out from all three FIRREA capital
requirements. Such phase-out will gradually increase to 100% on July 1, 1996, in
accordance with a delayed phase-in period approved by the OTS pursuant to
legislation enacted in October 1992. At September 30, 1993, the Bank also had
one equity investment with a balance, after subsequent valuation allowances, of
$43.3 million which is currently subject to a 60% phase-out from total capital
for risk-based capital purposes. Such phase-out will increase to 100% on July 1,
1994. Pursuant to OTS guidelines, $6.6 million of general reserves maintained
against the Bank's non-includable subsidiaries and equity investments is
available as a "credit" against the deduction from capital otherwise required
for such investments. The OTS adopted a rule, effective April 19, 1993,
eliminating the capital deduction for equity investments that are permissible
for national banks.
The Bank will continue to emphasize reduction of the level of its
investments in non-includable subsidiaries and its level of equity investments.
The level of the Bank's investments in non-includable subsidiaries is a key
factor in the capital calculation because, under the fully phased-in capital
requirements, those investments represent dollar-for-dollar reductions in core
capital, which in turn reduce the amount of supplementary capital which may be
included for risk-based capital purposes. The Bank does not anticipate entering
into any new transactions that would result in an increase in its investments in
non-includable subsidiaries, and is attempting to reduce the existing level of
those investments over the next several years.
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 would be required to deduct the then-current book
value of such REO property from risk-based capital. The following table sets
forth the Bank's REO at September 30, 1993, after valuation allowances of
$101.5 million, by the fiscal year in which the property was acquired, either
by foreclosure or deed-in-lieu of foreclosure.
Fiscal Year (In thousands)
----------- --------------
1990 (1) $151,007
1991 123,286
1992 21,460
1993 18,564
--------
314,317
In substance
foreclosures (2) 18,837
--------
Total REO $333,154
========
- -------------------------------------------------------------------------------
<FN>
(1) Includes one property with a net book value of $37.9 million, which the
Bank agreed in fiscal 1991 to treat as an equity investment for regulatory
capital purposes.
(2) Represents properties in which the Bank has not acquired title.
- 103 -
At September 30, 1993, the Bank had $52.4 million in supervisory goodwill,
of which $36.3 million was includable in core capital pursuant to statutory
provisions limiting the includable amount of supervisory goodwill to an amount
not to exceed 0.75% of tangible assets beginning January 1, 1993, 0.375%
beginning January 1, 1994 and 0% beginning January 1, 1995.
The Bank's ability to maintain capital compliance will be subject to
general economic conditions, particularly in the Bank's local markets. Continued
softness in general economic conditions or a renewed downturn in local real
estate markets could require further additions to the Bank's reserves for losses
and further charge-offs. Any such developments would adversely affect the Bank's
earnings and thus its ability to maintain capital compliance. The failure of the
Bank to maintain capital compliance could result in further regulatory
sanctions.
PROMPT CORRECTIVE ACTION. Under the OTS prompt corrective action
regulations which became effective on December 19, 1992, 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% and a total
risk-based capital ratio of at least 10.0%. At September 30, 1993, the Bank's
leverage, tier 1 risk-based and total risk-based capital ratios were 5.35%,
7.29% and 11.70%, respectively, which exceeded the ratios established for "well
capitalized" institutions. The OTS has the discretion to 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's levels of non-performing assets may result in reductions in capital to
the extent losses are recognized as a result of deteriorating collateral value
or economic conditions. Further, under the OTS's regulatory capital
requirements, the Bank is required to phase out from regulatory capital
supervisory goodwill and certain investments in subsidiaries and equity
investments. See Business - Banking - Regulation - Regulatory Capital."
Accordingly, there can be no assurance that the Bank will be able to maintain
levels of capital sufficient to continue to meet the standards for
classification as "well capitalized."
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 Trust's properties. Most of
the operating expenses and virtually all of the debt service payments associated
with income-producing properties are not decreased by reductions in occupancy or
rental income. Therefore, the ability of the Trust to produce net income in any
year
- 104 -
from its income-producing properties is highly dependent on the Real Estate
Trust's ability to maintain or increase the properties' levels of rental income
and hotel sales revenues. 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.
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. The deterioration of the real estate market and
other adverse economic conditions in the Washington, D.C. metropolitan area in
fiscal 1990 and 1991 caused the Bank to rely on alternative sources of income in
addition to net interest spread, including sales of credit card accounts (or
"relationships"), loans and mortgage-backed securities, and securitizations of
credit card and home equity credit line receivables. During fiscal 1991,
non-interest income from gains on sales of credit card relationships, loans and
mortgage-backed securities had a significant effect on net income. The Bank's
income from such sources decreased in fiscal 1992 and 1993 from the levels of
such income in fiscal 1991. In addition to interest paid on its interest-bearing
liabilities, the Bank's principal expenses are operating expenses.
FISCAL YEAR 1993 COMPARED TO FISCAL YEAR 1992
REAL ESTATE
The following tables set forth, for the fiscal years ended September 30,
1993, 1992 and 1991, direct operating results for the Real Estate Trust's
commercial properties portfolio, which includes shopping centers and office
properties, and the Real Estate Trust's hotel properties.
- 105 -
YEAR ENDED SEPTEMBER 30,
-----------------------------
1993 1992 1991
--------- --------- ---------
(In thousands)
SHOPPING CENTERS
Revenue
Base rent $ 19,635 $ 21,284 $ 21,446
Expense recoveries 4,488 4,857 5,259
Percentage rent 2,231 2,608 2,762
Other 725 1,157 386
--------- --------- ---------
Total revenues 27,079 29,906 29,853
--------- --------- ---------
Direct operating expenses
Real estate taxes 1,977 2,053 2,384
Repairs and maintenance 1,186 1,152 1,304
Utilities 929 951 976
Payroll 891 924 925
Insurance 304 347 397
Ground rent 429 467 452
Other 769 818 856
--------- --------- ---------
Total direct operating expenses 6,485 6,712 7,294
--------- --------- ---------
Income after direct operating expenses $ 20,594 $ 23,194 $ 22,559
========= ========= =========
OFFICE PROPERTIES
Revenue
Base rent $ 16,975 $ 19,101 $ 20,823
Expense recoveries 1,272 1,916 2,658
Other 410 566 701
--------- --------- ---------
Total revenues 18,657 21,583 24,182
--------- --------- ---------
Direct operating expenses
Real estate taxes 1,508 1,733 2,210
Repairs and maintenance 1,718 1,695 1,785
Utilities 2,261 2,326 2,363
Payroll 548 549 551
Insurance 282 296 328
Other 906 1,105 1,431
--------- --------- ---------
Total direct operating expenses 7,223 7,704 8,668
--------- --------- ---------
Income after direct operating expenses $ 11,434 $ 13,879 $ 15,514
========= ========= =========
COMMERCIAL PROPERTIES
(SHOPPING CENTERS AND OFFICE PROPERTIES)
Revenue
Base rent $ 36,610 $ 40,385 $ 42,269
Expense recoveries 5,760 6,773 7,917
Percentage rent 2,231 2,608 2,762
Other 1,135 1,723 1,087
--------- --------- ---------
Total revenues 45,736 51,489 54,035
--------- --------- ---------
Direct operating expenses
Real estate taxes 3,485 3,786 4,594
Repairs and maintenance 2,904 2,847 3,089
Utilities 3,190 3,277 3,339
Payroll 1,439 1,473 1,476
Insurance 586 643 725
Ground rent 429 467 452
Other 1,675 1,923 2,287
--------- --------- ---------
Total direct operating expenses 13,708 14,416 15,962
--------- --------- ---------
Income after direct operating expenses $ 32,028 $ 37,073 $ 38,073
========= ========= =========
- 106 -
YEAR ENDED SEPTEMBER 30,
-----------------------------
1993 1992 1991
--------- --------- ---------
(In thousands)
HOTELS
Revenue
Room sales $ 30,517 $ 31,715 $ 31,105
Food sales 8,885 8,703 9,056
Beverage sales 2,985 3,258 3,064
Other 2,998 2,952 2,544
--------- --------- ---------
Total revenues 45,385 46,628 45,769
--------- --------- ---------
Direct operating expenses
Payroll 14,887 15,145 15,882
Cost of sales 4,729 4,862 4,826
Utilities 3,027 2,957 2,892
Repairs and maintenance 2,426 2,447 2,685
Advertising and promotion 2,301 2,331 2,168
Property taxes 1,194 1,084 1,382
Insurance 543 544 700
Other 4,390 4,593 4,564
--------- --------- ---------
Total direct operating expenses 33,497 33,963 35,099
--------- --------- ---------
Income after direct operating expenses $ 11,888 $ 12,665 $ 10,670
========= ========= =========
- 107-
The Real Estate Trust recorded an operating loss of $44.5 million for the
fiscal year ended September 30, 1993, which represented a $16.0 million increase
from the $28.5 million operating loss recorded for fiscal 1992. Of the loss
recorded by the Real Estate Trust in fiscal 1993, $15.5 million consisted of
depreciation and amortization charges. The operating results for fiscal 1993
reflected a $13.1 million write-off of previously capitalized costs on
development projects which management has determined have no continuing value to
the Real Estate Trust.
On August 26, 1993, the Real Estate Trust transferred its 22 shopping
centers and one of its office properties to Saul Holdings Partnership and a
subsidiary limited partnership in exchange for securities representing a 21.5%
limited partnership interest in Saul Holdings Partnership (the "Saul Centers
Transaction"). See "Business - Real Estate - Investment in Saul Holdings Limited
Partnership." As a result of this transaction, the fiscal 1993 operating results
of commercial properties, which included the transferred properties, are not
entirely comparable to the prior year's results.
Income after direct operating expenses from commercial properties, which
include both shopping center and office properties, decreased $5.0 million
(13.6%) in fiscal 1993 from the prior fiscal year. Income from shopping centers
after direct operating expenses declined by $2.6 million (11.2%) from the fiscal
1992 level, while income from office buildings declined by $2.4 million (17.6%).
The decline in shopping center income and, to a lesser extent, office property
income was primarily attributable to the transfer of 22 shopping centers and one
office property to Saul Holdings Partnership and a subsidiary limited
partnership in the Saul Centers Transaction, which effectively limited fiscal
1993 operating results for the major part of the commercial property portfolio
to approximately 11 months of operations. The performance of the office
portfolio also was adversely affected by a reduction in the leasing rate, to 77%
at September 30, 1993 from 81% at September 30, 1992. The lower leasing rate
generally reflected the recessionary economic conditions in the markets in which
these properties are located, including the effects of the termination on March
31, 1993 of a lease for 134,000 square feet of space in one of the Trust's
office buildings located in Atlanta.
Income after direct operating expenses from hotel properties decreased
$0.8 million (6.1%) in fiscal 1993 from the prior fiscal year. Room sales
declined $1.2 million (3.8%), reflecting continued softness in some of the hotel
markets and a significant decrease in occupancy rates at one of the nine
properties. Direct operating expenses, which include a number of variable costs
tied to occupancy, decreased $0.5 million (1.4%) in the current year.
Interest expense declined $0.9 million (1.7%) in fiscal 1993 as a result
of lower interest rates and lower average total indebtedness. Average balances
of the Real Estate Trust's outstanding borrowings declined to $ 452.7 million in
fiscal 1993 from $478.9 million in fiscal
- 108 -
1992, primarily as a result of the transfer in the Saul Centers Transaction of
the mortgage debt associated with the properties transferred to Saul Holdings
Partnership.
Advisory, management and leasing fees-related parties increased $0.2
million (2.2%) in fiscal 1993 as the result of an increase, effective January 1,
1993, in the monthly advisory fee to $157,000 from $97,000. The effect of this
increase was partially offset by a decrease of $0.4 million in management and
leasing fees as a result of lower rental and sales income on which these fees
are based.
General and administrative expense decreased $2.1 million (49.9%) in
fiscal 1993 from the level in the prior fiscal year. Such expense in fiscal 1992
reflected payment of a $1.3 million litigation judgment awarded against the
Trust. Most of the balance of the decreased expenses in the current fiscal year
was attributable to lower legal expense.
The $13.1 million write-off of abandoned development costs, which were
incurred primarily before fiscal 1990, represents the expensing of costs
capitalized in previous years by the Real Estate Trust on projects for various
types of income-producing properties located in Georgia, Virginia, Kansas and
Florida. Because of changed economic circumstances in those locations,
management has determined that it would not be in the best interests of the Real
Estate Trust to continue development and that the costs expended to date have no
continuing value to the Real Estate Trust.
BANKING
OVERVIEW. The Bank recorded operating income of $63.8 million for the year
ended September 30, 1993, compared to operating income of $43.4 million for
fiscal 1992. The increase in operating income for the year ended September 30,
1993 was primarily attributable to a $26.5 million decrease in the provision for
loan losses, a $7.0 million increase in loan and deposit servicing fees, an $8.9
million increase in gain on sales of securities and a $37.9 million decrease in
loss on real estate held for investment or sale. The positive effect of these
items was offset in part by a $7.0 million decrease in net interest income
before provision for loan losses, an $8.2 million decrease in credit card fees,
a $12.9 million decrease in gains on sales of credit card relationships, loans
and mortgage-backed securities and a $29.5 million increase in operating
expenses.
NET INTEREST INCOME. Net interest income, before the provision for loan
losses, decreased $7.0 million (or 3.7%) for the year ended September 30, 1993,
as the average yield on interest-earning assets decreased at a rate greater than
the decrease in the average rate on interest-bearing liabilities. See "Financial
Condition - Banking - Asset and Liability Management."
- 109 -
The Bank would have recorded additional net interest income of $7.4
million for the year ended September 30, 1993 if the Bank's non-accrual assets
and restructured loans had been current in accordance with their original terms.
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.
- 110 -
NET INTEREST MARGIN ANALYSIS
(Dollars in thousands)
Year Ended September 30,
1993 1992 1991
September 30, ------------------------- -------------------------- --------------------------
1993 Average Yield/ Average Yield/ Average Yield/
Yield/Rate Balances Interest Rate Balances Interest Rate Balances Interest Rate
- ------------------------------------- ------------- ---------- -------- ------ ---------- -------- ------ ---------- -------- ------
Assets:
Interest-earning assets:
Loans receivable, net (1) 9.93% $2,136,157 $240,443 11.26% $2,411,405 $307,740 12.76% $3,111,735 $391,176 12.57%
Mortgage-backed securities (2) 5.95 1,508,948 95,085 6.30 1,115,975 83,504 7.48 680,382 62,429 9.18
Federal Funds sold - 14,283 427 2.99 25,919 1,063 4.10 65,337 4,608 7.05
Trading securities - - - - - - - 158,638 14,283 9.00
Investment securities 4.21 125,255 8,086 6.46 64,569 4,159 6.44 117,710 7,658 6.51
Other interest-earning assets 3.27 168,432 4,773 2.83 163,453 6,567 4.02 112,737 7,418 6.58
---------- -------- ---------- -------- ---------- --------
Total 8.19 3,953,075 348,814 8.82 3,781,321 403,033 10.66 4,246,539 487,572 11.48
--------- -------- ----- -------- ----- -------- -----
Non-interest earning assets:
Cash 104,195 106,297 123,295
Real estate held for investment or sale 466,717 564,325 447,960
Property and equipment, net 141,690 151,350 159,338
Cost in excess of net assets acquired, net 11,117 14,161 17,434
Other assets 172,178 172,888 190,454
---------- ---------- ----------
Total assets $4,848,972 $4,790,342 $5,185,020
========== ========== ==========
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits 2.89 $ 750,816 18,569 2.47 $ 714,736 22,523 3.15 $ 681,785 35,169 5.16
Savings deposits 3.46 860,280 27,980 3.25 689,882 27,800 4.03 483,985 27,313 5.64
Time deposits 4.32 964,926 41,813 4.33 1,347,438 75,914 5.63 1,675,588 120,905 7.22
Money market deposits 3.28 1,242,175 39,430 3.17 1,332,776 55,384 4.16 1,571,634 97,323 6.19
---------- -------- ---------- -------- ---------- --------
Total deposits 3.48 3,818,197 127,792 3.35 4,084,832 181,621 4.45 4,412,992 280,710 6.36
Borrowings 5.81 755,111 39,726 5.26 484,377 33,140 6.84 545,722 45,001 8.25
---------- -------- ---------- -------- ---------- --------
Total liabilities 3.83 4,573,308 167,518 3.66 4,569,209 214,761 4.70 4,958,714 325,711 6.57
--------- -------- ----- -------- ----- -------- -----
Non interest-bearing items:
Non-interest bearing deposits 46,670 38,489 23,435
Other liabilities 36,145 46,534 63,403
Stockholders' equity 192,849 136,110 139,468
---------- ---------- ----------
Total liabilities and stockholders' equity $4,848,972 $4,790,342 $5,185,020
========== ========== ==========
Net interest income $181,296 $188,272 $161,861
======== ======== ========
Net interest spread (3) 5.16% 5.96% 4.91%
===== ===== =====
Net yield on interest-earning assets (4) 4.59% 4.98% 3.81%
===== ===== =====
Interest-earning assets to interest-bearing liabilities 86.44% 82.76% 85.64%
===== ===== =====
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Includes loans held for sale and/or securitization. Interest on non-accruing loans has been included only to the extent
reflected in the consolidated statements of operations; however, the loan balance is included in the average amount
outstanding until transferred to real estate acquired in settlement of loans. Includes $19, $2,315 and $5,673 of amortized
loan fees, premiums and discounts in interest income for the years ended September 30, 1993, 1992 and 1991.
(2) Includes mortgage-backed securities held for sale.
(3) Equals weighted average yield on total interest-earning assets less weighted average rate on total interest-bearing
liabilities.
(4) Equals net interest income divided by the average balances of total interest-earning assets.
-111-
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.
- 112 -
VOLUME AND RATE CHANGES IN NET INTEREST INCOME
(In thousands)
Year Ended September 30, 1993 Year Ended September 30, 1992
Compared to Compared to
Year Ended September 30, 1992 Year Ended September 30, 1991
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 (2) $(33,153) $(34,144) $ (67,297) $(89,265) $ 5,829 $ (83,436)
Mortgage-backed securities (3) 26,187 (14,606) 11,581 34,290 (13,215) 21,075
Federal funds sold (397) (239) (636) (2,093) (1,452) (3,545)
Trading securities - - - (14,283) - (14,283)
Investment securities 3,914 13 3,927 (3,406) (93) (3,499)
Other interest-earning assets 196 (1,990) (1,794) 2,636 (3,487) (851)
--------- --------- ---------- --------- --------- ----------
Total interest income (3,253) (50,966) (54,219) (72,121) (12,418) (84,539)
--------- --------- ---------- --------- --------- ----------
Interest expense:
Deposit accounts (11,245) (42,584) (53,829) (19,666) (79,423) (99,089)
Borrowings 15,490 (8,904) 6,586 (4,706) (7,155) (11,861)
--------- --------- ---------- --------- --------- ----------
Total interest expense 4,245 (51,488) (47,243) (24,372) (86,578) (110,950)
--------- --------- ---------- --------- --------- ----------
Increase (decrease) in
net interest income $ (7,498) $ 522 $ (6,976) $(47,749) $ 74,160 $ 26,411
========= ========= ========== ========= ========= ==========
- ------------------------------------------------------------------------------------------------------------
<FN>
(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 rates.
(2) Includes loans held for sale and/or securitization.
(3) Includes mortgage-backed securities held for sale.
- 113 -
Interest income in fiscal 1993 decreased $54.2 million from the level in
fiscal 1992 as a result of lower average yields on the loan portfolio and lower
average balances of loans. The effect of the lower average yields on loans,
which reflected a decline in market interest rates, and lower average loan
balances was partially offset by higher average balances of certain
interest-earning assets, principally mortgage-backed securities and, to a lesser
extent, U.S. Government securities.
The Bank's net interest spread declined to 5.16% from 5.96%, reflecting
in part the effect of the Bank's actions to restructure its balance sheet as
part of its capital enhancement program. See "Liquidity and Capital Resources -
Banking - Capital." As described below, in order to reduce its overall
risk-based capital requirement, the Bank invested the proceeds from the
securitization and sale of home equity credit line and credit card receivables
in lower-yielding securities. In view of its improved capital position, the
Bank does not anticipate that it will be required in future periods to continue
to pursue comparable asset reallocations that could adversely affect its net
interest spread.
Interest income on loans, the largest category of the Bank's
interest-earning assets, declined by $67.3 million (or 21.9%) due to lower
average balances and decreased yields. The Bank's loan securitization and sale
activity was the single largest factor in reducing loan balances. The
securitization and sale of $194.2 million and $146.2 million of home equity
credit line receivables in the first and fourth quarters of fiscal 1993,
respectively, were reflected in a decrease of $27.5 million (or 15.0%) in
average balances of this loan type. A decrease of $259.5 million in average
credit card loan balances resulting from the securitization and sale of $200.0
million of credit card receivables in the fourth quarter of fiscal 1993 and
$150.0 million and $280.0 million of credit card receivables in the March 1993
and 1992 quarters, respectively, contributed to a $51.9 million decrease in
interest income from this category of loans. Average loan balances in the
construction and ground loan categories decreased $49.6 million (or 42.5%) from
the level in fiscal 1992 primarily as a result of loan principal repayments and
the acquisition of the underlying collateral through foreclosure or
categorization of the loans as in-substance foreclosed. Average loan balances of
residential permanent loans increased $10.1 million as a result of the Bank's
increased origination of single-family residential loans during fiscal 1993.
A decrease of 150 basis points in the average yield on the loan portfolio
for the year ended September 30, 1993 resulted primarily from a decrease to
7.33% from 8.62% in the average yield on residential permanent loans and a
decrease to 7.05% from 8.51% in the average yield on home equity credit line
loans. The Bank's residential permanent loans and home equity credit line loans
generally bear interest at variable rates that adjust based on specified market
interest rates, which declined from levels prevailing in fiscal 1992. See
"Business - Banking - Lending Activities - Single-Family Residential Real Estate
Lending."
Interest income on mortgage-backed securities increased $11.6 million
primarily as a result of higher average balances of these assets. Average
balances increased $393.0 million (or 35.2%) from the level in fiscal 1992
primarily as a result of increased purchases of mortgage-backed securities
during the year. Mortgage-backed security balances increased primarily as result
of management's desire to reduce its overall risk-based capital requirement.
Management accomplished this objective by reinvesting proceeds from the
securitization and sale of home equity credit line and credit card receivables
securitizations, and to a lesser extent, early curtailments on its residential
loans into
- 114 -
government and mortgage-backed securities. The effects of the higher average
balances were offset in part by lower average yields on these securities
resulting from lower market interest rates.
Interest income on securities increased $3.9 million as a result of higher
average balances of U.S. Government securities. As discussed above, the Bank's
higher balances in U.S. Government securities was a result of management's
desire to reduce risk- based capital requirements. Other interest income
decreased $2.4 million during the year ended September 30, 1993 primarily
because of lower average yields of interest bearing deposits, which declined to
2.2% from 3.8% (or 41.6%), and lower average yields and balances of federal
funds sold, which declined to 3.0% from 4.1% and to $14.3 million from $25.9
million (or 44.9%), respectively. The Bank's decrease in federal funds sold,
resulted primarily from the immediate reinvestment of various securitization
proceeds into agency mortgage-backed securities rather than into federal funds.
Interest expense decreased $47.2 million (or 22.0%) for the year ended
September 30, 1993 because of a decline of $53.8 million in interest expense on
deposits, the largest category of interest-bearing liabilities. Interest expense
on deposits decreased primarily as a result of a decrease in average rates (to
3.35% from 4.45%), which reflected a decline in market interest rates, and
secondarily to a decline of $266.6 million in average deposit balances. The
decline in average deposit balances, which began in fiscal 1992, has been
primarily attributable to two factors. First, thrifts and banks generally
experienced a net outflow of deposits in 1992 and 1993 as a result of low market
interest rates and the relative strength and attractiveness of bonds and equity
securities as alternate investments. Second, the Bank pursued a more
conservative strategy in fiscal 1992 than certain of its competitors in setting
interest rates on deposits, particularly on more costly certificates of deposit
and money market deposits. Interest on borrowings increased by $6.6 million,
primarily because of higher average balances of short-term borrowings which
replaced decreased deposit balances. The higher average balances of such
borrowings were offset in part by lower average interest rates.
PROVISION FOR LOAN LOSSES. The Bank's provision for loan losses decreased
to $62.5 million in the year ended September 30, 1993 from $89.1 million in the
prior fiscal year. The decrease was primarily attributable to a decrease of
$23.7 million in the provision for losses on credit card loans. The
securitization and sale of $200.0 million of credit card receivables in the
fourth quarter of fiscal 1993 and of $150.0 million and $280.0 million of credit
card receivables in the March 1993 and 1992 quarters, respectively, reduced the
amount of such receivables against which the Bank maintains the reserve. See
"Financial Condition - Banking - Asset Quality - Reserves for Losses."
OTHER INCOME. The increase in other (non-interest) income to $130.8
million for the year ended September 30, 1993 from $100.4 million
- 115 -
for fiscal 1992 was primarily attributable to an increase in loan and deposit
servicing fees, an increase in the gain on sales of securities and a decrease in
the loss on real estate held for investment or sale. These items were partially
offset by decreases in credit card fees and in gain on sales of credit card
relationships, loans and mortgage-backed securities.
Credit card fees, consisting of membership fees, late charges, interchange
fees and cash advance charges, decreased $8.2 million for the year ended
September 30, 1993 from the level in fiscal 1992. The decrease was attributable
to a decrease in interchange fees, a decrease in late charges collected and a
decrease in annual membership fees as a result of a lower number of accounts due
primarily to credit card securitization activity.
Loan servicing fees increased $6.2 million for the year ended September
30, 1993. Higher levels of securitized receivables serviced by the Bank
contributed to an increase of $6.9 million in credit card servicing fees, and
higher levels of purchased mortgage servicing rights contributed to an increase
of $2.6 million in residential single-family mortgage servicing fees. As the
Bank securitizes and sells assets, purchases mortgage servicing rights, or sells
mortgage loans and retains the servicing rights on those loans, servicing fee
income levels increase. The level of servicing fee income declines upon
repayment of assets previously securitized and sold and upon prepayment of
mortgage loans serviced for others. The amortization of the excess servicing
asset related to home equity credit line securitizations increased $3.8 million,
primarily due to an increase in the average prepayment rate of the underlying
receivables, which reflected continued high levels of loan prepayment activity.
The gain on sales of securities increased to $8.9 million as a result of
the Bank's sale in June 1993 of its portfolio of five-year U.S. Government
securities with a book value of $172.9 million. The Bank sold these securities
primarily to permit increased mortgage loan origination activity which would
otherwise have been limited under the asset growth limitations imposed on the
Bank by the OTS. See "Financial Condition - Banking - Capital - Regulatory
Action and Requirements."
The $37.9 million decrease in the loss on real estate held for investment
or sale was primarily attributable to a decrease in the provision for losses on
these assets of $30.2 million. See "Financial Condition - Banking - Asset
Quality - Reserves for Losses."
Gain on sales of credit card relationships, loans and mortgage-backed
securities in fiscal 1993 decreased $12.9 million from fiscal 1992 levels,
primarily because of a decrease in the amount of mortgage-backed securities
sold. In the June 1992 quarter, the Bank sold $438.4 million of long-term
fixed-rate mortgage-backed securities, which resulted in a gain of $21.0
million, in order to mitigate the effects on the Bank's capital levels of an
increase in the Bank's reserves for
- 116 -
losses on real estate and real estate-related charge-offs taken in the same
quarter. The decrease in the gain on sales of credit card relationships, loans
and mortgage-backed securities was partially offset by a $4.8 million gain
recognized on the sale of the Bank's portfolio of seven-year balloon fixed-rate
mortgage-backed securities, totaling $127.8 million, in the March 1993 quarter.
These securities were sold primarily to provide the Bank with flexibility under
existing regulatory growth limits and to reduce the Bank's exposure to possible
future increases in long-term interest rates. In addition, the Bank recognized
aggregate gains of $16.8 million on its securitization and sale of home equity
credit line receivables in fiscal 1993 compared to gains of $15.1 million in
fiscal 1992. See "Financial Condition - Banking - Capital - Regulatory Action
and Requirements."
OPERATING EXPENSES. Operating expenses for the year ended September 30,
1993 increased $29.5 million (18.9%) from the level in fiscal 1992. This
increase was primarily attributable to increases in salaries and employee
benefits, loan expenses and advertising expenses. Salaries and employee benefits
increased $7.0 million, of which $5.5 million resulted from staffing increases,
primarily in the asset workout, loan origination support and telemarketing
areas. The remaining increase was attributable to the increase in the level of
the Bank's contributions to its employee profit sharing plan. The $8.5 million
increase in advertising expenses was primarily attributable to increased direct
mail solicitation by the Bank of its credit card products and services in
connection with the resumption of active national solicitation of new credit
card accounts. See "Business - Banking - Lending - Credit Card Lending." The
$14.2 million increase in loan expenses was due primarily to a $10.5 million
increase in the amortization of purchased mortgage servicing rights, which
resulted from the amortization of the purchase price of approximately $1.2
billion principal amount of residential single-family mortgage servicing rights
acquired by the Bank during fiscal 1993 and the increased prepayments of the
underlying loans. See "Business - Banking - Lending - Loan Servicing."
Management believes that there exist additional opportunities to enhance
the Bank's longer-term profitability. In order to take advantage of such
opportunities, the Bank will be required to incur increased expenditures for
salaries and employee benefits, loan expenses and advertising expenses, which
will contribute to higher operating expenses in future periods.
FISCAL YEAR 1992 COMPARED TO FISCAL YEAR 1991
REAL ESTATE
The Real Estate Trust recorded an operating loss of $28.5 million for the
fiscal year ended September 30, 1992, which represented an $8.5 million increase
from the $20.0 million operating loss recorded for fiscal 1991. The operating
results for fiscal 1991 included a $20.3 million gain on the sale of a shopping
center, while fiscal 1992 results reflected a $0.5 million loss on property
sales. Excluding the effect of property sales in the two years, the Real Estate
Trust's operating loss declined to $28.0 million in fiscal 1992 from $40.3
million in fiscal 1991. This decreased operating loss was principally
attributable to lower interest expense as a result of declining market interest
rates and lower average indebtedness, a reduction in advisory fee payments and a
decrease in general and administrative costs. Of the loss recorded in
- 117 -
fiscal 1992, $15.1 million consisted of depreciation and amortization charges.
Income after direct operating expenses from commercial properties, which
include both shopping center and office properties, decreased $1.0 million
(2.6%) in fiscal 1992 from the prior fiscal year. The decrease was attributable
to a decline of $1.6 million (or 10.5%) in income from the office portfolio.
Base rent and expense recoveries, which declined 8.3% and 27.9%, respectively,
from the previous year, were adversely affected in fiscal 1992 by a reduction in
the leasing rate for the office portfolio. The level of leased office space
decreased to 81% at September 30, 1992 from 89% at September 30, 1991. The lower
leasing rate reflected the general recessionary economic conditions in the
markets in which these properties are located. Notwithstanding a slight
reduction in the leasing rate for shopping centers (to 95% from 96%) during the
same period, income from shopping centers increased $0.6 million (or 2.8%) in
fiscal 1992. An increase in lease termination payments in fiscal 1992 more than
offset slight declines in base rent, expense recoveries and percentage rent.
Income after direct operating expenses from hotel properties increased
$2.0 million (18.7%) in fiscal 1992 from the prior fiscal year. Approximately
$0.9 million of the increase was attributable to a 1.9% increase in income,
which resulted primarily from higher room sales, while $1.1 million of the
increase reflected a 3.2% reduction in operating costs, which consisted
principally of lower employment costs, property taxes and maintenance costs.
Lower interest rates and lower average total indebtedness contributed to a
decrease of $6.1 million (10.6%) in interest expense. Average balances of the
Real Estate Trust's outstanding borrowings declined to $478.9 million in fiscal
1992 from $492.9 million in fiscal 1991, primarily as the result of scheduled
amortization. A decrease in market interest rates, on which adjustments to the
interest rates of the Real Estate Trust's mortgage notes are based, was
reflected in a decline in the average interest rate paid on borrowings to 11.1%
in fiscal 1992 from 11.9% in fiscal 1991.
Advisory, management and leasing fees-related parties decreased $1.9
million (21.5%) in fiscal 1992, primarily as the result of a reduction in the
monthly advisory fee, effective April 1, 1991, to $97,000 from $318,000.
General and administrative expense decreased $847,000 (16.7%) in fiscal
1992 from the level in the prior year. Fiscal 1991 general and administrative
expense reflected the inclusion of a $2.1 million write-off of costs associated
with an abandoned securities offering. Legal expenses increased in fiscal 1992
by $1.3 million as a result of the payment of a litigation judgment awarded
against the Trust.
- 118 -
BANKING
OVERVIEW. The Bank recorded operating income of $43.4 million for the year
ended September 30, 1992, compared to an operating loss of $6.1 million for
fiscal 1991. The increase in operating income for the year ended September 30,
1992 was primarily due to an increase in the Bank's net interest spread (from
4.91% to 5.96%), which generated higher profits in the Bank's core businesses of
mortgage banking, home equity credit line lending and credit card lending,
reductions in operating expenses and a decrease in the provision for loan
losses. The increase in net interest income after provision for loan losses
during the current period was offset by a significant decrease in other income
resulting primarily from reduced gains on sales of credit card relationships,
loans and mortgage-backed securities.
NET INTEREST INCOME. Net interest income, before the provision for loan
losses, increased $26.4 million (or 16.3%) for the year ended September 30,
1992, reflecting an increase of 105 basis points in the Bank's net interest
spread. Because market interest rates generally declined in fiscal 1992, the
Bank's interest sensitivity gap contributed to the higher net interest spread,
as the average rate on interest-bearing liabilities (primarily deposits)
decreased at a rate greater than the decrease in the average yield on
interest-earning assets. See "Financial Condition - Banking - Asset and
Liability Management."
The Bank would have recorded additional net interest income of $11.3
million for the year ended September 30, 1992 if the Bank's non-accrual assets
and restructured loans had been current in accordance with their original terms.
During fiscal years 1990 and 1991, the Bank's non-interest income had a
significant effect on net income, because the Bank pursued a strategy of
generally selling all of its long-term fixed-rate mortgage production and
securitizing and selling credit card and home equity credit line receivables, in
part in furtherance of its asset-liability management strategy. See "Financial
Condition - Banking - Asset and Liability Management." Sales of such assets by
the Bank reduce the Bank's level of interest-earning assets, which could
contribute to lower interest income in the future. Such sales also may
contribute to an increase in other income, as a result of increased servicing
fees earned by the Bank on portfolios of home equity credit line and credit card
receivables securitized and sold by the Bank.
Interest income decreased $84.5 million in fiscal 1992 from the level in
fiscal 1991. Lower average balances of loans and, to a lesser extent, reduced
yields on mortgage-backed securities resulting from lower market interest rates
contributed to the decrease.
Interest income on loans, the largest category of interest-earning assets,
declined by $83.4 million due primarily to lower average balances. The Bank's
loan securitization and sale activity was the single
- 119 -
largest factor in reducing loan balances, although interest income on commercial
permanent, construction and ground loans decreased $13.2 million due to the
increase in the level of the Bank's real estate acquired in settlement of loans.
Interest income on residential permanent loans decreased $21.1 million due in
part to lower loan balances in that category resulting from the exchange of
$616.4 million of single-family mortgages for private label, AA-rated
mortgage-backed securities in the March 1992 quarter. Interest income on home
equity credit line loans decreased $22.1 million due primarily to decreases in
average balances of $159.4 million resulting from the securitization and sale of
$600.1 million and $253.6 million of these types of loans in the first quarter
of fiscal 1991 and the first quarter of 1992, respectively. Interest income on
other consumer loans decreased $16.5 million primarily because average balances
on these loans decreased $143.4 million as the result of the securitization and
sale of $113.9 million of automobile loan receivables in the fourth quarter of
fiscal 1991. Interest income on credit card loans decreased $7.9 million
primarily due to reduced average balances resulting from the securitization and
sale of $280.0 million of credit card receivables in March 1992.
A yield increase of 19 basis points on the loan portfolio for the year
ended September 30, 1992 resulted primarily from an increase in the yield on
credit card loans, from 17.80% to 18.24%. Partially offsetting this increase
was a decrease in the yield on residential permanent loans of 77 basis points,
from 9.39% to 8.62%. The Bank's residential permanent loans generally bear
interest at variable rates that adjust based on specified market interest rates,
which declined from levels prevailing in fiscal 1991.
Interest income on mortgage-backed securities increased $21.1 million
primarily as the result of higher average balances due to the $616.4 million
exchange in the March 1992 quarter. The increase was partially offset by lower
average yields on these securities resulting from lower market interest rates.
Interest income on trading securities declined $14.3 million, as the Bank
did not hold trading securities during fiscal 1992.
Interest income on investment securities decreased $3.5 million as the
result of lower average balances of U.S. Government securities.
Other interest income decreased $4.4 million from fiscal 1991 primarily
due to a decline in income on federal funds sold. Interest income on federal
funds sold decreased $3.5 million as average balances decreased $39.4 million
and the average yield declined by 295 basis points.
Interest expense decreased $111.0 million (or 34.1%) for the year ended
September 30, 1992 primarily because of a decline of $99.1 million in interest
expense on deposits, the largest category of interest-bearing liabilities.
Interest expense on deposits decreased primarily due
- 120 -
to a decrease in average rates (from 6.36% to 4.45%), which reflected a decline
in market interest rates, and secondarily to a decline of $328.2 million in
average deposit balances. Interest on borrowings decreased $11.9 million because
of lower average interest rates and, to a lesser extent, lower average balances.
PROVISION FOR LOAN LOSSES. The provision for loan losses decreased $58.1
million in fiscal 1992 from the provision in fiscal 1991. The provision for
credit card and other consumer loans decreased $35.7 million, primarily because
the March 1992 securitization and sale of $280.0 million of credit card
receivables reduced the amount of receivables against which the Bank maintains
the reserve. The provision for losses on real estate loans decreased by $22.4
million, as corresponding balances on real estate construction and ground loans
decreased by $41.6 million.
OTHER INCOME. The significant decrease in other income (to $100.4 million
for the year ended September 30, 1992 from $161.1 million for the year ended
September 30, 1991) was primarily attributable to (i) a decline in loan
servicing fee income, (ii) a decline in credit card fees, (iii) an increase in
the loss on real estate held for investment and (iv) a decrease in gains on
sales of credit card relationships, loans and mortgage-backed securities.
Loan servicing fees decreased $7.7 million (or 16.2%) in fiscal 1992
compared to fiscal 1991. The decline was partially attributable to a net
decrease of $3.4 million in home equity credit line and automobile loan
servicing fees. A decrease of $10.8 million related to changes in the method of
amortizing gains previously recognized on the securitization and sale of home
equity credit line and automobile loan receivables, and a decrease of $6.6
million in credit card servicing fees, which was related to temporary
subservicing agreements on credit card relationships previously sold, was
partially offset by an increase of $7.4 million in fees earned by the Bank in
servicing portfolios of home equity credit line receivables securitized in
December 1990 and December 1991. In addition, credit card servicing fees
increased by $3.6 million due to the securitization and sale of $280.0 million
of credit card receivables in March 1992. As the Bank securitizes and sells
assets, purchases mortgage servicing rights, or sells mortgage loans and retains
the servicing rights on those loans, the level of servicing fee income
increases. Servicing fee income declines upon repayment of assets previously
securitized and sold and repayment of mortgage loans serviced for others.
Credit card fees, consisting of membership fees, late charges, interchange
fees and cash advance charges, decreased $7.2 million (or 17.3%) for the year
ended September 30, 1992, compared to fiscal 1991. The decline was primarily
attributable to lower volumes of cardholder purchases on which the Bank receives
fees.
- 121 -
The increase of $3.2 million in the loss on real estate held for
investment in fiscal 1992 resulted primarily from an increase in the provision
for losses on real estate of $12.6 million. The increased provision was
partially offset by a $9.4 million increase in operating income and gains on
sales attributable to the Bank's real estate held for investment or sale.
The gain on sales of credit card relationships, loans and mortgage-backed
securities decreased $24.9 million from the gain recorded for fiscal 1991.
During the year ended September 30, 1992, the Bank sold long-term fixed-rate
mortgage-backed securities with a book value of $817.5 million, of which $387.7
million constituted sales of mortgage-backed securities from the Bank's mortgage
banking operations, and recognized net gains of $16.7 million, securitized and
sold $253.6 million of home equity credit line receivables and recognized a gain
of $15.1 million, and sold credit card relationships with related receivables
balances of $14.9 million and recognized a gain of $1.4 million. During fiscal
1991, mortgage-backed securities with a book value of $815.9 million were sold,
of which $189.2 million constituted mortgage-backed securities from the Bank's
mortgage banking operations, $600.1 million of home equity credit line
receivables were securitized and sold and $273.4 million of credit card
receivables were sold, resulting in gains of $20.0 million, $25.8 million and
$20.7 million, respectively. See "Business - Banking - Lending Activities -
Sales of Mortgage-Backed Securities."
The $3.8 million gain on sales of mortgage servicing rights during the
year ended September 30, 1992 resulted from the sale of $255.7 million of such
rights. The $9.1 million gain in fiscal 1991 resulted from the sale of $1.0
billion of mortgage servicing rights. The Bank will continue to sell mortgage
servicing rights related to mortgage loans which are originated for sale to
third parties.
OPERATING EXPENSES. Operating expenses decreased $25.8 million (or 14.2%)
in fiscal 1992 from the level in the previous year. The decrease reflects the
effects of the Bank's program to reduce operating expenses, which was initiated
in the latter half of fiscal 1990 and was reflected in the Bank's capital plan.
The principal components of the overall decline were a decrease of $15.6 million
in salaries and employee benefits (primarily as a result of reduced staffing
levels), a decrease of $5.1 million in computer expenses and a decrease of $2.2
million in advertising expenses. The lower computer and advertising expenses
were achieved primarily by the curtailment of the Bank's credit card account
solicitation activities.
- 122 -
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:
Page
----
(a) Independent Auditor's Report F-2
(b) Consolidated Balance Sheets - September 30,
1993 and 1992 F-3
(c) Consolidated Statements of Operations -
Years ended September 30, 1993, 1992 and 1991 F-4
(d) Consolidated Statements of Shareholders'
Equity - Years ended September 30, 1993,
1992, and 1991 F-6
(e) Consolidated Statements of Cash Flows -
Years ended September 30, 1993, 1992 and 1991 F-7
(f) Summary of Significant Accounting Policies F-9
(g) Notes to Consolidated Financial Statements F-16
The selected quarterly financial data included in Note 35 of Notes to the
Consolidated Financial Statements referred to above are incorporated herein by
reference.
F-1
INDEPENDENT AUDITOR'S REPORT
To the Trustees and Shareholders of
B. F. Saul Real Estate Investment Trust
We have audited the accompanying consolidated balance sheets of B. F. Saul Real
Estate Investment Trust as of September 30, 1993 and 1992, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the years in the three-year period ended September 30, 1993. These
financial statements are the responsibility of the Trust's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 financial position of B. F. Saul Real
Estate Investment Trust as of September 30, 1993 and 1992, and the results of
its operations and its cash flows for each of the years in the three-year period
ended September 30, 1993, in conformity with generally accepted accounting
principles.
As explained in Summary of Significant Accounting Policies - the Bank, effective
December 31, 1992, the Bank changed its method of accounting for foreclosed
assets.
STOY, MALONE & COMPANY, P.C.
Bethesda, Maryland
November 4, 1993
F-2
CONSOLIDATED BALANCE SHEETS
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- --------------------------------------------------------------------
September 30
---------------------------
(DOLLARS IN THOUSANDS) 1993 1992
- ----------------------------------------------------------------------------------------------- ------------- -------------
ASSETS
REAL ESTATE
Income-producing properties
Commercial $109,513 $231,315
Hotel 111,484 111,662
Other 3,985 7,189
------------- -------------
224,982 350,166
Accumulated depreciation (62,626) (95,466)
------------- -------------
162,356 254,700
Land parcels 38,411 50,981
Cash and cash equivalents 2,710 628
Other assets 17,079 28,069
------------- -------------
Total real estate assets 220,556 334,378
------------- -------------
BANKING
Cash and due from banks 178,508 115,975
Interest-bearing deposits 4,691 4,566
Investment securities (market value $4,822 and $180,845, respectively) 4,789 173,390
Loans held for sale 176,027 175,698
Loans held for securitization and sale 300,000 350,000
Mortgage-backed securities (market value $1,528,060 and $1,640,819, respectively) 1,501,192 1,599,653
Loans receivable (net of reserve for losses of $68,040 and $78,818, respectively) 1,861,753 1,636,359
Federal Home Loan Bank stock 31,150 29,385
Real estate held for investment or sale (net of reserve for losses of $111,644 and $109,044,
respectively) 388,459 521,927
Property and equipment, net 135,800 145,726
Cost in excess of net assets acquired, net 9,383 12,244
Excess servicing assets, net 27,573 29,549
Purchased mortgage servicing rights, net 20,472 13,007
Other assets 232,974 191,277
------------- -------------
Total Banking assets 4,872,771 4,998,756
------------- -------------
TOTAL ASSETS $5,093,327 $5,333,134
============= =============
LIABILITIES
REAL ESTATE
Mortgage notes payable $264,776 $429,968
Notes payable - unsecured due 1992-2003 38,661 50,417
Deferred gains - real estate 109,027 4,687
Other liabilities and accrued expenses 37,689 37,688
------------- -------------
Total real estate liabilities 450,153 522,760
------------- -------------
BANKING
Deposit accounts 3,870,023 3,915,958
Securities sold under repurchase agreements and other short-term borrowings 88,266 450,321
Bonds payable 24,605 25,130
Notes payable 7,925 8,640
Federal Home Loan Bank advances 412,000 275,000
Custodial accounts 25,925 14,518
Amounts due to banks 26,723 22,950
Other liabilities and accrued expenses 40,034 34,172
Capital notes -- subordinated 138,500 138,500
------------- -------------
Total banking liabilities 4,634,001 4,885,189
------------- -------------
Commitments and contingencies (Notes 1, 3, 4, 7, 17, 19, 25, 26, 28, 30, and 32)
Minority interest held by affiliates 34,495 27,912
Minority interest -- other 74,307 0
------------- -------------
TOTAL LIABILITIES 5,192,956 5,435,861
------------- -------------
SHAREHOLDERS' EQUITY (DEFICIT)
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
Deficit (157,882) (160,980)
------------- -------------
(57,781) (60,879)
Less cost of 1,814,688 common shares of beneficial interest in treasury (41,848) (41,848)
------------- -------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) (99,629) (102,727)
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $5,093,327 $5,333,134
============= =============
- ---------------------------------------------------------------------------------------------------------------------------
See summary of significant accounting policies and notes to consolidated
financial statements.
F-3
CONSOLIDATED STATEMENTS OF OPERATIONS
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- ---------------------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED SEPTEMBER 30
-----------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1993 1992 1991
- --------------------------------------------------------------------------------- ------------- ------------- -------------
REAL ESTATE
Income
Commercial properties $45,736 $51,489 $54,035
Hotels 45,385 46,628 45,769
Other 2,124 2,062 2,209
------------- ------------- -------------
Total income 93,245 100,179 102,013
------------- ------------- -------------
Expenses
Direct operating expenses:
Commercial properties 13,708 14,416 15,962
Hotels 33,497 33,963 35,099
Land parcels and other 1,623 1,814 2,036
Interest expense 50,470 51,326 57,419
Interest capitalized 0 0 (37)
Amortization of debt expense 3,029 1,698 2,729
Depreciation 12,457 13,400 14,827
Advisory, management and leasing fees - related parties 7,249 7,093 9,036
General and administrative 2,119 4,226 5,073
Abandoned development costs 13,104 0 0
------------- ------------- -------------
Total expenses 137,256 127,936 142,144
------------- ------------- -------------
Equity in losses of partnership investments (668) (208) (212)
------------- ------------- -------------
Gain (loss) on sales of property 184 (546) 20,308
------------- ------------- -------------
REAL ESTATE OPERATING LOSS $(44,495) $(28,511) $(20,035)
------------- ------------- -------------
BANKING
Interest income
Loans $240,443 $307,740 $391,176
Mortgage-backed securities 95,085 83,504 62,429
Trading securities 0 0 14,283
Investment securities 8,086 4,159 7,658
Other 5,200 7,630 12,026
------------- ------------- -------------
Total interest income 348,814 403,033 487,572
------------- ------------- -------------
Interest expense
Deposit accounts 127,792 181,621 280,710
Short-term borrowings 13,333 12,169 24,135
Long-term borrowings 26,393 20,971 20,866
------------- ------------- -------------
Total interest expense 167,518 214,761 325,711
------------- ------------- -------------
Net interest income 181,296 188,272 161,861
Provision for loan losses (62,513) (89,062) (147,141)
------------- ------------- -------------
Net interest income after provision for loan losses 118,783 99,210 14,720
------------- ------------- -------------
Other income
Credit card fees 26,405 34,611 41,856
Loan servicing fees 46,083 39,924 47,632
Deposit service fees 18,575 17,756 15,953
Gain on sales of securities, net 8,895 0 12,810
Loss on real estate held for investment or sale, net (12,722) (50,649) (47,495)
Gain on sales of credit card relationships, loans and mortgage-backed
securities, net 31,375 44,259 69,117
Gain on sales of mortgage servicing rights, net 4,828 3,750 9,137
Other 7,314 10,766 12,133
------------- ------------- -------------
Total other income 130,753 100,417 161,143
------------- ------------- -------------
Continued on following page
F-4
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- ---------------------------------------------------------------------------------------------------------------------------
For the Year Ended September 30
-----------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1993 1992 1991
- --------------------------------------------------------------------------------- ------------- ------------- -------------
Operating expenses
Salaries and employee benefits $ 69,739 $ 62,725 $ 78,344
Loan expenses 22,001 7,799 9,394
Property and equipment 24,039 24,481 24,653
Advertising expenses 13,157 4,632 6,831
Computer expenses 22,249 22,801 27,940
Deposit insurance premiums 11,273 9,736 9,941
Amortization of cost in excess of net assets acquired 2,863 3,143 3,279
Other 20,366 20,901 21,593
------------- ------------- -------------
Total operating expenses 185,687 156,218 181,975
------------- ------------- -------------
BANKING OPERATING INCOME (LOSS) $ 63,849 $ 43,409 $ (6,112)
------------- ------------- -------------
TOTAL COMPANY
Operating income (loss) before income taxes, extraordinary items
and minority interest $ 19,354 $ 14,898 $ (26,147)
Provision for income taxes 11,703 7,385 3,225
------------- ------------- -------------
Income (loss) before extraordinary items and minority interest 7,651 7,513 (29,372)
Extraordinary items:
Adjustment for tax benefit of operating loss carryovers 7,738 3,817 0
Loss on early extinguishment of debt 0 (132) 0
------------- ------------- -------------
Income (loss) before minority interest 15,389 11,198 (29,372)
Minority interest held by affiliates (6,582) (5,261) 2,113
Minority interest -- other (4,334) 0 0
------------- ------------- -------------
TOTAL COMPANY NET INCOME (LOSS) $ 4,473 $ 5,937 $ (27,259)
============= ============= =============
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS $ (947) $ 517 $ (32,679)
NET INCOME (LOSS) PER COMMON SHARE
Income (loss) before extraordinary items and minority interest $0.46 $0.43 $ (7.21)
Extraordinary items:
Adjustment for tax benefit of operating loss carryovers 1.60 0.79 0.00
Loss on early extinguishment of debt 0.00 (0.03) 0.00
------------- ------------- -------------
Income (loss) before minority interest 2.06 1.19 (7.21)
Minority interest held by affiliates (1.36) (1.08) 0.44
Minority interest - other (0.90) 0.00 0.00
------------- ------------- -------------
NET INCOME (LOSS) PER COMMON SHARE $ (0.20) $ 0.11 $ (6.77)
============= ============= =============
- ---------------------------------------------------------------------------------------------------------------------------
See summary of significant accounting policies and notes to consolidated
financial statements.
F-5
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- --------------------------------------------------------------------------------
- -------------------------------------------
For the Year Ended September 30
-----------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1993 1992 1991
- --------------------------------------------------------------------------------- ------------- ------------- -------------
PREFERRED SHARES OF BENEFICIAL INTEREST (Note 34)
Beginning and end of year (516,000 shares) $516 $516 $516
------------- ------------- -------------
COMMON SHARES OF BENEFICIAL INTEREST
Beginning and end of year (6,641,598 shares) 6,642 6,642 6,642
------------- ------------- -------------
PAID-IN SURPLUS (Note 34)
Beginning and end of year 92,943 92,943 92,943
------------- ------------- -------------
DEFICIT (Note 34)
Beginning of year (160,980) (166,917) (138,458)
Net income (loss) 4,473 5,937 (27,259)
Dividend distributions:
Real Estate Trust:
Redeemable preferred (per share: 1993 - $550.00) (1,375) 0 0z
Preferred (per share: 1991 - $2.32) 0 0 (1,200)
------------- ------------- -------------
End of year (157,882) (160,980) (166,917)
------------- ------------- -------------
TREASURY SHARES
Beginning and end of year (1,814,688 shares) (41,848) (41,848) (41,848)
------------- ------------- -------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) $(99,629) $(102,727) $(108,664)
============= ============= =============
- ---------------------------------------------------------------------------------------------------------------------------
See summary of significant accounting policies and notes to consolidated
financial statements.
F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- --------------------------------------------------------------------------------
- -------------------------------------------
For the Year Ended September 30
-----------------------------------------
(IN THOUSANDS) 1993 1992 1991
- --------------------------------------------------------------------------------- ------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
REAL ESTATE
Net loss $(21,857) $(15,108) $(18,809)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 12,457 13,400 14,827
Abandoned development costs 13,104 0 0
(Gain) loss on sales of property (184) 546 (20,308)
Decrease (increase) in accounts receivable and accrued income 98 2,906 (1,380)
Increase in accounts payable and accrued expenses 7,047 11,594 5,700
Increase in tax sharing receivable (22,984) (13,567) (1,284)
Other 9,170 (655) 4,880
------------- ------------- -------------
(3,149) (884) (16,374)
------------- ------------- -------------
BANKING
Net income (loss) 26,330 21,045 (8,450)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Accretion of premiums, discounts and deferred loan fees (7,896) (17,775) (25,218)
Depreciation and amortization 16,191 15,773 14,672
Amortization of cost in excess of net assets acquired, purchased mortgage
servicing rights and excess servicing assets 36,410 24,663 15,175
Provision for loan losses 62,513 89,062 147,141
Purchases of trading securities 0 0 (147,605)
Net fundings of loans held for sale and/or securitization (903,941) (768,149) (258,383)
Proceeds from sales of trading securities 0 0 441,044
Proceeds from sales of loans and securities held for sale and/or
securitization 1,946,826 1,708,234 1,383,972
Equity (earnings) loss from investments in limited partnerships (1,694) (391) 598
(Gain) loss on sales of real estate held for investment or sale, net (9,503) 244 3,124
Provision for losses on real estate held for investment or sale 30,415 60,596 47,983
Gain on sale of securities, net (8,895) 0 (12,810)
Gain on sales of credit card relationships, loans and mortgage-backed
securities, net (31,375) (44,259) (69,117)
Gain on sales of mortgage servicing rights, net (4,828) (3,750) (9,137)
Minority interest held by affiliates 6,582 5,261 (2,113)
Minority interest - other 4,334 0 0
Increase in other assets (41,710) (42,621) (403)
Increase (decrease) in other liabilities and accrued expenses 9,635 (19,709) (10,107)
Increase in tax sharing payable 22,984 13,567 1,284
Other, net 4,779 1,857 9,374
------------- ------------- -------------
1,157,157 1,043,648 1,521,024
------------- ------------- -------------
Net cash provided by operating activities 1,154,008 1,042,764 1,504,650
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
REAL ESTATE
Capital expenditures - properties (7,465) (6,193) (7,720)
Property sales 3,780 4,908 34,544
Equity investment in unconsolidated entities (150) (58) (1,551)
Other investing activities 836 10 458
------------- ------------- -------------
(2,999) (1,333) 25,731
------------- ------------- -------------
BANKING
Proceeds from sales of investment securities 0 0 246,990
Proceeds from maturities of investment securities 0 140,000 520,000
Proceeds from sales of mortgage-backed securities 0 0 646,678
Proceeds from sales of loans 4,954 7,834 428,920
Proceeds from sales of real estate 150,115 44,287 21,776
Proceeds from sales of mortgage servicing rights 5,978 4,790 19,009
Net fundings of loans receivable (463,919) (73,984) (1,473,390)
Principal collected on mortgage-backed securities 447,951 133,152 61,733
Purchases of investment securities (4,682) (173,414) (801,438)
Purchases of mortgage-backed securities (664,284) (1,157,759) (440,076)
Purchases of loans receivable (259,770) (115,557) (281,011)
Purchases of property and equipment (4,602) (3,373) (12,091)
Purchases of mortgage servicing rights (20,716) (1,604) (3,525)
Excess servicing assets capitalized (19,471) (16,943) (41,596)
Disbursements for real estate held for investment or sale (74,320) (28,652) (76,716)
Other investing activities, net 4,117 180 1,704
------------- ------------- -------------
(898,649) (1,241,043) (1,183,033)
------------- ------------- -------------
Net cash used in investing activities (901,648) (1,242,376) (1,157,302)
------------- ------------- -------------
Continued on following page
F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- --------------------------------------------------------------------------------
- -------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------
For the Year Ended September 30
------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1993 1992 1991
- --------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
REAL ESTATE
Proceeds from mortgage financing $ 2,603 $ 35,070 $ 0
Repayments of mortgages (1,907) (5,126) (16,000)
Principal curtailments of mortgages (4,268) (5,065) (2,441)
Proceeds from sales of unsecured notes 6,184 0 0
Repayments of unsecured notes (17,940) (17,115) (21,980)
Proceeds from bank borrowings 0 5,520 12,725
Repayments of bank borrowings (404) (8,441) (11,936)
Costs of obtaining financings (1,170) (4,674) (577)
Net proceeds from the issuance of redeemable preferred stock 21,507 0 0
Dividends paid (1,375) 0 (1,500)
------------- ------------- -------------
3,230 169 (41,709)
------------- ------------- -------------
Banking
Proceeds from customer deposits and sales of certificates of deposit 10,801,085 11,173,419 13,544,669
Customer withdrawals of deposits and payments for maturing certificates of
deposit (10,847,020) (11,520,494) (13,660,230)
Net increase (decrease) in securities sold under repurchase agreements (363,216) 446,367 (398,052)
Advances from Federal Home Loan Bank 744,000 480,000 630,000
Repayments of advances from Federal Home Loan Bank (607,000) (405,000) (430,000)
Proceeds from other borrowings 59,580 62,583 75,264
Repayments of other borrowings (59,658) (64,277) (107,137)
Net proceeds from sale of preferred stock 71,869 0 0
Cash dividends paid on preferred stock (1,896) 0 0
Other financing activities, net 11,406 (15,415) (3,138)
------------- ------------- -------------
(190,850) 157,183 (348,624)
------------- ------------- -------------
Net cash provided by (used in) financing activities (187,620) 157,352 (390,333)
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents 64,740 (42,260) (42,985)
Cash and cash equivalents at beginning of year 121,169 163,429 206,414
------------- ------------- -------------
Cash and cash equivalents at end of year $ 185,909 $ 121,169 $ 163,429
============= ============= =============
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (net of amount capitalized) $215,427 $275,184 $385,187
Income taxes 6,522 5,170 (1,472)
Supplemental schedule of noncash investing and financing activities:
Rollovers of notes payable - unsecured 5,681 0 0
Loans receivable exchanged for mortgage-backed securities 51,956 646,785 121,286
Loans held for sale exchanged for mortgage-backed securities held for sale 442,017 307,782 54,175
Mortgage-backed securities transferred to loans and securities held for sale 131,390 442,412 0
Investment securities transferred to loans and securities held for sale 173,036 0 0
Loans receivable transferred to loans held for securitization and sale 440,361 350,000 647,507
Loans receivable transferred to loans held for sale 0 0 288,313
Loans made in connection with the sale of real estate 54,061 7,766 0
Loans receivable transferred to real estate acquired in settlement of loans 23,158 43,046 177,582
Investments in real estate ventures transferred to real estate
acquired in settlement of loans 0 0 8,502
Mortgage notes payable assumed in connection with foreclosure on real estate
properties 0 0 14,377
- ---------------------------------------------------------------------------------------------------------------------------
See summary of significant accounting policies and notes to consolidated
financial statements.
F-8
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting practices of the B.F. Saul Real Estate Investment
Trust and its consolidated subsidiaries (the "Trust") conform to generally
accepted accounting principles and, as appropriate, predominant practices within
the real estate and banking industries.
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the accounts of the B.F. Saul Real
Estate Investment Trust and its wholly-owned subsidiaries (collectively the
"Real Estate Trust"), which are involved in the ownership and development of
income-producing properties and operation of hotels. The Trust's 80%-owned
banking subsidiary, Chevy Chase Savings Bank, F.S.B., and its subsidiaries (the
"Bank" or the "Corporations") have been consolidated as required under the
Financial Accounting Standards Board's Statement of Financial Accounting
Standards No. 94, Consolidation of All Majority-owned Subsidiaries. Accordingly,
the accompanying financial statements reflect the assets, liabilities, operating
results, and cash flows for two business segments: Real Estate and Banking. All
significant intercompany balances and transactions have been eliminated.
RECLASSIFICATIONS
Certain reclassifications have been made to the consolidated financial
statements for the years ended September 30, 1992 and 1991 to conform with the
presentation used for the year ended September 30, 1993.
INCOME TAXES
The Real Estate Trust files a consolidated federal income tax return which
includes operations of all 80% or more owned subsidiaries. Tax benefits
resulting from utilization of operating loss carryovers for financial statement
purposes are recorded as extraordinary credits.
NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share is determined by dividing net income (loss),
after deducting preferred share dividend requirements, by the weighted average
number of common shares outstanding during the year assuming exercise of any
outstanding stock options, if applicable.
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" (SFAS 109"), was issued in February 1992. SFAS 109 changes the manner in
which companies record deferred tax liabilities or assets and requires ongoing
adjustments for enacted changes in tax rates and regulations. The Trust
currently plans to adopt SFAS 109 in the first quarter of fiscal 1994; however,
SFAS 109 is not expected to have a significant impact on the financial condition
or results of operations of the Trust.
F - 9
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - REAL ESTATE TRUST
CASH EQUIVALENTS
The Real Estate Trust considers all highly liquid debt instruments purchased
with a maturity of three months or less to be cash equivalents.
PROPERTIES
Investments in real property are recorded at 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.
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.
In the initial rental operations of development projects, 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.
Depreciation is calculated using the straight-line method and estimated useful
lives of 33 to 50 years for buildings and up to 20 years for certain other
improvements. Leasehold interests are amortized over the lives of the related
leases using the straight-line method.
INCOME RECOGNITION
Rental and interest income are accrued as earned except when doubt exists as to
their collectibility, in which case accrual is discontinued. When rentals vary
from a straight-line basis due to free rent periods or stepped increases, income
is recognized on a straight-line basis. Additional rental income based on
tenants' gross revenues ("overage rent") is accrued on the basis of the prior
year's overage rents adjusted to give effect to currently available sales data.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate the
value.
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short-term maturity
of these instruments.
LIABILITIES
The fair value of Mortgage notes payable is assumed to approximate carrying
amount since most of the debt has been financed in recent periods. 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, 1993 the fair value of
Notes payable - unsecured was $41.6 million.
The Real Estate Trust and certain of its subsidiaries are obligated to reimburse
the partners of certain partnerships, including a partnership in which the Real
Estate Trust has an equity interest, in an amount of up to $116.1 million if
those partnerships fail to make payments with respect to specified debt and such
partners personally make payments with respect to such debt. See Note 1. The
operations of those partnerships are presently adequate to service that debt.
Accordingly, as of the balance sheet date, the Real Estate Trust has determined
that the fair value of this contingent obligation was zero.
F - 10
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - THE BANK
The Bank 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, primarily
credit card loans.
A summary of significant accounting policies of the Bank is as follows:
AFFILIATION OF CORPORATIONS AND BASIS OF PRESENTATION:
All of the outstanding common stock of the Bank is owned by an affiliated group
of companies, with the majority (80%) owned by the Trust.
CASH AND CASH EQUIVALENTS:
For purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks and interest-bearing deposits.
The Bank is required to maintain reserve balances with the Federal Reserve Bank.
Average reserves maintained at the Federal Reserve Bank were $21.8, $30.2 and
$41.1 million during the years ended September 30, 1993, 1992 and 1991,
respectively.
LOANS HELD FOR SALE:
At September 30, 1993 and 1992, loans held for sale are composed of
single-family residential loans originated or purchased for sale in the
secondary market and are carried at aggregate cost which is lower than aggregate
market value. Single-family residential loans held for sale will either be
delivered against forward whole loan sale commitments or will be exchanged for
mortgage-backed securities and then delivered against forward mortgage-backed
security sale commitments. See Note 28.
SECURITIES HELD FOR SALE:
Securities to be held for indefinite periods of time, including securities that
management intends to use as part of its asset-liability strategy, or that may
be sold in response to changes in interest rates, changes in prepayment risks,
the need to increase regulatory capital or other similar factors, are classified
as held for sale and are carried at the lower of aggregate cost or aggregate
market value. Gains and losses on sales of loans and securities held for sale
are determined using the specific identification method.
LOANS HELD FOR SECURITIZATION AND SALE:
The Bank periodically sells receivables through asset-backed securitizations, in
which receivables are transferred to a trust, and the Bank sells certificates to
investors representing ownership interests in the trust.
F - 11
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - THE BANK (CONTINUED)
The amount of asset-backed securitizations contemplated to occur during the
six-month period subsequent to the balance sheet date is classified as held for
securitization and sale to the extent that such amounts are outstanding. Such
assets held for sale are reported at the lower of aggregate cost or aggregate
market value for each asset type.
INVESTMENT AND MORTGAGE-BACKED SECURITIES:
Investment and mortgage-backed securities held for investment are stated at
cost, adjusted for amortization of premiums and accretion of discounts. Premiums
and discounts are amortized or accreted using the level-yield method. These
securities are carried at amortized cost because management has the intent and
ability to hold such securities until maturity. Gains and losses resulting
from the sale of investment and mortgage-backed securities are determined using
the specific identification method.
TRADING SECURITIES:
Trading securities, which were purchased during fiscal 1990 and sold during
fiscal 1991, were valued at market with gains and losses, both realized and
unrealized, included in gain on sales of securities. There were no realized or
unrealized gains or losses for the years ended September 30, 1993 and 1992.
Realized gains for the year ended September 30, 1991 were $11.7 million. The
Bank had no trading securities at September 30, 1993 and 1992.
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 or straight-line 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 become a component of the gain
or loss on sale.
CREDIT CARD FEES AND COSTS:
Credit card membership fees are deferred and recognized as income on a
straight-line basis over the period the fee entitles the cardholder to use the
card, which is one year. Credit card origination costs are deferred and
recognized as income on a straight-line basis over the privilege period.
RESERVES FOR LOSSES:
Management reviews the loan, real estate held for investment and real estate
held for sale portfolios to establish reserves for estimated losses. The
reserves for losses are reviewed periodically, and reserves are provided after
consideration of the borrower's financial condition and the estimated value of
collateral, including estimated selling and holding costs. Reserves are also
provided by management after considering such factors as the economy in lending
areas, delinquency statistics, past loss experience and estimated future loss
experience.
The reserves for losses are based on estimates and ultimate losses may vary from
current estimates. As adjustments to the reserves become necessary, provisions
for losses are reported in operations in the periods they are determined to be
necessary.
F - 12
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - THE BANK (CONTINUED)
ACCRUED INTEREST RECEIVABLE ON LOANS:
Loans are reviewed on a monthly basis and are placed on a 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
Real estate held for investment consists of an office building, apartment
buildings, developed land and investments in limited partnerships which are
owned by one of the Bank's subsidiaries. Also included in real estate held for
investment is a loan to a developer with a 50% profit participation feature.
This investment in real estate venture, which was non-performing at September
30, 1993, is accounted for as an ADC arrangement.
REAL ESTATE HELD FOR SALE
Real estate held for sale includes in-substance foreclosures and real estate
acquired in settlement of loans. In-substance foreclosures include those
investments for which the Bank has determined that (i) the debtor has little or
no equity in the collateral, considering the current fair value of the
collateral (ii) proceeds for repayment of the loan can be expected to come only
from the operation or sale of the collateral and (iii) the debtor has either
formally or effectively abandoned control to the Bank or retained control of the
collateral but, because of the current financial condition of the debtor, or the
economic prospects for the debtor and/or the collateral, it is doubtful that the
debtor will be able to rebuild equity in the collateral or otherwise repay the
loan in the foreseeable future.
In-substance foreclosures are recorded at the lower of cost or fair value at the
date of reclassification as in-substance foreclosed. Prior to December 31, 1992,
in-substance foreclosures were carried at the lower of adjusted cost or net
realizable value subsequent to the date of reclassification as in-substance
foreclosed. Effective December 31, 1992, in-substance foreclosures are carried
at the lower of adjusted cost or fair value (less estimated selling costs).
Real estate acquired in settlement of loans is recorded at the lower of cost or
fair value at acquisition. Prior to December 31, 1992, real estate acquired in
settlement of loans was carried at the lower of adjusted cost or net realizable
value. Effective December 31, 1992, real estate acquired in settlement of loans
is carried at the lower of adjusted cost or fair value (less estimated selling
costs). Costs relating to development and improvement of property are
capitalized, whereas costs relating to the holding of property are expensed.
Interest costs are capitalized on real estate projects under development.
Capitalized interest amounted to $10.2, $13.2 and $15.8 million for the years
ended September 30, 1993, 1992 and 1991, respectively.
ACCOUNTING STANDARDS ADOPTED
Effective December 31, 1992, OTS regulations required that foreclosed assets
(including assets classified as in-substance foreclosed) be carried at the lower
of cost or fair value. The effect of this regulatory change required the Bank
to adopt Statement of Position 92-3, "Accounting for Foreclosed Assets" ("SOP
92-3"), issued by the Accounting Standards Division of the American Institute of
Certified Public Accountants, before the September 30, 1993 deadline for
adoption that
F - 13
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - THE BANK (CONTINUED)
otherwise would have applied to the Bank. SOP 92-3 requires that foreclosed
assets held for sale (including assets classified as in-substance foreclosed) be
carried at the lower of fair value (less estimated selling costs) or cost. Under
SOP 92-3, the Bank's real estate acquired in settlement of loans (including
assets classified as in-substance foreclosed) is considered to be held for sale.
Due to the early adoption of SOP 92-3, the Bank was required to revise its
method of accounting for in-substance foreclosures and real estate acquired in
settlement of loans. Based on management's internal calculations and
preliminary information with respect to certain appraisals, the Bank recorded
valuation allowances against its foreclosed assets at December 31, 1992 of
approximately $40.5 million to reduce the book balance of foreclosed assets to
fair value. Because the increase in the Bank's reserves during the year ended
September 30, 1992 was designed in part to reduce the effects of SOP 92-3, $21.5
million of valuation allowances previously provided partially offset the
valuation allowances required by SOP 92-3.
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 Bank
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.
COST IN EXCESS OF NET ASSETS ACQUIRED:
Cost in excess of net assets acquired is stated net of accumulated amortization
and is being amortized using the straight-line method over a period of 15 years.
Accumulated amortization was $28.2 and $25.3 million at September 30, 1993 and
1992, respectively.
MORTGAGE SERVICING RIGHTS:
Purchased mortgage servicing rights, which are stated net of accumulated
amortization, are being amortized in proportion to the estimated remaining net
cash flows from the mortgage servicing rights purchased. Amortization of these
assets amounted to $12.1, $1.6, and $2.3 million for the years ended September
30, 1993, 1992 and 1991, respectively. Accumulated amortization was $36.0 and
$27.9 million at September 30, 1993 and 1992, respectively. During fiscal 1993,
1992 and 1991, the Bank capitalized $20.7, $1.6 and $3.5 million, respectively,
related to the acquisition of mortgage servicing rights. During fiscal 1993 and
1991, the Bank sold approximately $1.2 and $9.9 million, respectively, of
rights, to service mortgage loans with principal balances of approximately $76.1
and $977.0 million, respectively, and recognized a loss of $0.4 million in
fiscal 1993 and a gain of $8.6 million in fiscal 1991.
In fiscal 1993, 1992 and 1991, the Bank sold the rights to service mortgage
loans with principal balances of approximately $476.1, $255.7 and $29.6 million,
respectively, which were originated by the Bank in connection with its mortgage
banking activities, and recognized gains of $5.2, $3.8 and $0.6 million,
respectively.
F - 14
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - THE BANK (CONTINUED)
Management periodically evaluates the carrying value of purchased mortgage
servicing rights taking into consideration current portfolio factors such as
prepayment rates. Any adjustments to the assets' carrying value of such rights
as a result of this evaluation are included in the amortization for the
respective period.
EXCESS SERVICING ASSETS:
When loans are sold with the servicing rights retained by the Bank, the net
present value of estimated future servicing income in excess of normal servicing
income is recorded as an adjustment to the sales price of the loans. Estimated
future losses are deducted in the computation of such excess servicing income.
The resulting assets are amortized using the level-yield ("interest") method
over the estimated lives of the underlying loans. Amortization of these assets
amounted to $21.4, $20.0 and $9.7 million for the years ended September 30,
1993, 1992 and 1991, respectively. Accumulated amortization was $52.5 and $31.0
million at September 30, 1993 and 1992, respectively. Excess servicing assets
capitalized in fiscal 1993, 1992 and 1991 of $19.5, $16.9 and $41.6 million,
respectively, were the result of the servicing retained on the securitization of
home equity credit line and automobile loan receivables. See Note 15.
Management periodically evaluates the carrying value of excess servicing assets
taking into consideration current portfolio factors such as prepayment rates.
Any adjustments to the assets' carrying value of such assets as a result of this
evaluation are included in the amortization for the respective period.
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED:
Statement of Financial Accounting Standards No. 114, "Accounting by Creditors
for Impairment of a Loan" ("SFAS 114"), was issued in May 1993. SFAS 114
defines impaired loans and requires such loans to be measured based on the
present value of expected future cash flows or the fair value of the collateral
if the loan is collateral-dependent. SFAS 114 is effective for fiscal years
beginning after December 15, 1994. The Bank has not yet determined the effect
that implementation of SFAS 114 will have on its financial statements, but
believes that such effect will not be material.
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS 115"), was also issued in May
1993. SFAS 115 establishes accounting standards for investments in equity
securities that have readily determinable fair values and for all investments in
debt securities. SFAS 115 requires companies to classify such equity and debt
securities into one of three categories on the date of acquisition and the date
of all subsequent financial statements. Under SFAS 115, securities that are
categorized either as "available for sale" or "trading" are reported at fair
value, and securities that are categorized as "held-to-maturity" are reported at
amortized cost. SFAS 115 is effective for fiscal years beginning after December
15, 1993, and may be applied at the end of earlier fiscal years for which annual
statements have not been issued. The Bank is currently evaluating SFAS 115 and
has not yet determined the effect that the implementation of SFAS 115 will have
on its financial statements.
F - 15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NEW PARTNERSHIP INTEREST - REAL ESTATE TRUST
In late August 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. ("Saul Centers"). 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 Limited Partnership ("Saul Holdings"), in
which the Real Estate Trust owns (directly or through one of its wholly-owned
subsidiaries) a 21.5% interest, other entities affiliated with the Real Estate
Trust own a 5.5% interest, and Saul Centers owns a 73.0% interest. B. Francis
Saul II, Chairman of the Board of Trustees of the Trust, is also Chairman of the
Board of Directors and Chief Executive Officer of Saul Centers, which is the
sole general partner of Saul Holdings.
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 those of 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 the date of transfer, the maximum potential obligations of
the Real Estate Trust and its subsidiaries under this agreement totalled
$116.1 million.
The fair market value of each of the properties contributed to the Partnerships
by the Real Estate Trust and its subsidiaries 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 Differ-
ence"). 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 pur-
poses would be allocated to the Real Estate Trust or its subsidiaries as a
result of the property disposition. 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), an amount of gain
equal to the FMV-Tax Difference (as adjusted) will be allocated to the Real
Estate Trust or its subsidiaries. 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 partners in Saul
Holdings based on their relative percentage interests. In general, the amount
of gain allocated to the Real Estate Trust or its subsidiaries 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 or its subsidi-
aries 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 or its subsidiaries, could cause the Real
Estate Trust or its subsidiaries to have taxable constructive distributions
without the receipt of any corresponding amounts of cash.
The value of the partnership interest in Saul Holdings received by the Real
Estate Trust was approximately equal to the net value (value minus associated
debt) of the properties transferred by the Real Estate Trust to Saul Holdings,
as estimated by the Real Estate Trust. However, since the assets and liabilities
of the properties were not sold, but instead were transferred, to Saul Holdings,
they were recorded in Saul Holdings at their historical costs rather than at
their market values. At the date of transfer, liabilities exceeded assets on an
historical cost basis. Consequently, the Real Estate Trust has recorded its
investment in Saul Holdings at zero and has included the excess of liabilities
over assets transferred, which amounted to $104.3 million, in its balance sheet
account entitled "Deferred gains - real estate". The new account will reflect
changes in the future only when Saul Holdings sells or disposes of one of the
transferred properties to an unaffiliated entity, at which time the gain on that
property will be recorded as income.
The Condensed Consolidated Balance Sheet at September 30, 1993 and the Condensed
Consolidated Statement of Operations for August 27, 1993 through September 30,
1993 of Saul Centers follow.
Saul Centers, Inc.
Condensed Consolidated Balance Sheet (Unaudited)
September 30, 1993
(In thousands)
ASSETS
Real estate investments $262,408
Accumulated depreciation (72,931)
Other assets 21,245
--------
Total assets $210,722
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable $192,299
Other liabilities 5,603
--------
Total liabilities 197,902
Total stockholders' equity 12,820
--------
Total liabilities and stockholders' equity $210,722
========
F - 16
Saul Centers, Inc.
Condensed Consolidated Statement of Operations (Unaudited)
August 27, 1993 through September 30, 1993
(In thousands)
REVENUE
Base rent $3,854
Other revenue 1,014
--------
Total revenue 4,868
--------
EXPENSES
Operating expenses 1,137
Interest expense 1,122
Amortization of deferred debt expense 275
Depreciation and amortization 806
General and administrative 181
--------
Total expenses 3,521
--------
Operating income before extraordinary item and
holders of convertible limited partnership units
in operating partnership 1,347
Extraordinary item - early extinguishment of debt (3,519)
--------
Net loss before holders of convertible limited
partnership units in operating partnership (2,172)
Holders of convertible limited partnership units
in operating partnership (586)
--------
Net loss $(1,586)
========
2. INVESTMENT PROPERTIES - REAL ESTATE TRUST
The following table summarizes the cost basis of income-producing properties and
land parcels together with their related debt. Schedule XI of the Trust's Annual
Report to the Securities and Exchange Commission on Form 10-K contains
additional information.
Buildings and Leasehold Related
(Dollars in thousands) No. Land Improvements Interests Total Debt
--- ---------- ------------- --------- --------- --------
SEPTEMBER 30, 1993
INCOME-PRODUCING PROPERTIES
Office & industrial 8 $5,249 $104,264 - $109,513 $112,242
Hotels 9 8,872 102,612 - 111,484 90,234
Other 7 3,575 261 149 3,985 -
-- -------- -------- -------- -------- --------
24 $17,696 $207,137 $149 $224,982 $202,476
== ======== ======== ======== ======== ========
LAND PARCELS 10 $38,411 - - $38,411 $63,625
== ======== ======== ======== ======== ========
SEPTEMBER 30, 1992
INCOME-PRODUCING PROPERTIES
Shopping centers 22 $21,194 $85,983 $1,821 $108,998 $178,395
Office & industrial 9 5,920 116,397 - 122,317 137,482
Hotels 9 8,872 102,790 - 111,662 92,933
Other 8 4,064 2,976 149 7,189 2,040
-- -------- -------- -------- -------- --------
48 $40,050 $308,146 $1,970 $350,166 $410,850
== ======== ======== ======== ======== ========
LAND PARCELS 12 $40,095 $10,684 $202 $50,981 $20,517
== ======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------
F - 17
3. DEBT - REAL ESTATE TRUST
Mortgage notes payable are secured by various income-producing properties and
land parcels. Almost all mortgage notes are payable in monthly installments,
have maturity dates ranging to 2003 and accrue interest at annual rates from
5.4% to 18.7%. Certain mortgages contain a number of restrictions, including
cross default provisions.
In the first quarter of fiscal 1992, the Real Estate Trust obtained new
financing from existing lenders and reached agreement with its five principal
lenders on refinancings of approximately $330 million of existing secured debt
and $19 million of previously unsecured debt which became secured debt. Three of
the lenders agreed to make available a total of approximately $25.5 million in
new loans, of which approximately $8.7 million was used to retire existing
indebtedness, yielding approximately $16.8 million in net proceeds to the Real
Estate Trust. As a result of these transactions, the maturities of $264 million
of the Real Estate Trust's secured borrowings were extended for five years, and
the Real Estate Trust received options for further extensions of $146 million of
such borrowings for up to another five years. Borrowings from one lender,
amounting to approximately $85.5 million in the aggregate, were extended until
December 1, 1993. Interest pay rates on the affected loans in some cases were
permanently reduced and in other cases were reduced for a specified period
subject to payment of the deferred interest in the future. Management estimates
that, as a result of these transactions, interest payments required under these
loans for fiscal 1992 were reduced by approximately $14.4 million from the
payments which would have been required prior to the refinancings.
In March 1992, the Real Estate Trust received $3.75 million in loan proceeds
pursuant to collateralized borrowings. It also sold certain land parcels for
approximately $4 million in cash. The proceeds from these two transactions were
used to fund operations, including payment of past-due real estate taxes.
The Real Estate Trust obtained a $5 million 18-month secured loan from an
affiliate in August 1992. Borrowings under this loan totalled $5.0 million and
$2.9 million at September 30, 1993 and 1992, respectively.
At September 30, 1992, mortgage notes payable included two nonrecourse mortgage
loans with a combined principal balance of approximately $2.0 million, one of
which matured in August 1992 and the other of which matured in September 1992.
The Real Estate Trust repaid these loans in fiscal 1993 with funds from the sale
of the associated income-producing property.
In December 1992, the Trust completed the sale to an institutional investor, for
$25 million, of 100% of the preferred stock of a newly organized Trust
subsidiary to which the Trust contributed certain real estate and other assets.
The assets contributed included six shopping centers and one office building,
several parcels of unencumbered raw land, and a capital note in the amount of
$58 million secured by a junior lien on 30% of the Bank's stock. The net
proceeds of the transaction were lent by the subsidiary to the Trust in exchange
for notes of the Trust secured by specified real estate properties and other
assets of the Trust (the "Trust Notes"). Such proceeds were applied by the
Trust for its general corporate purposes, with approximately $2.3 million of
such proceeds being reserved for capital improvements to certain of the real
estate properties contributed to the new subsidiary. In late August 1993, the
Real Estate Trust was relieved of approximately $196 million in mortgage debt
and deferred interest in connection with the formation of Saul Holdings (See
Note 1). As a part of this transaction, the preferred stock issued to the
institutional investor was redeemed in exchange for the Trust Notes and the
pledge of all of the stock of the Trust subsidiary, together with $60 million,
at their then-market value, of the Real Estate Trust's partnership interests in
Saul Holdings.
F - 18
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. Notes sold after November 14, 1986, are subject to a
provision permitting the Real Estate Trust to call them prior to maturity. The
weighted average interest rates at September 30, 1993 and 1992 were 12.7% and
13.7%, respectively. No notes were sold during fiscal 1992. During fiscal 1993
the Real Estate Trust sold notes amounting to approximately $11.9 million.
The maturity schedule for the Real Estate Trust's outstanding debt at September
30, 1993 for the fiscal years commencing October 1, 1993 is set forth in the
following table.
Debt Maturity Schedule
------------------------
(In thousands)
- -----------------------------------------------------------------------
Mortgage Unsecured
Fiscal Year Notes Notes Total
----------- -------- --------- --------
1994 $ 8,538 $ 14,044 $22,582
1995 7,342 6,784 14,126
1996 4,494 5,223 9,717
1997 185,028 (a)(b) 1,735 186,763 (a)(b)
1998 16,024 7,777 23,801
Thereafter 43,350 3,098 46,448
- -----------------------------------------------------------------------
<FN>
(a) The Real Estate Trust has five one-year options to extend
$146 million of this amount upon payment of $9 million in
reduction of principal in fiscal 1997 and $8 million in
reduction of principal each year thereafter.
(b) Balance does not include deferred interest, which amounted
to approximately $14.5 million at September 30, 1993 and is
payable at maturity.
The Real Estate Trust currently anticipates that, in subsequent fiscal years,
operating cash flow will continue to be sufficient to satisfy its liquidity
requirements other than its need for cash to pay debt amortization and capital
improvement costs. In order to meet these cash needs, the Real Estate Trust
will be required to raise substantial amounts of cash from a combination of
mortgage loan refinancings, unsecured borrowings, sales of assets and tax
payments and cash dividends from the Bank. Its ability to do so will be subject
to significant contingencies. To the degree that the Real Estate Trust is not
able to sell sufficient new unsecured notes to finance the scheduled repayments
of outstanding unsecured notes as they mature, it will finance such repayments
from other sources of funds.
In fiscal 1991, the Bank made tax sharing payments totalling $29.6 million. The
Bank has agreed not to make any additional tax sharing payments to the Real
Estate Trust without the prior approval of the OTS. In April 1993, the Bank
successfully completed a $75 million offering of preferred stock, which
significantly strengthened the Bank's regulatory capital ratios. This capital
infusion, together with the Bank's improved operating results, should enhance
the prospects of the Real Estate Trust to receive tax sharing payments and
dividends from the Bank in the future. In June 1993, after receiving approval of
the OTS, the Bank made a $5.0 million payment to the Real Estate Trust pursuant
to the tax sharing agreement between the Bank and the Real Estate Trust. OTS
approval of this payment was conditioned on a pledge by the Real Estate Trust of
certain assets to secure certain of its obligations under the tax sharing
agreement. Following execution of the pledge, the OTS approved, and the Bank
made subsequent to September 30, 1993, additional tax sharing payments of $4.6
million to the Real Estate Trust. As of September 30, 1993, the estimated tax
sharing payment due to the Real Estate Trust from the Bank is $21.9 million.
The Real Estate Trust has never received cash dividends from the Bank. Its
ability to receive cash dividends in the future will depend on the Bank's
earnings and regulatory capital levels, among other factors. The Bank's written
agreement with the OTS was amended in October 1993 to eliminate the requirement
that the Bank obtain the written approval of the OTS before declaring or paying
any dividends on its common stock.
F - 19
4. LONG-TERM LEASE OBLIGATIONS - REAL ESTATE TRUST
The Real Estate Trust had several noncancelable long-term leases which applied
principally to land underlying some of its shopping centers that were
transferred to Saul Holdings in August 1993. The only remaining lease provides
for periodic adjustments of the basic annual rent. This lease will expire in
2061. The minimum future rental commitments under this lease amount to $101,000
per year for the next five fiscal years; thereafter, the total commitment is
$6.3 million.
The Consolidated Statements of Operations contain minimum ground rent expense of
$286,000, $312,000, and $308,000 in fiscal 1993, 1992 and 1991, respectively. In
addition to the minimum ground rent payments, real estate taxes on the land are
an obligation of the Real Estate Trust.
5. INCOME FROM COMMERCIAL PROPERTIES - REAL ESTATE TRUST
This income classification includes minimum and overage rent arising from
noncancelable commercial leases. Minimum rent for fiscal years 1993, 1992, and
1991 amounted to $38.0, $41.7 and $43.6 million, respectively. Overage rent for
these periods amounted to $2.7, $3.0 and $3.2 million, respectively. Future
minimum rentals under noncancelable leases are as follows:
Fiscal Year (IN THOUSANDS)
- -----------------------------------------------------------------------
1994 $13,605
1995 10,087
1996 3,802
1997 1,789
1998 811
Thereafter 369
- -----------------------------------------------------------------------
6. 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 (the "Advisor"),
a wholly-owned subsidiary of B. F. Saul Company ("Saul Co."). All of the Real
Estate Trust officers and three Trustees of the Trust are also officers and/or
directors of Saul Co. and/or its subsidiary corporations. The Advisor is paid a
fixed monthly fee which is subject to annual review by the Trustees. The
monthly fee was $318,000 during the period from July 1, 1990 through March 31,
1991. The fee was decreased effective April 1, 1991 to $97,000 per month and
remained at that rate through December 31, 1992. Effective January 1, 1993, the
monthly fee rate was increased to $157,000. As of October 1, 1993, the monthly
rate was increased to $250,000. The advisory contract has been extended until
September 30, 1994, and will continue thereafter unless cancelled by either
party at the end of any contract year. Certain loan agreements prohibit
termination of this contract.
F - 20
Saul Co. and Franklin Property Company ("Franklin"), a wholly-owned subsidiary
of Saul Co., 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. The fee schedules for providing those services by Saul Co. and
Franklin are reviewed and approved by the Trustees after comparison with rates
charged by competitive firms for comparable services in the various market
areas. Fees paid to Saul Co. and Franklin amounted to $7.7, $8.7 and $7.7
million in fiscal 1993, 1992 and 1991, respectively. The Real Estate Trust
reimburses the Advisor and Franklin 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 for all travel expenses
incurred in connection with the affairs of the Real Estate Trust.
The Real Estate Trust pays the Advisor 1% of the principal amount of the
unsecured notes as they are issued to offset its costs of administering the
program. These payments amounted to $118,000 in fiscal 1993. There were no
such payments in fiscal 1992 or 1991.
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 $221,000, $229,000 and
$219,000 in fiscal 1993, 1992 and 1991, respectively.
REMUNERATION OF TRUSTEES AND OFFICERS
For fiscal years 1993, 1992, and 1991, the Real Estate Trust paid the Trustees
$79,000, $88,000 and $79,000, respectively, 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 two received payments for their services as
directors of the Bank. Three of the Trustees and all of the officers of the
Real Estate Trust receive compensation from Saul Co. and/or its subsidiary
corporations as directors or officers thereof.
LEGAL SERVICES
The law firm in which one of the Trustees is a partner received $1.2, $2.1 and
$2.2 million, excluding expense reimbursements, during fiscal 1993, 1992, and
1991, respectively, for legal services to the Real Estate Trust and its
consolidated subsidiaries.
SALE OF AVENEL BUSINESS PARK-PHASE I
In 1984, the Real Estate Trust sold Avenel Business Park-Phase I to an
affiliate, Avenel Associates Limited Partnership (the"Partnership"), for $8.9
million based on an independent appraisal. The managing general partner of the
Partnership was a subsidiary of Saul Co., and a subsidiary of the Bank owned a
46% interest in the Partnership. The Real Estate Trust received the sales price
for the property in the form of cash, a purchase money note in the amount of
$1,735,000 and the assumption of a first trust loan. The net gain realized upon
the sale was $3,023,000, after deducting a $781,000 discount of the purchase
money note due to its below market interest rate. The Real Estate Trust has
continued to defer recognition of this gain pending a sale of the property to an
unaffiliated entity.
In late August 1993, the Partnership sold Avenel Business Park-Phase I to Saul
Holdings and redeemed the purchase money note held by the Real Estate Trust.
Since Saul Holdings is an affiliate of the Real Estate Trust, this transaction
has had no effect on the status of recognition of the gain deferred since 1984.
F - 21
PARTNERSHIP TRANSACTIONS
NVA Development Corporation ("NVA"), a wholly-owned subsidiary of the Real
Estate Trust, is the managing general partner of the Dulles/Route 28 Limited
Partnership (the "Dulles Partnership"). The Dulles Partnership was formed in
September, 1984 for the purpose of acquiring and developing approximately 58
acres of land in Loudoun County, Virginia. The contract to purchase the land
was acquired from five nonrelated individuals in exchange for a 10% interest
each in the Dulles Partnership, while NVA contributed $1,000 in exchange for a
50% interest. In fiscal 1990, the partnership agreement was amended so that NVA
effectively acquired a controlling interest in the partnership. As a result of
this change in control, in fiscal 1990 the Trust began consolidating the
financial statements of the Dulles Partnership. For prior years, the Trust
accounted for this investment under the equity method.
1113 Corporation ("1113"), a wholly-owned subsidiary of the Real Estate Trust,
is both the managing general partner and a limited partner in the Mark-Sun
Limited Partnership ("Mark-Sun"). There is also a non-managing general partner
not otherwise affiliated with the Trust. Mark-Sun was formed in May 1985 for
the purpose of acquiring and developing approximately 11 acres of land in Boca
Raton, Florida and 12 acres of land in Fairfax County, Virginia. The land was
purchased by Mark-Sun from the Real Estate Trust for approximately its carrying
cost of $5.7 million. 1113 contributed $3.25 million to Mark-Sun in exchange
for a 1% general and a 49% limited partnership interest. In June 1987, the
partnership entered into a tax-free exchange, of its holdings in Fairfax County
for a completed 38,500 square foot one-story office project located in
Chantilly, Virginia. At the time of the exchange, the project was 96% leased
and was encumbered by a $2.9 million construction loan, which was subsequently
repaid with refinancing proceeds. Mark-Sun is not currently involved in an
active development program. The Real Estate Trust's share of Mark-Sun's losses
for fiscal 1993, 1992 and 1991 was $201,000, $208,000 and $212,000,
respectively. These amounts have been recorded as equity in losses of
partnership investments in the consolidated statements of operations.
SAUL HOLDINGS LIMITED PARTNERSHIP
See Note 1 for a description of this partnership. The Real Estate Trust
accounts for this investment under the equity method. The Real Estate Trust's
share of losses for Saul Holdings for its initial period of operations August
27, 1993 through September 30, 1993, was $467,000.
OTHER TRANSACTIONS
The Real Estate Trust leases space to the Bank, Franklin and Saul Co. at several
of its income-producing properties. Minimum rents and recoveries paid by these
affiliates amounted to approximately $460,000, $533,000 and $558,000, in fiscal
1993, 1992 and 1991, respectively.
F - 22
7. REGULATORY MATTERS - THE BANK
At September 30, 1993, the Bank was in compliance with all of its regulatory
capital requirements under the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA"), with tangible, core and risk-based capital
ratios of 4.60%, 5.35% and 11.70%, respectively. See Note 26.
At June 30, 1991, the Bank did not meet its risk-based capital requirement and,
as a result, is subject to a written agreement with the OTS. The agreement, as
amended on October 29, 1993, addresses, among other things, transactions with
affiliates, reductions of real estate acquired in settlement of loans and asset
quality. Specifically, the Bank agreed that, without receiving the prior
approval of the OTS, it would not increase its investment in certain real estate
projects beyond specified levels. In addition, the Bank must provide the OTS
with 15 days notice prior to selling certain significant business assets.
On July 26, 1993, the OTS released the Bank from a capital plan and capital
directive because of the Bank's return to full regulatory capital compliance as
a result of its operating performance and the sale of $75.0 million of preferred
stock. See Note 24. The Bank was required to submit a capital plan to the OTS
following its failure to meet its risk-based capital requirement at June 30,
1991. In connection with OTS acceptance of the capital plan, the Bank became
subject to the capital directive in December 1991.
The Trust and an affiliated entity have entered into an agreement with the OTS
to maintain the Bank's regulatory capital at the required levels and, if
necessary, to infuse additional capital for that purpose. To the extent the
Bank is unable to meet its regulatory capital requirements in the future, the
OTS could seek to enforce the Trust's obligations under the agreement.
8. LOANS HELD FOR SECURITIZATION AND SALE - THE BANK
Loans held for securitization and sale are composed of the following:
- ----------------------------------------------------------------------
September 30,
-------------------
( IN THOUSANDS ) 1993 1992
- -------------------------------------------------- -------- ---------
Credit card receivables $300,000 $ 150,000
Home equity credit line receivables - 200,000
-------- ---------
Total $300,000 $ 350,000
======== =========
- ----------------------------------------------------------------------
F - 23
9. INVESTMENT SECURITIES - THE BANK
Investment securities are composed of the following:
- ----------------------------------------------------------------------
Gross Gross Estimated
Carrying Unrealized Unrealized Market
( IN THOUSANDS ) Value Gains Losses Value
- ---------------------------- --------- ---------- --------- ----------
SEPTEMBER 30, 1993
U.S. Government Securities $ 4,686 $ 33 $ - $ 4,719
Other securities 103 - - 103
--------- ---------- --------- ----------
Total $ 4,789 $ 33 $ - $ 4,822
========= ========== ========= ==========
SEPTEMBER 30, 1992
U.S. Government Securities $ 173,285 $ 7,455 $ - $ 180,740
Other securities 105 - - 105
--------- ---------- --------- ----------
Total $ 173,390 $ 7,455 $ - $ 180,845
========= ========== ========= ==========
- ----------------------------------------------------------------------
Investment securities as of September 30, 1993 will mature as follows:
- -----------------------------------------------------------------------
Due After
Due One Year
Within Through
( IN THOUSANDS ) One Year Five Years Total
- --------------------------------------- --------- ---------- ---------
U.S. Government Securities $ 293 $ 4,393 $ 4,686
Other securities - 103 103
--------- -------- ---------
Total $ 293 $ 4,496 $ 4,789
========= ======== =========
Weighted average interest rate 3.38% 4.41% 4.35%
========= ======== =========
Proceeds from sales of investment securities, including securities held for
sale, during fiscal 1993 and fiscal 1991 were $181.8 and $247.0 million. Gross
gains of $8.9 and $1.4 million and gross losses of $0 and $0.2 million were
realized on those sales for the years ended September 30, 1993 and 1991,
respectively. There were no sales of investment securities during the year
ended September 30, 1992.
At September 30, 1993, certain investment securities were pledged as collateral
for certain letters of credit. See Note 28.
F - 24
10. MORTGAGE-BACKED SECURITIES - THE BANK
Mortgage-backed securities are composed of the following:
- --------------------------------------------------------------------------------------------------------
( IN THOUSANDS )
- ------------------------------- Estimated
Principal Unamortized Unearned Carrying Market
Balance Premiums Discounts Value Value
------------- ------------- ------------- ------------- -------------
SEPTEMBER 30, 1993
FNMA $ 51,535 $ 954 $ (24) $ 52,465 $ 53,234
FHLMC 1,138,175 17,663 (1,465) 1,154,373 1,173,539
Private label, AA rated 295,558 - (1,204) 294,354 301,287
------------- ------------- ------------- ------------- -------------
Total $ 1,485,268 $ 18,617 $ (2,693) $ 1,501,192 $ 1,528,060
============= ============= ============= ============= =============
SEPTEMBER 30, 1992
FNMA $ 88,861 $ 1,018 $ (351) $ 89,528 $ 91,630
FHLMC 974,862 13,331 (2,149) 986,044 1,011,744
Private label, AA rated 525,833 - (1,752) 524,081 537,445
------------- ------------- ------------- ------------- -------------
Total $ 1,589,556 $ 14,349 $ (4,252) $ 1,599,653 $ 1,640,819
============= ============= ============= ============= =============
- --------------------------------------------------------------------------------------------------------
Gross unrealized gains were $27.1 and $41.2 million at September 30, 1993 and
1992, respectively. Gross unrealized losses were $230,000 and $5,000 at
September 30, 1993 and 1992, respectively.
Proceeds from sales of mortgage-backed securities, including mortgage-backed
securities held for sale, were $810.8, $834.2 and $835.9 million during the
years ended September 30, 1993, 1992 and 1991, respectively. Gross gains of
$10.2, $23.0 and $21.0 million and gross losses of $4.4, $3.0 and $1.0 million
were realized on the sale of mortgage-backed securities, including
mortgage-backed securities held for sale, during the years ended September 30,
1993, 1992 and 1991, respectively.
Accrued interest receivable on mortgage-backed securities totaled $8.9 and $10.1
million at September 30, 1993 and 1992, respectively, and is included in other
assets in the Consolidated Balance Sheets.
At September 30, 1993, certain mortgage-backed securities were pledged as
collateral for securities sold under repurchase agreements, other short-term
borrowings and other recourse arrangements. See Notes 19 and 28. Other
mortgage-backed securities with a book value of $45.3 million were pledged as
collateral primarily for credit card settlement obligations.
F - 25
11. LOANS RECEIVABLE - THE BANK
Loans receivable is composed of the following:
- --------------------------------------------------------------------------------
( IN THOUSANDS ) September 30,
- -------------------------------------------------- ----------------------------
1993 1992
------------- -------------
Single-family residential $ 1,111,306 $ 758,169
Home equity 60,549 23,148
Commercial and multifamily 95,611 61,522
Real estate construction 69,940 88,428
Ground 19,340 30,008
Credit card 454,520 722,672
Automobile 104,702 18,524
Overdraft lines of credit 42,198 38,963
Other 33,318 36,505
------------- -------------
1,991,484 1,777,939
------------- -------------
Less:
Undisbursed portion of loans 63,620 58,284
Unearned discounts 1,543 2,589
Net deferred loan origination fees (costs) (3,472) 1,889
Reserve for loan losses 68,040 78,818
------------- -------------
129,731 141,580
------------- -------------
Total $ 1,861,753 $ 1,636,359
============= ==============
The Bank serviced loans owned by others amounting to $3.4, $2.4 and $2.8 billion
at September 30, 1993, 1992 and 1991, respectively.
Accrued interest receivable on loans totaled $16.0 and $17.3 million at
September 30, 1993 and 1992, respectively, and is included in other assets in
the Consolidated Balance Sheets.
F - 26
12. 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 ) 1993 1992
- ------------------------------------------------- -------- ---------
Land, development, construction
and rental properties $ 69,313 $ 92,363
Investments in limited partnerships (1,580) (1,222)
Investments in real estate ventures 8,898 8,892
-------- ---------
Total real estate held for investment 76,631 100,033
-------- ---------
Real estate held for sale 434,616 541,352
-------- ---------
Less:
Reserve for losses on real estate held 10,182 14,919
for investment
Reserve for losses on real estate held for sale 101,462 94,125
Accumulated depreciation and amortization 11,144 10,414
-------- ---------
Total real estate held for investment or sale $388,459 $ 521,927
======== =========
- ----------------------------------------------------------------------
Loss on real estate held for investment or sale is composed of the following:
- ----------------------------------------------------------------------
Year Ended September 30,
------------------------------
( IN THOUSANDS ) 1993 1992 1991
- --------------------------------------- --------- -------- ---------
Provision for losses $ (30,415) $(60,596) $ (47,983)
Net income from operating properties 6,496 9,800 4,210
Equity earnings (loss) from investments
in limited partnerships 1,694 391 (598)
Net gain (loss) on sales 9,503 (244) (3,124)
--------- -------- ---------
Total $ (12,722) $(50,649) $ (47,495)
========= ======== =========
- ----------------------------------------------------------------------
The Corporations have an ADC arrangement with, and hold partnership interests
in, various limited partnerships. The partnerships and ADC arrangement were
formed for the purpose of acquiring, developing, operating and selling real
estate and are accounted for under the equity method with profits and losses
allocated proportionately among the partnership interests. As of September 30,
1993, there are no outstanding commitments, lines of credit or other
arrangements between the Corporations and the partnerships relating to these
investments. Combined, condensed financial information for the partnerships and
ADC arrangement is presented below:
F - 27
BALANCE SHEETS
September 30,
-------------------
( IN THOUSANDS ) 1993 1992
- ------------------------------------------------- -------- ---------
ASSETS
Land, buildings, construction in progress
and other assets $ 77,803 $ 91,941
======== =========
LIABILITIES AND PARTNERSHIP EQUITY
Notes payable to the Corporations $ 9,168 $ 9,248
Other liabilities 69,241 78,596
Partnership (deficit) equity:
- Corporations (2,344) (1,986)
- Others 1,738 6,083
-------- ---------
$ 77,803 $ 91,941
======== =========
- ----------------------------------------------------------------------
STATEMENTS OF OPERATIONS
Year Ended September 30,
------------------------------
( IN THOUSANDS ) 1993 1992 1991
- -------------------------------------- --------- -------- ---------
Income $ 12,492 $ 12,041 $ 9,832
Expenses (13,669) (12,155) (11,113)
Gain on sales of property 4,892 - 197
--------- -------- ---------
Net gain (loss) $ 3,715 $ (114) $ (1,084)
========= ======== =========
- ----------------------------------------------------------------------
With respect to the ADC arrangement, the limited partnership classifies the
Bank's investment in the real estate project as a liability payable to the Bank
rather than as equity.
F - 28
13. RESERVES FOR LOSSES - THE BANK
Activity in the reserves for losses on loans receivable and real estate held for
investment or sale is summarized as follows:
- ---------------------------------------------------------------
Real Estate
Held for
Loans Investment
( IN THOUSANDS ) Receivable or Sale
- -------------------------------------- ---------- -----------
Balance, September 30, 1990 $ 58,339 $ 12,878
Provision for losses 147,141 47,983
Charge-offs (126,451) (3,363)
Recoveries 10,716 -
--------- --------
Balance, September 30, 1991 89,745 57,498
Provision for losses 89,062 60,596
Charge-offs (112,544) (9,050)
Recoveries 12,555 -
--------- --------
Balance, September 30, 1992 78,818 109,044
Provision for losses 62,513 30,415
Charge-offs (87,194) (27,815)
Recoveries 13,903 -
--------- --------
Balance, September 30, 1993 $ 68,040 $111,644
========= ========
- ---------------------------------------------------------------
The reserves for losses as of September 30, 1993 are based on management's
estimates of the amount of reserves required to reflect the risks in the loan
and real estate portfolios based on circumstances and conditions known at the
time. The Bank's primary lending and real estate investment market is the
Washington, D.C. metropolitan area, which was adversely affected by the downturn
in recent years in the local real estate market. The ultimate impact of these
economic developments, the absence of a continued recovery in the real estate
markets and the effect of general market conditions on the Bank's borrowers
could result in difficulties in certain borrowers meeting their obligations to
the Bank and the Bank's ability to dispose of its real estate properties. As a
result, the Bank may incur additional provisions for losses.
F - 29
14. NON-PERFORMING ASSETS - THE BANK
The Bank's primary lending and real estate investment market is the Washington,
D.C. metropolitan area, which was adversely affected by the prolonged downturn
in the local real estate market in recent years. Non-performing assets are
composed of the following as of September 30, 1993:
- -------------------------------------------------------------------------
Non-accrual Real
( DOLLARS IN THOUSANDS ) Loans Estate Total
- --------------------------------------- ----------- --------- ---------
Single-family residential $ 9,108 $ 2,947 $ 12,055
Residential land, development and
construction - 285,831 285,831
Office buildings - 6,697 6,697
Retail centers - 16,084 16,084
Industrial buildings - 5,471 5,471
Commercial land (2) - 25,022 25,022
--------- -------- ---------
Total real estate assets 9,108 342,052 351,160
Credit card 20,557 - 20,557
Other 314 - 314
--------- -------- ---------
Total non-performing assets $ 29,979 $342,052 $ 372,031
========= ======== =========
RESERVES FOR LOSSES
Real estate $ 19,973 $111,644 $ 131,617
Credit card 46,886 - 46,886
Other 1,181 - 1,181
--------- -------- ---------
Total $ 68,040 $111,644 $ 179,684
========= ======== =========
RESERVES FOR LOSSES AS A PERCENTAGE OF
NON-PERFORMING ASSETS (3)
Real estate 219.29% 25.17% 37.48%
Credit card 228.08% - 228.08%
Other 376.11% - 376.11%
--------- --------- --------
Total 226.96% 25.17% 48.30%
========= ========= ========
- -------------------------------------------------------------------------
<FN>
(1) Real estate acquired in settlement of loans is shown net of
valuation allowances.
(2) An $8.9 million participating loan to a joint venture is
classified for accounting purposes as real estate held for
investment and, accordingly, is presented in the above table
as Real Estate.
(3) The ratio of reserves for losses to non-performing assets is
calculated before the deduction of such reserves.
Approximately 13.2% of the Bank's non-performing credit card loans are located
in the Washington, D.C. metropolitan area. In general, the Bank's remaining
non-performing assets are located in the Washington, D.C. metropolitan area,
including approximately 56.1% located in Loudoun County, Virginia.
The ultimate collection or realization of the Bank's non-performing assets will
be primarily dependent on the general economic conditions in the Washington,
D.C. metropolitan area. Based upon current economic conditions and other
factors, the Bank has provided loss reserves and initial write-downs for real
estate acquired in settlement of loans. See Note 13. As circumstances change,
it may be necessary to provide additional reserves based on new information.
F - 30
At September 30, 1993 and 1992, the Bank had $36.7 and $31.7 million,
respectively, of loans accounted for as troubled debt restructurings, of which
$0 and $5.3 million, respectively, were included as non-accrual loans. At
September 30, 1993, the Bank had commitments to lend $4.6 million of additional
funds on loans which have been restructured.
The amount of interest income that would have been recorded if non-accrual
assets and restructured loans had been current in accordance with their original
terms was $10.5, $16.3, and $21.3 million for the years ended September 30,
1993, 1992 and 1991, respectively. The amount of interest income that was
recorded on these loans was $3.0, $5.0 and $5.1 million for the years ended
September 30, 1993, 1992 and 1991, respectively.
15. SIGNIFICANT SALE TRANSACTIONS - THE BANK
The Bank periodically sells credit card receivables through asset-backed
securitizations, in which credit card receivables are transferred to trusts, and
the Bank sells certificates to investors representing ownership interests in the
trusts. The Bank sold and received gross proceeds of $350.0 and $280.0 million
for these asset-backed certificates for the years ended September 30, 1993 and
1992, respectively. No gains or losses were recorded on the transactions;
however, excess servicing fees are recognized over the related lives of the
transactions. No such securitizations occurred during fiscal 1991. In fiscal
1991, the Bank repurchased $231.2 million of trust certificates representing
securitized receivables previously sold in order to sell certain of the
underlying account relationships as discussed below. Outstanding trust
certificate balances related to these and previous securitizations were $841.8
and $689.2 million at September 30, 1993 and 1992, respectively. The related
receivable balances contained in the trusts were $1.2 billion and $830.9 million
at September 30, 1993 and 1992, respectively. The Bank continues to service the
underlying loans and is contingently liable under various letters of credit or
surety bonds that were issued in connection with these transactions. See Note
28.
During fiscal 1992 and 1991, the Bank sold credit card relationships with
related outstanding receivable balances of $14.8 and $273.4 million,
respectively. Gains of $1.5 and $20.7 million were recorded in connection with
these sales for the years ended September 30, 1992 and 1991, respectively, and
the Bank no longer services these relationships. No such sales occurred during
the year ended September 30, 1993.
In fiscal 1993, 1992 and 1991, the Bank sold home equity credit line receivables
through asset-backed securitizations, in which home equity credit line
receivables were transferred to trusts, and the Bank sold certificates to
investors representing ownership interests in the trusts. The amount of
receivables sold and gross proceeds received was $340.4, $253.6 and $600.1
million, respectively. Gains recognized on these transactions were $16.8, $15.1
and $25.8 million, respectively, and the Bank continues to service the
underlying loans. The outstanding trust certificate balances and the related
receivable balances contained in the trusts were $530.1 and $457.2 million at
September 30, 1993 and 1992, respectively. The Bank is contingently liable
under various surety bonds issued in connection with these transactions. See
Note 28.
In September 1991, the Bank sold automobile loan receivables through an
asset-backed securitization, in which automobile loan receivables were
transferred to a trust, and the Bank sold certificates to investors representing
ownership interests in the trust. The amount of receivables sold and gross
proceeds received was $113.9 million. A gain of $4.3 million was recognized on
this transaction and the Bank continues to service the underlying loans. The
outstanding trust certificate balances and the related receivable balances
contained in the trust were $29.6 and $64.2 million at September 30, 1993 and
1992, respectively. The Bank is contingently liable under a surety bond
issued in connection with this transaction. See Note 28.
F - 31
16. PROPERTY AND EQUIPMENT - THE BANK
Property and equipment is composed of the following:
- -----------------------------------------------------------------------
Estimated September 30,
Useful -------------------
( DOLLARS IN THOUSANDS ) Lives 1993 1992
- --------------------------------------- ----------- --------- ---------
Land - $ 23,033 $ 23,045
Construction in progress - 2,366 2,287
Buildings and improvements 10-45 years 47,001 49,391
Leasehold improvements 5-20 years 44,164 43,652
Furniture and equipment 5-10 years 106,603 101,289
Automobiles 3-5 years 791 233
-------- ---------
223,958 219,897
Less:
Accumulated depreciation and amortization 88,158 74,171
-------- ---------
Total $135,800 $ 145,726
======== =========
- -----------------------------------------------------------------------
Depreciation expense amounted to $14.8, $14.5 and $14.2 million for the years
ended September 30, 1993, 1992 and 1991, respectively.
17. LEASES - THE BANK
The Corporations have noncancelable, long-term leases for office premises and
retail space, which have a variety of terms expiring from 1993 to 2019. 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, 1993:
FISCAL YEAR (IN THOUSANDS)
- -----------------------------------------------------------------------
1994 $ 8,888
1995 7,732
1996 7,168
1997 6,109
1998 5,315
Thereafter 39,045
---------
Total $ 74,257
=========
- -----------------------------------------------------------------------
Rent expense totaled $9.2, $9.0 and $9.0 million for the years ended September
30, 1993, 1992 and 1991, respectively.
F - 32
18. 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,
------------------------------------------------------
1993 1992
-------------------------- --------------------------
Weighted Weighted
Average Average
( DOLLARS IN THOUSANDS ) Amount Rate Amount Rate
- ------------------------------------------- ------------- ----------- ------------- -----------
Demand accounts $ 72,518 - $ 51,306 -
NOW accounts 762,566 2.89% 691,908 2.62%
Money market deposit accounts 1,196,690 3.28% 1,292,779 3.47%
Statement savings accounts 941,289 3.48% 690,328 3.48%
Other deposit accounts 50,277 2.99% 47,381 2.99%
Certificate accounts, less than $100 790,806 4.33% 1,067,816 5.20%
Certificate accounts, $100 or more 55,877 4.18% 74,440 4.77%
------------- -------------
Total $ 3,870,023 3.42% $ 3,915,958 3.77%
============= =============
- ---------------------------------------------------------------------------------------------------
Interest expense on deposit accounts is composed of the following:
- -----------------------------------------------------------------
Year Ended September 30,
-------------------------------
( IN THOUSANDS ) 1993 1992 1991
- --------------------------------------- ---------- --------- ----------
NOW accounts $ 18,523 $ 22,442 $ 35,048
Money market deposit accounts 39,430 55,384 97,323
Statement savings accounts 26,598 26,081 25,008
Other deposit accounts 1,381 1,719 2,306
Certificate accounts 41,813 75,914 120,905
---------- --------- ----------
127,745 181,540 280,590
Custodial accounts 47 81 120
---------- --------- ----------
Total $ 127,792 $181,621 $ 280,710
========== ========= ==========
- -----------------------------------------------------------------------
Outstanding certificate accounts at September 30, 1993 mature in the years
indicated as follows:
Fiscal Year (IN THOUSANDS)
- -----------------------------------------------------------------------
1994 $ 639,808
1995 121,497
1996 27,794
1997 21,757
1998 35,827
---------
Total $ 846,683
=========
- -----------------------------------------------------------------------
At September 30, 1993, certificate accounts of $100 thousand or more have
contractual maturities as indicated below:
(IN THOUSANDS)
- -----------------------------------------------------------------------
Three months or less $ 26,931
Over three months through six months 11,536
Over six months through 12 months 5,977
Over 12 months 11,433
---------
Total $ 55,877
=========
- -----------------------------------------------------------------------
F - 33
19. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER
SHORT-TERM BORROWINGS - THE BANK
Short-term borrowings are summarized as follows:
- -----------------------------------------------------------------------
Year Ended September 30,
-------------------------------
( Dollars in thousands ) 1993 1992 1991
- --------------------------------------- ---------- --------- ----------
Securities sold under repurchase
agreements:
Balance at year-end $ 83,151 $446,367 $ -
Average amount outstanding during the
year 265,176 123,480 213,185
Maximum amount outstanding at any
month-end 478,534 485,067 471,062
Amount maturing within 30 days 83,151 446,367 -
Weighted average interest rate during
the year 3.28% 3.64% 6.96%
Weighted average interest rate on
year-end balances 3.23% 3.36% -
Other short-term borrowings:
Balance at year-end $ 5,115 $ 3,954 $ 3,459
Average amount outstanding during the
year 2,212 2,918 4,021
Maximum amount outstanding at any
month-end 5,115 6,112 7,869
Amount maturing within 30 days 5,115 3,954 3,459
Weighted average interest rate during
the year 2.77% 4.03% 6.22%
Weighted average interest rate on
year-end balances 3.71% 4.00% 5.34%
The investment and mortgage-backed securities underlying the repurchase
agreements had a book value, including accrued interest, of $85.0 million and
had a market value of $85.9 million at September 30, 1993. The securities
underlying these 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 have agreed to resell to the Bank the
identical securities at the maturities of the agreements.
At September 30, 1993, the Bank had pledged mortgage-backed securities with a
book value of $9.8 million to secure certain other borrowings.
F - 34
20. BONDS PAYABLE - THE BANK
Bonds payable represent bonds (term and serial) issued by a local housing
finance agency secured by land and two residential apartment buildings having an
aggregate net book value of $26.4 and $27.0 million at September 30, 1993 and
1992, respectively. The assets securing these bonds are included in real estate
held for investment or sale.
The term bonds amounting to $23.7 million mature November 1, 2006, and currently
bear interest at 9.7%. On November 1, 1995, November 1, 1998, November 1, 2001
and November 1, 2004, the interest rate on the outstanding term bonds will be
adjusted to be equal to the rate at which such bonds could be sold at par on
such date. The term bonds are not redeemable prior to November 1, 1995. On or
after such date, the term bonds will be redeemable, in whole or in part, at the
option of the Corporations, at a redemption price equal to the principal amount
redeemed plus accrued interest to the redemption date. Beginning May 1, 1995,
and continuing each November 1 and May 1 thereafter, the term bonds will be
subject to mandatory sinking fund redemption payments. Such payments will
retire approximately 55.0% of the principal amount of the term bonds prior to
November 1, 2006.
Serial bonds amounting to $880 thousand mature from November 1, 1993 to November
1, 1994. Interest rates on these bonds range from 9.1% to 9.3%.
The aggregate principal payments on the bonds payable outstanding at September
30, 1993 for the next five years are summarized as follows:
FISCAL YEAR (IN THOUSANDS)
- -----------------------------------------------------------------------
1994 $ 575
1995 630
1996 685
1997 760
1998 830
Thereafter 21,125
---------
Total $ 24,605
=========
Deferred debt issuance costs, net of accumulated amortization, amounted to $0.8
and $1.1 million at September 30, 1993 and 1992, respectively, and are included
in other assets. These amounts are being amortized using the level-yield method
over the life of the related debt.
At September 30, 1993, $3.0 million of bond proceeds were held in a restricted
cash account by the trustee for the purpose of paying principal and interest on
the bonds in the event that the Corporations are unable to fund payments. This
amount is included in interest-bearing deposits in the Consolidated Balance
Sheets.
F - 35
21. NOTES PAYABLE - THE BANK
Notes payable bear interest at rates ranging from 8.9% to 13.0% and are due in
varying installments through 2004.
Scheduled repayments of notes payable at September 30, 1993 are as follows:
FISCAL YEAR (IN THOUSANDS)
- -----------------------------------------------------------------------
1994 $ 196
1995 215
1996 236
1997 260
1998 286
Thereafter 6,732
---------
Total $ 7,925
=========
22. FEDERAL HOME LOAN BANK ADVANCES - THE BANK
At September 30, 1993, the Bank had $412,000 of advances from the Federal Home
Loan Bank of Atlanta ("FHLB"). The interest rates on $225.0 million of the
advances adjust quarterly based primarily on the three-month London Interbank
Offered Rate ("LIBOR"). At September 30, 1993, the interest rates ranged from
3.07% to 3.20%. The weighted average interest rate on $150.0 million of
advances was 3.94% and is fixed for the term of the advances and the interest
rate on the remaining $37.0 million of advances was 3.60% and reprices daily.
Advances with the FHLB mature in the years indicated as follows:
Fiscal Year (In thousands)
----------- --------------
1994 $312,000
1995 --
1996 100,000
--------
$412,000
========
Under a Specific Collateral Agreement with the FHLB, advances are secured by all
of the Bank's FHLB stock, qualifying first mortgage loans with a principal
balance of $385.8 million and mortgage-backed securities with a book value of
$184.0 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, 1993 advances is
available to secure additional advances from the FHLB, subject to its
collateralization guidelines. Certain documents for each of the mortgage loans
have been delivered to the FHLB pursuant to its requirements.
23. CAPITAL NOTES - SUBORDINATED - THE BANK
Capital notes, which are subordinated to the interest of deposit account
holders, are composed of the following:
- -----------------------------------------------------------------------
September 30,
-------------------- Interest
( DOLLARS IN THOUSANDS ) 1993 1992 Rate
- --------------------------------------- ---------- --------- ----------
Private placement:
BACOB Savings Bank, s.c.,
due 1996 $ 10,000 $ 10,000 LIBOR
+ 3.0%
Public placements:
Subordinated debentures due 2002 78,500 78,500 13.5%
Subordinated debentures due 2003 50,000 50,000 15.0%
--------- --------
Total $ 138,500 $138,500
========= ========
F - 36
Deferred debt issuance costs, net of accumulated amortization, amounted to $4.9
and $5.2 million at September 30, 1993 and 1992, respectively, and are included
in other assets in the Consolidated Balance Sheets.
In July 1987, the Bank issued $80.5 million of 13.5% Subordinated Capital
Debentures (the "1987 Debentures") due July 15, 2002, of which $78.5 million
remain outstanding at September 30, 1993. Interest is payable semi-annually on
January 15 and July 15 of each year. As of July 15, 1992, the 1987 Debentures
are redeemable, in whole or in part, at the option of the Bank. Mandatory
annual sinking fund payments on July 15, 2000 and July 15, 2001, each in the
amount of 25% of the original principal amount of the 1987 Debentures, will
retire 50% of the issue prior to maturity at a redemption price equal to 100% of
the principal amount redeemed, plus accrued interest. The net proceeds to the
Bank from the sale of the 1987 Debentures were $76.9 million.
In November 1988, the Bank issued $50.0 million of 15.0% Subordinated Capital
Debentures (the "1988 Debentures") due November 15, 2003. Interest is payable
semi-annually on May 15 and November 15 of each year. As of November 15, 1993,
the 1988 Debentures are redeemable, in whole or in part, at the option of the
Bank. The Bank may not redeem any portion of the 1988 Debentures unless its
outstanding 1987 Debentures have been paid in full. The net proceeds to the
Bank from the sale of the 1988 Debentures were $47.6 million.
Subsequent to September 30, 1993, the Bank provided a notice of redemption to
holders of the 1987 Debentures and the 1988 Debentures. See Note 31.
The terms of the Indenture Agreements under which the 1988 Debentures and 1987
Debentures were issued provide that the Bank may not pay dividends in the event
of a continuing default, nor if the dividend would cause the Bank to fail any
regulatory capital requirements. In addition, the dividend may not exceed (i)
50% of the Bank's earnings after September 30, 1987 for the 1988 Debentures and
after September 30, 1986 for the 1987 Debentures plus (ii) the net cash proceeds
of any sale, after September 30, 1987 for the 1988 Debentures and after
September 30, 1986 for the 1987 Debentures, of the Bank's capital stock to any
person other than a subsidiary of the Bank or any other entity in which the
Corporations have an equity interest plus (iii) the net cash proceeds from the
issuance of any indebtedness of the Bank which thereafter has been converted to
capital stock.
Regulatory capital requirements limit the amount of subordinated capital notes
that may be included in regulatory capital. See Note 26.
24. PREFERRED STOCK - THE BANK
In April 1993, the Bank sold $75.0 million of its Noncumulative Perpetual
Preferred Stock, Series A ("Preferred Stock") in a private offering. Cash
dividends on the Preferred Stock are payable quarterly in arrears at an annual
rate of 13%. In the event that the Bank's Board of Directors does not declare
the full cash dividend payable in any period, the Board of Directors is
obligated to declare and pay a dividend in the form of shares of a new series of
noncumulative perpetual preferred stock in the amount of the unpaid cash
dividend.
The Bank received confirmation from the OTS that the Preferred Stock qualifies
for inclusion as tier 1 or core capital and received OTS approval to pay
dividends on the Preferred Stock, provided certain conditions are met. The
Preferred Stock is not redeemable until May 1, 2003 and is redeemable
thereafter at the option of the Bank. Any noncumulative perpetual preferred
stock issued as a
F - 37
dividend on the Preferred Stock is redeemable at the option of the Bank at any
time after the date of issuance. 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.
25. RETIREMENT PLAN - THE BANK
The Corporations participate 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. The Plan, which can be modified or
discontinued at any time, requires participating employees to contribute 2.0% of
their compensation. Corporate contributions, which are discretionary, were
three times the employee contribution prior to January 1, 1991, equal to the
employee contribution from January 1, 1991 to June 30, 1992 and three times the
employee contribution subsequent to June 30, 1992. Corporate contributions were
$3.1, $1.5 and $1.5 million for the years ended September 30, 1993, 1992 and
1991, respectively. There are no past service costs associated with the Plan and
the Corporations have no liability under the Plan other than their current
contributions. The Plan owns 4.0% of the Bank's common stock.
26. REGULATORY CAPITAL - THE BANK
Under FIRREA, the Bank's regulatory capital requirements at September 30, 1993
were a 1.5% tangible capital requirement, a 3.0% core capital requirement and an
8.0% risk-based capital requirement. At September 30, 1993, the Bank was in
compliance with its tangible, core and risk-based regulatory capital
requirements. The information below is based upon the Trust's understanding of
the applicable regulations and related interpretations.
F - 38
ACTUAL CAPITAL REQUIREMENT
----------------------------- -----------------------------------------
As a % of As a % of Excess
(Dollars in thousands ) Amount Assets Amount Assets Capital
- -------------------------------------------------------- ------------ ------------- ------------- -------------
Capital per financial statements $ 284,794
Adjustments for tangible and
core capital:
Intangible assets (55,270)
Non-includable subsidiaries (1) (6,458)
-------------
Total tangible capital 223,066 4.60% $ 72,665 1.50% $ 150,401
=========== ============= ============ =============
Supervisory goodwill 36,333
-------------
Total core capital (2) 259,399 5.35% $ 145,330 3.00% $ 114,069
------------- =========== ============= ============ =============
Tier 1 risk-based capital (2) 259,399 7.29% N/A N/A N/A
------------- =========== ============= ============ =============
Adjustments for risk-based capital:
Subordinated capital debentures 132,800
Reserve for general loan losses 60,548
-------------
Total supplementary capital 193,348
Excess loan loss reserves (15,892)
-------------
Adjusted supplementary capital 177,456
-------------
Total available capital 436,855
Equity investments (1) (20,568)
-------------
Total risk-based capital (2) $ 416,287 11.70% $ 284,528 8.00% $ 131,759
============= =========== ============= ============ =============
- ------------------------------------------------------------------------------------------------------------------
<FN>
(1) Reflects an aggregate offset of $6.6 million representing the amount of
general reserves 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.
(2) 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 OTS regulations that became effective on December 31, 1992, foreclosed
assets must be carried at the lower of cost or fair value subsequent to
acquisition. See Significant Accounting Policies. In connection with the
fair value regulations, the OTS amended its capital regulation to place all
assets previously assigned to the 200% risk-weighted category, including
foreclosed assets, into the 100% risk-weighted category.
At September 30, 1993, the Bank had $30.6 million in investments in subsidiaries
engaged in activities impermissible for national banks ("non-includable
subsidiaries") which are required to be phased out from all three capital
requirements according to the following schedule (which reflects OTS approval of
the Bank's use of a delayed phase-in period pursuant to legislation enacted in
October 1992): 25% beginning July 1, 1991; 40% beginning July 1, 1994; 60%
beginning July 1, 1995; and 100% beginning July 1, 1996. At September 30, 1993,
the Bank also had $43.3 million in equity investments required to be phased out
from total capital for risk-based capital purposes according to the following
schedule: 60% beginning July 1, 1993; and 100% beginning July 1, 1994. The OTS
adopted a rule which was effective April 19, 1993, eliminating the capital
deduction for equity investments that are permissible for national banks.
As of September 30, 1993, the Bank had $52.4 million in supervisory goodwill of
which $36.3 million was included in core capital in an amount not to exceed
0.75% of tangible assets beginning January 1, 1993; 0.375% beginning January 1,
1994; and 0% beginning January 1, 1995.
At September 30, 1993, the Bank recorded a net deferred tax asset of $44.8
million which generally represents the cumulative excess of the Bank's actual
income tax liability over its income tax expense for financial reporting
purposes. This net deferred tax asset is reported on the Bank's financial
statements in accordance with Accounting Principles Board Opinion No. 11 ("APB
No. 11"). See Significant Accounting Policies.
F - 39
On January 20, 1993, the OTS issued Thrift Bulletin 56 ("TB 56") setting forth
additional guidance regarding the treatment of net deferred tax assets for
regulatory reporting and capital purposes. For regulatory reporting purposes, TB
56 provides that thrift institutions are required to report net deferred tax
assets in accordance with SFAS No. 109 as of January 1, 1993, or the beginning
of the first fiscal year thereafter, if later (although early adoption of SFAS
No. 109 is permitted). Management does not believe that reporting the Bank's net
deferred tax asset under SFAS No. 109 will have a material effect on the asset
for regulatory reporting purposes.
For regulatory capital purposes, TB 56 generally sets forth a limitation on the
amount of a thrift's net deferred tax asset reported under SFAS No. 109 that can
be included in a thrift's regulatory capital. However, TB 56 provides a
transition rule under which net deferred tax assets reportable as of December
31, 1992 under the standards of APB No. 11 are not subject to this limitation.
Because the Bank's net deferred tax asset of $44.8 million at September 30, 1993
is reported under APB No. 11, the Bank believes that the entire amount of this
asset is grandfathered under this transition rule. This grandfathering of the
Bank's net deferred tax asset will not prevent or otherwise affect future
reductions in the asset due to a reversal of timing differences. TB 56 also
provides that net deferred tax assets reported under the transition rule remain
subject to previously existing rules and supervisory policy, including periodic
evaluation as to realizability.
Under OTS "prompt corrective action" regulations which became effective on
December 19, 1992, an institution is categorized as "well-capitalized" if 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%. The Bank's
regulatory capital ratios exceeded the requirements for a well-capitalized
institution at September 30, 1993.
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, 1993 is as follows:
( IN THOUSANDS )
- -----------------------------------------------------------------------
Balance, September 30, 1992 $ 4,142
Additions 613
Collections (453)
---------
Balance, September 30, 1993 $ 4,302
=========
SERVICES:
B. F. Saul Company, which is a shareholder of the Trust, and its subsidiaries
provide certain services to the Corporations. These services include property
management, cafeteria management, insurance brokerage and leasing. Fees for
these services were $630, $603 and $460 thousand for the years ended September
30, 1993, 1992 and 1991, respectively.
The law firm in which one director of the Bank is a partner received $2.7, $3.0
and $3.0 million for legal services rendered to the Corporations during the
years ended September 30, 1993, 1992 and 1991, respectively.
F - 40
For the years ended September 30, 1993 and 1992, one of the directors of the
Bank was paid $28 and $25 thousand, respectively, for consulting services
rendered to the Bank. Two of the directors of the Bank were paid total fees of
$220 thousand for the year ended September 30, 1991 for consulting services.
A director of the Bank and his wife are entitled to $125 thousand per year in
supplemental retirement benefits under an agreement entered into by the Bank in
1990 in connection with the director's former employment as a Vice Chairman of
the Bank. In addition, the director receives compensation under the agreement
for his service as a Vice Chairman and for ongoing services provided to the
Bank. Amounts paid to the director under this agreement totaled $165 thousand in
fiscal 1993.
TAX SHARING AGREEMENT:
The Bank and the other companies in the Trust's affiliated group entered into 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 $5.0 and $29.6 million to the Real
Estate Trust during the years ended September 30, 1993 and 1991, respectively,
under the Tax Sharing Agreement. There were no tax sharing payments made to the
Real Estate Trust during the year ended September 30, 1992. OTS approval of the
$5.0 million payment in fiscal 1993 was conditioned on a pledge by the Real
Estate Trust of certain assets to secure certain of its obligations under the
Tax Sharing Agreement. Following execution of such a pledge and after receipt of
OTS approval, the Bank made tax sharing payments totaling $4.6 million to the
Real Estate Trust subsequent to September 30, 1993. Under the terms of the
Bank's written agreement, as amended, with the OTS, the Bank has agreed not to
make any tax sharing payments to the Real Estate Trust unless such payments are
approved by the OTS. However, the Bank continues to account for income taxes in
accordance with the Tax Sharing Agreement. At September 30, 1993 and 1992, the
estimated tax sharing payment payable to the Real Estate Trust by the Bank was
$21.9 and $13.6 million, respectively.
OTHER:
The Corporations paid $3.5, $3.4 and $3.9 million for office space leased from
or managed by companies affiliated with the Bank or its directors during the
years ended September 30, 1993, 1992 and 1991, respectively.
The Corporations own approximately 45% of Avenel Associates Limited Partnership
("Avenel"), which owns a commercial property. The general partner in the
partnership is a subsidiary of the B. F. Saul Company. In August 1993, Avenel
sold this property and the Bank sold two real estate properties to Saul
Holdings. See Note 1. These assets were sold at amounts that exceeded their net
carrying values.
F - 41
28. FINANCIAL INSTRUMENTS - THE BANK
The Bank, in the normal course of business, is a party to financial instruments
with off-balance-sheet risk. These financial instruments include commitments to
extend credit, letters of credit and assets sold with limited recourse.
The contract or notional amounts of these instruments reflect the extent of
involvement the Bank has in particular classes of financial instruments. The
Bank's exposure to credit loss in the event of nonperformance by the other party
is represented by the contractual notional amount of these instruments. 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 $3.3 billion of outstanding commitments to extend
credit at September 30, 1993. Commitments to extend credit are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since 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.
Loans approved but not closed are commitments for fixed or adjustable rate
residential loans which are secured by real estate. The Bank currently requires
borrowers to obtain private mortgage insurance on all loans where the
loan-to-value ratio exceeds 80%.
To manage the potentially adverse impact of interest rate movements on its
fixed-rate mortgage loan pipeline, the Bank hedges these loans by entering into
whole loan and mortgage-backed security forward sale commitments. At September
30, 1993, the Bank had forward whole loan and mortgage-backed security sale
commitments of $30.0 and $169.0 million, respectively. In addition, at
September 30, 1993, the Bank had $15.5 million in forward mortgage-backed
security purchase commitments related to its hedging activities.
LETTERS OF CREDIT:
Letters of credit are conditional commitments issued by the Bank to guarantee
the performance of a customer to a third party. At September 30, 1993, the Bank
had written letters of credit in the amount of $73.3 million, of which $66.4
million were issued to guarantee the performance of and irrevocably assure
payment by customers under construction projects and $6.9 million were issued to
assure payment of specified financial obligations of customers.
Of the total, $35.4 million will expire in fiscal 1994 and the remainder will
expire over time through 1998. The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan commitments to
customers. Investment and mortgage-backed securities with a book value of $8.6
million were pledged as collateral for certain of these letters of credit at
September 30, 1993.
F - 42
RECOURSE ARRANGEMENTS:
The Bank is obligated under various recourse provisions (primarily related to
credit losses) related to the securitization and sale of credit card, home
equity credit line and automobile loan receivables through the asset-backed
securitizations described in Note 15. At September 30, 1993, the primary
recourse to the Bank was $74.8 million. As a result of recourse provisions, the
Bank maintained restricted cash accounts amounting to $125.8 and $96.2 million,
at September 30, 1993 and 1992, respectively, which are included in other
assets in the Consolidated Balance Sheets.
The Bank is obligated under various recourse provisions related to the swap of
single-family residential loans for participation certificates and
mortgage-backed securities issued to the Bank by FHLMC and FNMA. At September
30, 1993, recourse to the Bank under these arrangements was $6.1 million. As
security for the payment of funds due under the FHLMC recourse obligations, the
Bank is required to post collateral. At September 30, 1993, mortgage-backed
securities pledged as collateral under these obligations had a book value of
$5.9 million.
CONCENTRATIONS OF CREDIT:
The Bank's principal real estate lending market is the metropolitan Washington,
D.C. area. In addition, approximately 16.7% of the Bank's outstanding credit
card loans at September 30, 1993 were generated by cardholders residing in the
metropolitan Washington, D.C. area. Service industries and Federal, state and
local governments employ a significant portion of the Washington, D.C. 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.
Comparability 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, 1993 are as follows:
F - 43
Carrying Fair
( IN THOUSANDS ) Amount Value
- --------------------------------------------------------------------------------------------------------------------
Financial assets:
Cash, due from banks and interest-bearing deposits $ 183,199 $ 183,199
Loans held for sale 176,027 179,615
Loans held for securitization and sale 300,000 300,000
Investment securities 4,789 4,822
Mortgage-backed securities 1,501,192 1,528,060
Loans receivable, net of reserve 1,861,753 1,938,886
Other financial assets 275,609 275,609
Financial liabilities:
Deposit accounts with no stated maturities 3,023,340 3,023,340
Deposit accounts with stated maturities 846,683 854,398
Securities sold under repurchase agreements and 531,973 (1) 536,831
other short-term borrowings, bonds payable, notes
payable and Federal Home Loan Bank advances
Capital notes-subordinated 133,596 (1) 144,153
Other financial liabilities 76,580 76,580
- --------------------------------------------------------------------------------------------------------------------
<FN>
(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, 1993:
CASH, DUE FROM BANKS AND INTEREST-BEARING DEPOSITS: 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 carrying value of credit card loans
held for securitization and sale approximates fair value because such
receivables are sold at face value.
INVESTMENT 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 RECEIVABLE, NET OF RESERVE. Fair value of certain homogeneous groups of
loans (e.g., single-family residential, non-credit card consumer loans and
fixed-rate commercial and multifamily loans) is estimated using discounted cash
flow analyses based on contractual repayment schedules. 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. Because credit card receivables are generally sold at
face value through the Bank's securitization program, such face value is used as
the estimated fair value of these receivables. The fair value of the Bank's loan
portfolio as presented above does not include the value of established credit
card and home equity credit line customer relationships, or the value relating
to estimated cash flows from future receivables and the associated fees
generated from existing customers.
F - 44
OTHER FINANCIAL ASSETS: The carrying amount of Federal Home Loan Bank stock,
accrued interest receivable, excess servicing assets, interest-bearing deposits
maintained pursuant to various asset securitizations and other short-term
receivables approximates fair value.
DEPOSIT ACCOUNTS WITH NO STATED MATURITIES: Deposit liabilities payable on
demand, consisting of NOW accounts, money market deposit, 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.
BORROWINGS: These instruments consist of securities sold under repurchase
agreements and other short-term borrowings, bonds payable, notes payable and
Federal Home Loan Bank advances. For 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 1987 Debentures and 1988
Debentures is based on each issue's call price which approximates market. The
carrying amount of the $10.0 million private placement approximates fair value
since it has a variable rate.
OTHER FINANCIAL LIABILITIES: The carrying amount of custodial accounts, amounts
due to banks, accrued interest payable and other short-term payables
approximates fair value.
OFF-BALANCE SHEET INSTRUMENTS: There is no market value associated with the
Bank's commitments to extend credit and letters of credit because any prices
charged by the Bank are consistent with the prices charged by other companies
for similar agreements. Fair value of forward commitments is based on the
estimated amount that the Bank would pay to terminate the arrangements at the
reporting date, taking into account the remaining terms of the arrangements and
the counterparties' credit standing, where applicable.
30. LITIGATION - THE BANK
The Bank was one of numerous defendants in an action captioned Brandenburg, et
al. v. Hogg, et al., which was commenced in the Circuit Court for Montgomery
County, Maryland, in March 1989. This lawsuit was the same case dismissed in
1987 by the federal district court, and sought unspecified damages in fraud,
breach of fiduciary duty, negligence and conspiracy against the Bank and others
for interest lost by depositors of First Maryland Savings and Loan when that
savings institution was taken over by the State of Maryland in 1985. On December
18, 1991, the Circuit Court granted summary judgement for the Bank and the other
defendants finding that the plaintiffs' claims were barred by the statute of
limitations. The plaintiffs filed an appeal of the Court's decision on January
17, 1992. A settlement was reached pursuant to which the plaintiffs dismissed
their claims against all parties, including the Bank, in return for a payment of
$25 thousand from certain of the other defendants. The plaintiffs filed a motion
with the consent of all parties for approval of the settlement by the Court of
Appeals. Subsequently, the Court of Appeals approved the settlement.
F - 45
During the normal course of business, the Corporations are involved in certain
litigation, including litigation arising out of the collection of loans, the
enforcement or defense of the priority of their security interests, and the
continued development and marketing of certain of their real estate properties.
Although the amounts claimed in some of these suits in which the Corporations
are defendants are material, the Corporations deny 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 Corporations.
31. SUBSEQUENT EVENT - THE BANK
On November 23, 1993, the Bank sold $150.0 million 9 1/4% Subordinated
Debentures due 2005 (the "1993 Debentures") and provided a notice of redemption
to the holders of the Bank's outstanding 1987 Debentures and 1988 Debentures.
The Bank received net proceeds of $143.6 million from the sale of the 1993
Debentures and will use approximately $134.2 million of such proceeds to redeem
the 1987 Debentures and the 1988 Debentures. The remaining net proceeds will be
used for general corporate purposes. The Bank expects to incur a loss of
approximately $6.5 million, after related income taxes, in connection with the
redemption of the 1987 Debentures and the 1988 Debentures. The OTS has approved
the inclusion of the principal amount of the 1993 Debentures in the Bank's
supplementary capital for regulatory capital purposes.
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 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 (i)
$15 million, (ii) 66 2/3% of the Bank's consolidated net income (as defined)
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. 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
Preferred Stock 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.
F - 46
32. COMMITMENTS AND CONTINGENCIES - THE TRUST
In November 1990, the Trust was notified that the Securities and Exchange
Commission (the "SEC") had initiated an informal inquiry concerning the Bank's
reserves for losses on loans and related matters, and the Bank was requested to
provide the SEC with certain documents relating to the Bank covering the period
since October 1, 1988. The Real Estate Trust and the Bank have cooperated fully
with the SEC's inquiry and, pursuant to the SEC's original request, the last set
of documents was produced on February 6, 1991. On March 27, 1992, the Trust
received a letter from the SEC staff seeking additional documents in connection
with the inquiry. The last documents responsive to this additional request were
produced on July 31, 1992. The SEC has not taken any additional action to date
with respect to the inquiry. Based upon the information available to it at this
time, management believes that the matter should be resolved in a manner that
will not result in a material adverse financial impact on the Trust.
The Real Estate Trust has pledged 1,200 shares of its stock in the Bank as
security for a term loan made to B.F. Saul Company, a shareholder of the Real
Estate 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.
33. 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 1993, 1992, and
1991 provisions for income taxes consist of the following:
- ----------------------------------------------------------------------
Year Ended September 30,
------------------------------
(In thousands) 1993 1992 1991
- --------------------------------------- --------- -------- ---------
FEDERAL TAX PROVISION (BENEFIT)
Real Estate Trust - Current $(15,246) $(9,750) $(1,284)
The Bank
Current 14,189 16,504 13,191
Deferred 8,795 (2,937) (11,907)
--------- -------- ---------
Total 7,738 3,817 -
--------- -------- ---------
STATE TAX PROVISION (BENEFIT)
Real Estate Trust - Current 346 32 58
The Bank
Current 3,625 5,332 4,121
Deferred (6) (1,796) (954)
--------- -------- ---------
Total 3,965 3,568 3,225
--------- -------- ---------
TOTAL TAX PROVISION (BENEFIT)
Real Estate Trust - Current (14,900) (9,718) (1,226)
The Bank
Current 17,814 21,836 17,312
Deferred 8,789 (4,733) (12,861)
--------- -------- ---------
Total $11,703 $7,385 $3,225
========= ======== =========
- ----------------------------------------------------------------------
F - 47
As a result of the Trust's increase in its equity interest in the Bank to 80%,
for federal income tax purposes, the Bank became a member of the Trust's
affiliated group filing consolidated federal income tax returns for taxable
years and partial taxable years beginning on or after June 28, 1990. In
addition, the companies in the Trust's affiliated group, including the Bank,
entered into a tax sharing agreement dated June 28, 1990. 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 $5.0 and $29.6 million, respectively, to the Trust
during fiscal 1993 and 1991. It made no payments during fiscal 1992. Effective
June 30, 1991, the Bank agreed with the OTS not to make any further tax sharing
payments to the Trust without the permission of OTS; however, the Trust
continues to account for income taxes in accordance with the tax sharing
agreement.
In recent years, the operations of the Trust have generated significant net
operating losses while the Bank has reported net income. It is anticipated that
the Trust's consolidation of the Bank's operations into the Trust's federal
income tax return will result in the use of the Trust's net operating losses
("NOL's") to reduce the federal income taxes the Bank would otherwise owe. If in
any future year, the Bank has taxable losses or unused tax 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.
At September 30, 1993, the Trust's NOL's for federal income tax purposes were
approximately $11.5 million which will expire in 2008. At September 30, 1993,
the Trust had a federal alternative minimum tax credit carryforward of $2.7
million.
For the periods presented, the effective income tax rate varies from the
statutory federal income tax rate because of the following factors:
- -----------------------------------------------------------------------
Year Ended September 30,
-------------------------------
(In thousands) 1993 1992 1991
- --------------------------------------- ---------- --------- ----------
REAL ESTATE TRUST
Computed tax at statutory Federal
income tax rate - - -
Increase (reduction) in taxes
resulting from:
Use of current losses to offset
taxable income (15,246) (9,750) (1,284)
State income taxes 346 32 58
--------- -------- ---------
Subtotal (14,900) (9,718) (1,226)
--------- -------- ---------
THE BANK
Computed tax at statutory Federal
income tax rate 22,238 12,969 (1,984)
Increase (reduction) in taxes
resulting from:
Purchase accounting basis
adjustments 1,915 1,822 4,457
State franchise tax effect 2,359 2,171 2,091
Other 91 141 (113)
--------- -------- ---------
Subtotal 26,603 17,103 4,451
--------- -------- ---------
TOTAL COMPANY $11,703 $7,385 $3,225
========= ======== =========
- ----------------------------------------------------------------------
F - 48
The tax effect of each timing difference resulting in a deferred income tax
provision is as follows:
- ----------------------------------------------------------------------
Year Ended September 30,
-------------------------------
(In thousands) 1993 1992 1991
- -------------------------------------- --------- -------- ---------
Deferred loan fees $(938) $2,121 $164
Provision for loan losses less than
(in excess of) deductible amounts 13,477 (8,493) (25,062)
Depreciation (2,864) 1,610 2,587
Valuation allowances 19 77 5,928
Delinquent interest 960 346 (2,619)
Real estate mortgage investment conduit (1,454) (624) 204
State taxes (211) - 324
State net operating losses (1,577) - 1,564
Other 1,377 230 4,049
--------- -------- ---------
Total $8,789 $(4,733) $(12,861)
========= ======== =========
- ----------------------------------------------------------------------
34. SHAREHOLDERS EQUITY - THE TRUST
In July 1988, the Trust and an affiliated company, Westminster Investing
Corporation ("Westminster"), jointly made a tender offer to purchase all shares
of the Trust held by nonaffiliated shareholders at a price of $28 per share. By
the terms of the offer, Westminster was to purchase the first 770,000 shares
tendered and the Trust to purchase the remainder. Simultaneously, holders of the
Trust's 6 1/2% Convertible Subordinated Debentures were notified that they could
elect to convert their debentures at the conversion price of $23 per share and
tender their new shares at the $28 per share purchase price in the tender offer.
Debenture conversions resulted in the issuance of 556,852 shares of $1 par value
per share with resulting paid-in surplus of $12.2 million. Including the
newly-issued shares, 1,643,953 total shares were tendered, of which 873,953 were
purchased by the Trust as treasury shares in fiscal 1988. The approximate cost
of this transaction to the Trust was $25 million. At a meeting on October 24,
1988, shareholders approved a merger pursuant to which the Trust and its
affiliates would acquire the remaining equity ownership of the Trust
(approximately 3% of the outstanding shares) at $28 per share. In fiscal 1989,
the Trust acquired an additional 161,399 shares at an approximate cost of $5
million.
In June 1990, the Trust acquired from affiliated companies an additional equity
interest in the bank. The acquisition 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 ("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 Westminster in
June 1990, and assumed the related debt of $2.5 million in exchange for 66,000
preferred shares. The transaction has been accounted for at historical cost
because the entities are considered to be under common control. The debt assumed
by the Trust exceeded the carrying amount of the properties by $736,000.
Accordingly, this transaction had no effect on total shareholders' equity. The
$736,000 excess will remain on the Real Estate Trust's balance sheet until the
property is sold to an independent party.
At September 30, 1993, 1992, and 1991, the amount of dividends in arrears on the
preferred shares was $15,808,500 ($30.64 per share), $10,390,500 ($20.14 per
share), and $4,972,500 ($9.64 per share), respectively.
F - 49
35. QUARTERLY FINANCIAL DATA (UNAUDITED) - THE TRUST
- ---------------------------------------------------------------------------------------------------------------------
Year Ended September 30, 1993
----------------------------------------------------------
(In thousands, except per share amounts) December March June September
- ---------------------------------------------------------- ------------- ------------- ------------- -------------
Real Estate Trust
Total income $24,250 $23,205 $25,257 $20,533
Operating loss (6,962) (7,388) (6,465) (23,680)
The Bank
Interest income 92,144 87,745 83,243 85,682
Interest expense 44,988 41,188 40,281 41,061
Provision for loan losses (27,754) (15,207) (12,933) (6,619)
Gain (loss) on real estate held for investment (19,601) 978 38 5,863
Gain on sales of credit card relationships, loans and
mortgage-backed securities 12,664 5,820 2,390 10,501
Operating income 1,266 21,670 20,823 20,090
Total Company
Operating income (loss) before income taxes, extraordinary
items and minority interest (5,696) 14,282 14,358 (3,590)
Income (loss) before extraordinary items and minority
interest (5,928) 9,962 8,272 (4,655)
Extraordinary items - 2,554 4,790 394
Income (loss) before minority interest (5,928) 12,516 13,062 (4,261)
Net income (loss) (6,046) 9,910 9,033 (8,424)
Net income (loss) per common share (1.53) 1.77 1.59 (2.03)
- ---------------------------------------------------------------------------------------------------------------------
Year Ended September 30, 1992
----------------------------------------------------------
(In thousands, except per share amounts) December March June September
- ---------------------------------------------------------- ------------- ------------- ------------- -------------
Real Estate Trust
Total income $24,666 $23,789 $26,109 $25,615
Operating loss (7,221) (8,230) (5,140) (7,920)
The Bank
Interest income 112,262 105,257 94,080 91,434
Interest expense 65,451 54,309 49,282 45,719
Provision for loan losses (27,061) (12,990) (34,692) (14,319)
Loss on real estate held for investment (3,285) (2,525) (43,385) (1,454)
Gain on sales of credit card relationships, loans and
mortgage-backed securities 17,710 1,447 21,843 3,259
Operating income (loss) 20,468 18,206 (21,032) 25,767
Total Company
Operating income (loss) before income taxes, extraordinary
items and minority interest held by affiliates 13,247 9,976 (26,172) 17,847
Income (loss) before extraordinary items and minority interest
held by affiliates 6,946 5,111 (16,856) 12,312
Extraordinary items 4,132 2,855 (7,119) 3,817
Income (loss) before minority interest held by affiliates 11,078 7,966 (23,975) 16,129
Net income (loss) 8,733 5,866 (21,882) 13,220
Net income (loss) per common share 1.53 0.93 (4.81) 2.46
- ---------------------------------------------------------------------------------------------------------------------
F - 50
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.
- ---------------------------------------------------------------------------------------------------------------------0
Year Ended September 30
-------------------------------------------
(In thousands) 1993 1992 1991
- ------------------------------------------------------------------------ ------------ ------------- -------------
INCOME
Commercial properties $45,736 $51,489 $54,035
Hotels 45,385 46,628 45,769
Other 2,124 2,062 2,209
------------ ------------- -------------
$93,245 $100,179 $102,013
============ ============= =============
OPERATING PROFIT (LOSS)
Commercial properties $24,316 $28,531 $28,324
Hotels 7,228 7,937 5,812
Other (252) (90) (259)
------------ ------------- -------------
31,292 36,378 33,877
Gain (loss) on sales of property 184 (546) 20,308
Interest and debt expense (net of interest capitalized) (53,499) (53,024) (60,111)
Advisory fee, management and leasing fees - related
parties (7,249) (7,093) (9,036)
General and administrative (2,407) (4,226) (5,073)
Abandoned development costs (12,816) - -
------------ ------------- -------------
Operating loss $(44,495) $(28,511) $(20,035)
============ ============= =============
IDENTIFIABLE ASSETS (AT YEAR END)
Commercial properties:
Operating properties $87,142 $183,731 $186,045
Properties under development - 640 669
Hotels - operating properties 82,472 83,897 86,541
Other 50,942 66,110 72,833
------------ ------------- -------------
$220,556 $334,378 $346,088
============ ============= =============
DEPRECIATION
Commercial properties $7,712 $8,542 $9,749
Hotels 4,660 4,728 4,858
Other 85 130 220
------------ ------------- -------------
$12,457 $13,400 $14,827
============ ============= =============
CAPITAL EXPENDITURES
Commercial properties:
Operating properties $5,996 $3,814 $4,722
Properties under development - 32 64
Hotels - operating properties 1,458 2,279 2,822
Other 11 68 112
------------ ------------- -------------
$7,465 $6,193 $7,720
============ ============= =============
- ---------------------------------------------------------------------------------------------------------------------
F - 51
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) 1993 1992
- --------------------------------------------------------------------------------------- ------------ ------------
ASSETS
Income-producing properties $224,982 $350,166
Accumulated depreciation (62,626) (95,466)
------------ ------------
162,356 254,700
Land parcels 38,411 50,981
Equity investment in savings bank 129,968 85,655
Cash and cash equivalents 2,710 628
Other assets 17,079 28,069
------------ ------------
Total assets 350,524 420,033
============ ============
LIABILITIES
Mortgage notes payable $264,776 $429,968
Notes payable - unsecured due 1992-2003 38,661 50,417
Deferred gains - real estate 109,027 4,687
Other liabilities and accrued expenses 37,689 37,688
------------ ------------
Total liabilities 450,153 522,760
------------ ------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT)* (99,629) (102,727)
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $350,524 $420,033
============ ============
<FN>
*Consolidated Statements of Shareholders' Equity
- --------------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF OPERATIONS
- ------------------------------------------------------------------------------------------------------------------
For the Year Ended September 30
-----------------------------------------
(In thousands) 1993 1992 1991
- ------------------------------------------------------------------------ ------------ ------------ ------------
Total income $93,245 $100,179 $102,013
Total expenses (137,256) (127,936) (142,144)
Equity in losses of partnership investments (668) (208) (212)
Gain (loss) on sales of property 184 (546) 20,308
------------ ------------ ------------
Real estate operating loss (44,495) (28,511) (20,035)
Equity in earnings (losses) of savings bank 49,314 34,612 (7,166)
------------ ------------ ------------
Total company operating income (loss) 4,819 6,101 (27,201)
Provision for income taxes 346 32 58
------------ ------------ ------------
Income (loss) before extraordinary item 4,473 6,069 (27,259)
Extraordinary item: loss on early extinguishment of debt - (132) -
------------ ------------ ------------
TOTAL COMPANY NET INCOME (LOSS) $4,473 $5,937 $(27,259)
============ ============ ============
- --------------------------------------------------------------------------------------------------------------------
F - 52
CONDENSED STATEMENTS OF CASH FLOWS
-------------------------------------------------------------------------------------------------------------------------
For the Year Ended September 30
------------------------------------------
(In thousands) 1993 1992 1991
- ---------------------------------------------------------------------------- ------------ ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $4,473 $5,937 $(27,259)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation 12,457 13,400 14,827
Abandoned development costs 13,104 - -
Loss (gain) on sales of property (184) 546 (20,308)
Equity in losses (earnings) of savings bank (49,314) (34,612) 7,166
Decrease (increase) in accounts receivable and accrued income 98 2,906 (1,380)
Increase in accounts payable and accrued expenses 7,047 11,594 5,700
Other 9,170 (655) 4,880
------------ ------------ ------------
Net cash used in operating activities (3,149) (884) (16,374)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures - properties (7,465) (6,193) (7,720)
Property sales 3,780 4,908 34,544
Equity investment in unconsolidated entities 4,850 (58) 28,049
Other investing activities 836 10 458
------------ ------------ ------------
Net cash provided by (used in) investing activities 2,001 (1,333) 55,331
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 8,787 40,590 12,725
Repayments of long-term debt (24,519) (35,747) (52,357)
Costs of obtaining financings (1,170) (4,674) (577)
Proceeds from the issuance of redeemable preferred stock 21,507 - -
Dividends paid (1,375) - (1,500)
------------ ------------ ------------
Net cash provided by (used in) financing activities 3,230 169 (41,709)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 2,082 (2,048) (2,752)
Cash and cash equivalents at beginning of year 628 2,676 5,428
------------ ------------ ------------
Cash and cash equivalents at end of year $2,710 $628 $2,676
============ ============ ============
- --------------------------------------------------------------------------------------------------------------------
F - 53
MANAGEMENT'S STATEMENT ON RESPONSIBILITY
The Consolidated Financial Statements and related financial information
in this report have been prepared by the Advisor (management) 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 controls 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. They provide an objective assessment of the degree to
which management meets its responsibility for fairness and accuracy in financial
reporting and regularly evaluate the system of internal accounting controls,
performing 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.
SIGNATURES
In accordance with the requirments of the Securities Exchange Act of 1934,
the registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on January 28, 1994.
B.F. SAUL REAL ESTATE
INVESTMENT TRUST
By: /s/ PHILIP D. CARACI
_____________________________
Philip D. Caraci
Senior Vice President
By: /s/ ROSS E. HEASLEY
_____________________________
Ross E. Heasley
Vice President