EXHIBIT 13
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B. F. Saul
Real Estate Investment Trust
Annual Report 1994
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TABLE OF CONTENTS
PAGE
BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Real Estate . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Real Estate . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . 68
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . . . . . . . . . 69
MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . . . . . . . . . 70
SELECTED FINANCIAL DATA. . . . . . . . . . . . . . . . . . . . . . . . . . 70
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS. . . . . . . . . . . . . . . 74
Financial Condition. . . . . . . . . . . . . . . . . . . . . . . . . 74
Real Estate . . . . . . . . . . . . . . . . . . . . . . . . . . 74
Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
Liquidity and Capital Resources. . . . . . . . . . . . . . . . . . . 102
Real Estate . . . . . . . . . . . . . . . . . . . . . . . . . . 102
Banking
Liquidity. . . . . . . . . . . . . . . . . . . . . . . . . . . 105
Capital. . . . . . . . . . . . . . . . . . . . . . . . . . . . 108
Results of Operations. . . . . . . . . . . . . . . . . . . . . . . . 113
Fiscal 1994 Compared to Fiscal 1993 . . . . . . . . . . . . . . . 114
Real Estate . . . . . . . . . . . . . . . . . . . . . . . . . . 114
Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
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Fiscal 1993 Compared to Fiscal 1992. . . . . . . . . . . . . . . . . 127
Real Estate . . . . . . . . . . . . . . . . . . . . . . . . . . 127
Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128
FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION . . . . . . . . . . . . F-1
Management's Statement on Responsibility . . . . . . . . . . . . . . 134
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE. . . . . . . . . . . . . . . . . . . . 134
FINANCIAL STATEMENT SCHEDULES. . . . . . . . . . . . . . . . . . . . . . . 135
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BUSINESS
GENERAL
B.F. Saul Real Estate Investment Trust (the "Trust") operates as an
unincorporated common law trust governed by Maryland law. 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.
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 Bank, F.S.B.,
formerly Chevy Chase Savings Bank, F.S.B. ("Chevy Chase" or the "Bank"), whose
assets accounted for approximately 93% of the Trust's consolidated assets at
September 30, 1994. 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 recorded net income of $23.1 million in the fiscal year ended
September 30, 1994, compared to net income of $4.5 million in the fiscal year
ended September 30, 1993 and net income of $5.9 million in the fiscal year
ended September 30, 1992.
The Trust has prepared its financial statements and other disclosures on a
fully consolidated basis. The Term "Trust" used in the text and the financial
statements included herein refers to the combined entity, which includes B.F.
Saul Real Estate Investment Trust and its subsidiaries, including Chevy Chase
and Chevy Chase's subsidiaries. "Real Estate Trust" refers to B.F. Saul Real
Estate Investment Trust and its subsidiaries, excluding Chevy Chase and Chevy
Chase's subsidiaries. The operations conducted by the Real Estate Trust are
designated as "Real Estate," while the business conducted by Chevy Chase and its
subsidiaries is identified by the term "Banking."
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 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 and industrial projects, hotels and undeveloped land
parcels.
BANKING. Chevy Chase is a federally chartered and federally insured stock
savings bank which at September 30, 1994 was
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conducting business from 81 full-service offices and 383 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, 16 of which are operated by a
wholly-owned mortgage banking subsidiary. At September 30, 1994, the Bank had
total assets of $4.7 billion and total deposits of $4.0 billion. Based on
total consolidated assets at September 30, 1994, 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.
Chevy Chase 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 credit card and other types of consumer loans. As a complement to
its basic deposit and lending activities, the Bank provides a number of related
financial services to its customers, including securities brokerage and
insurance products offered through its subsidiaries.
Chevy Chase recorded operating income of $53.2 million for the year ended
September 30, 1994, compared to operating income of $63.8 million for the
year ended September 30, 1993. The Bank was in compliance with all of its
regulatory capital requirements at September 30, 1994. The Bank's tangible,
core (or leverage) and risk-based regulatory capital ratios at September 30,
1994 were 4.96%, 5.34% and 12.19%, respectively, compared to the requirements
under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
of 1.5%, 3.0% and 8.0%, respectively. At September 30, 1994, the Bank's
leverage, tier 1 risk-based and total risk-based regulatory capital ratios of
5.34%, 6.95% and 12.19%, respectively, were sufficient for the Bank to meet the
standards of 5.0%, 6.0% and 10.0%, respectively, for classification of the Bank
as "well capitalized" under the "prompt corrective action" regulations of the
Office of Thrift Supervision ("OTS"). In November 1994, the OTS revised its
existing policy and announced that, beginning as early as December 1994, savings
associations may exclude net unrealized holding gains (losses) on debt
securities classified as available-for-sale from regulatory capital for purposes
of computing regulatory capital ratios. If this revised policy had been in
effect on September 30, 1994, the Bank's tangible, core, tier 1 risk-based and
total risk-based regulatory capital ratios would have increased to 5.27%, 5.64%,
7.35% and 12.66%,
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respectively. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Financial Condition - Banking - Capital."
Chevy Chase is subject to comprehensive regulation, examination and
supervision by the OTS and by the Federal Deposit Insurance Corporation (the
"FDIC"). The Bank's deposit accounts are fully insured up to $100,000 per
insured depositor by the Savings Association Insurance Fund (the "SAIF"), which
is administered by the FDIC.
REAL ESTATE
REAL ESTATE INVESTMENTS
The 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, 1994.
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OFFICE AND INDUSTRIAL
Leasing Percentages Expiring Leases (1)
-------------------------- -------------------------
Gross September 30, Year Ending September 30,
Leasable -------------------------- -------------------------
Location Name Area (1) 1994 1993 1992 1995 1996
- -------------------------------------------- -------- -------------------------- -------------------------
FLORIDA
Fort Lauderdale Commerce Center-
Phase II, 64,040 72% 53% 62% 6,948 2,220
GEORGIA
Atlanta 900 Circle 75 Parkway 345,502 100% 85% 82% 145,636 88,311
1000 Circle 75 Parkway 86,096 96% 97% 82% 24,496 25,241
1100 Circle 75 Parkway 267,460 98% 49% 84% 46,523 17,137
Perimeter Way 57,605 52% 50% 52% 27,304 1,964
LOUISIANA
Metairie Metairie Tower 91,372 92% 90% 90% 35,166 12,669
VIRGINIA
Chantilly Dulles South (2) 38,502 63% 55% 49% 5,491 5,348
McLean 8201 Greensboro Drive 353,742 98% 90% 87% 229,379 36,694
Sterling Dulles North (3) 59,000 87% 86% 84% 0 15,665
--------- ------------------------ ---------------------
1,363,319 93% 77% 81% 520,943 205,249
<FN>
- ---------------------
(1) Square feet.
(2) A Real Estate Trust subsidiary owns a 50% interest in this office
building.
(3) A Real Estate Trust subsidiary owns a 99% interest in this office
building.
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HOTELS
Average Occupancy (1) Average Room Rate
---------------------- -----------------------------
Year Ended Year Ended
September 30, September 30,
Available ---------------------- ----------------------------
Location Name Rooms 1994 1993 1992 1994 1993 1992
- ------------- ------------------------------------ --------- ------ ------ ------ ------ ------ ------
COLORADO
Pueblo Holiday Inn - Pueblo 193 79% 76% 78% $48.75 $46.37 $44.62
MARYLAND
Gaithersburg Holiday Inn - Gaithersburg 303 57% 59% 66% $60.12 $58.56 $56.44
NEW YORK
Rochester Holiday Inn - Rochester 280 64% 69% 74% $64.24 $63.61 $63.66
OHIO
Cincinnati Holiday Inn - Sharonville 274 52% 52% 51% $58.77 $55.83 $56.19
VIRGINIA
Arlington Howard Johnsons - National Airport 279 70% 73% 69% $65.27 $58.48 $60.67
McLean Holiday Inn - Tysons Corner 315 74% 78% 77% $64.41 $57.79 $60.09
Norfolk Howard Johnsons - Norfolk 344 42% 33% 69% $36.00 $40.80 $34.54
Sterling Hampton Inn - Dulles Airport (2) 127 73% 81% 71% $54.10 $46.12 $45.86
Holiday Inn - Dulles Airport 297 65% 66% 62% $56.84 $54.17 $56.64
------ ----- ----- ----- ------ ------ ------
TOTALS 2,412 62% 63% 68% $57.57 $54.94 $54.01
- ---------------------
<FN>
(1) Average occupancy is calculated by dividing the rooms occupied by the rooms
available.
(2) A Real Estate Trust subsidiary owns a 99% interest in this hotel.
(3) On November 30, 1994, the Real Estate Trust acquired a 192-room Holiday Inn
located in Auburn Hills, Michigan.
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LAND PARCELS
Location Name Acres Zoning
- -------------------------------------------------------------------------------------------------------
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
----
Total 433
<FN>
- ---------------------
(1) A Real Estate Trust subsidiary owns a 50% interest in 11 acres of this
parcel.
(2) A Real Estate Trust subsidiary owns a 99% interest in this parcel.
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OTHER REAL ESTATE INVESTMENTS
Location Name
- -------------------------- -------------------------------------------------
PURCHASE - LEASEBACK PROPERTIES (1)
Number
of Units
--------------
APARTMENTS
Louisiana Metairie Chateau Dijon 336
Tennessee Knoxville Country Club 232
-----
Total 568
Gross Leasable
Area (2)
--------------
SHOPPING CENTERS
Georgia Atlanta Old National 160,000
Warner Robbins Houston Mall 264,000
Wyoming Casper Beverly Plaza 150,000
-------
Total 574,000
APARTMENT PROJECT
Number
of Units
--------------
TEXAS Dallas San Simeon 124
MISCELLANEOUS PROPERTY (RETAIL)
Gross Leasable
Area (2)
--------------
MARYLAND Oxon Hill Wheeler Road 24,000
<FN>
- ---------------------
(1) The Real Estate Trust owns the ground under certain income-producing
properties and receives fixed ground rent, which is subject to periodic
escalation, from the owners of the improvements. In certain instances, the
Real Estate Trust also receives percentage rent based upon the income
generated by the properties.
(2) Square feet.
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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.
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 a 21.5% limited partnership interest (and 3,495,713 partnership
units corresponding thereto) in Saul Holdings Partnership, which it holds
directly and through two wholly owned subsidiaries. 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. 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 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 the basis of one share
of Saul Centers common stock for each partnership unit at the end of a 36-month
period commencing after the initial public offering, provided that they do not
own Rights to the extent that they collectively would be treated as owning,
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
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the New York Stock Exchange (trading symbol "BFS").
In July 1994, Saul Centers established Saul QRS, Inc. and SC Finance
Corporation, as wholly owned subsidiaries of Saul Centers. Saul QRS, Inc. was
established to succeed to the interest of Saul Centers as the sole general
partner of one of the Subsidiary Partnerships, Saul Subsidiary I Limited
Partnership, and SC Finance Corporation was established for the purpose of
issuing $128 million of collateralized floating rate mortgage notes (the
"Mortgage Notes"). In connection with these transactions, Saul Holdings
Partnership transferred ten shopping centers previously owned by it to Saul
Subsidiary I Limited Partnership as an additional capital contribution and the
second Subsidiary Partnership, Saul Subsidiary II Limited Partnership,
transferred one shopping center previously owned by it to Saul Subsidiary I
Limited Partnership as an initial capital contribution in return for a limited
partnership interest in Saul Subsidiary I Limited Partnership. As a consequence
of these transfers, Saul Subsidiary I Limited Partnership currently owns a total
of 17 shopping centers (the "Mortgaged Properties"). The Mortgaged Properties,
which continue to be managed by Saul Holdings Partnership and Saul Subsidiary II
Partnership, secure the mortgage purchased with the proceeds of issuance of the
Mortgage Notes.
At September 30, 1994, Saul Holdings Partnership owned, directly or
indirectly through the Subsidiary Partnerships, 29 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 in a Maryland suburb of Washington, D.C. (the
"Portfolio Properties").
SAUL CENTERS. Saul Centers has made 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 ended
December 31, 1993. Under the Internal Revenue Code, REITs are subject to
numerous organizational and operational requirements. If Saul Centers continues
to qualify, it generally will not be subject to federal income tax, provided it
makes certain distributions to its stockholders and meets certain organizational
and other requirements. Saul Centers has announced that it intends to make
regular quarterly dividend distributions to its stockholders.
MANAGEMENT OF THE PROPERTIES. The Partnerships 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
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management capability through approximately 150 professionals and staff
personnel 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.
Saul Centers shares 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 shares insurance
expense on a pro rata basis. The Real Estate Trust and the Trust Affiliates
sublease office space to Saul Centers at their cost. The terms of all sharing
arrangements, including payments related thereto, are 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 Real Estate 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 has the right to 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, as
amended, 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
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obligations. At September 30, 1994, the maximum potential obligations of the
Real Estate Trust and its subsidiaries under this agreement totaled $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.
POTENTIAL CONFLICTS OF INTEREST. 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 or Saul QRS, Inc., acting as general partner of a
Partnership, causes such Partnership to dispose of, or there is an involuntary
disposition of, one or more of such properties, a disproportionately large share
of the total gain for federal income tax purposes would be allocated to the Real
Estate Trust or its subsidiaries as a result of the property disposition. In
general, if the gain recognized by the Partnership on such 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), all such gain will be allocated to the Real Estate
Trust or its subsidiaries. To the extent the gain recognized by the Partnership
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 federal income
tax liability in respect 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, any release
of the guarantees of such debt by the Real Estate Trust or its subsidiaries
(described above under "Reimbursement Agreement") or any refinancings in which
the Real Estate Trust or its subsidiaries do not assume a comparable obligation
to that contained in the 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. See Note 2 to the Consolidated
Financial Statements in this report.
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
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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.
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 that there are no material environmental
hazards associated with such property.
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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 wholly owned 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 Real Estate Trust and the Saul Company and
its related entities and affiliates and believe that such fees and compensation
arrangements are as favorable to the Real Estate 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, 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."
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
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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 the OTS setting forth,
among other things, the steps the Bank would take to become adequately
capitalized.
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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 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 total income, and as a result the Trust
has had substantial net operating loss carryovers for federal income tax
purposes ("NOLs"). The Trust and its 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.
BAD DEBT RESERVE. Savings institutions that satisfy certain requirements
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 qualify for this
treatment, 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
-15-
property and loans made for the improvement of residential real property.
A qualifying thrift generally may compute the amount of the addition to a
reserve for losses on qualifying real property loans under the more favorable 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. 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 1994, approximately $78.0 million) into taxable
income. 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 ownership of the common stock of Chevy Chase from 60% to
80%. As a result of the Trust's 80% ownership of the common stock 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. The Trust's NOLs as
of its taxable year beginning October 1, 1994 are approximately $39.9 million.
It is anticipated that, because Chevy Chase's operations will be included in the
Trust's consolidated returns for the foreseeable future, 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.
The Tax Sharing Agreement generally provides that each member of the
Trust's affiliated group is required to pay the Trust an amount equal to 100% of
the tax liability that the member would have been required to pay to the IRS if
the member had filed on a separate return basis. These amounts generally
-16-
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 tax
authorities the overall tax liability, if any, of the group. In addition, to
the extent the net operating losses or tax credits of a particular member reduce
the overall tax liability of the group, the Trust is required to reimburse 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 fiscal 1993. OTS approval of the $5.0 million
payment made in fiscal 1993 was conditioned on a pledge by or on behalf of the
Trust of certain 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, tax sharing payments of $9.6 million to the Trust in fiscal 1994.
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, 1994, the amount of
tax sharing payments due to the Trust, but then unpaid, was $12.0 million.
Subsequent to such date, the Bank made a tax sharing payment of $5.0 million to
the Trust.
In general, if the Bank has net operating losses or unused tax credits in
any taxable year, under the Tax Sharing Agreement the Trust is obligated to
reimburse the Bank in an amount generally equal to (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, 1994 $12.0 million of
tax sharing payments were due to the Trust (of which $5 million was
-17-
subsequently paid). 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.
STATE TAXATION
Maryland law does not allow the filing of consolidated income tax returns,
and thus the Trust, the Bank and the subsidiaries of the Trust and the Bank
subject to Maryland tax are required to file separately in Maryland. The 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. From time to time, the Bank obtains
advances from the FHLB. At September 30, 1994, the Bank had outstanding a
$100.0 million advance from the FHLB of Atlanta. See Note 22 to the
Consolidated Financial Statements in this report and "Deposits and Other Sources
of Funds - Borrowings."
As a member of the FHLB of Atlanta, the Bank is required to acquire and
hold shares of capital stock in that bank in an amount equal to the greater of:
(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 $31.9 million in FHLB stock at September 30, 1994. The Bank
earned dividends of $1.8 million during each of the years ended September 30,
1994 and 1993, at weighted average annual rates of 5.65% and 5.63%,
respectively, during such years.
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,
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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 or short-term 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, 1994, the Bank was in compliance
with both requirements, with a liquid assets ratio of 18.6% and a short-term
liquid assets ratio of 5.1%.
DEPOSIT INSURANCE PREMIUMS. Under FDIC insurance regulations, the Bank is
required to pay premiums to SAIF for insurance of its accounts. The FDIC has
adopted a risk-based premium system, which took effect October 1, 1993, pursuant
to which 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."
Although the FDIC insures commercial banks as well as thrifts, the
insurance reserve funds for commercial banks and thrifts have been segregated
into the Bank Insurance Fund ("BIF") and the SAIF, respectively. The FDIC is
required to increase the reserves of both the BIF and the SAIF to 1.25% of
insured deposits over a reasonable period of time and thereafter to maintain
such reserves at not less than that level. According to forecasts by the FDIC
and others, the BIF reserve is expected to reach 1.25% of insured deposits as
early as mid-1995, at which point the insurance premium that commercial banks
are required to pay could be reduced substantially. On the other hand, the
SAIF, of which Chevy Chase is a member, is not expected to achieve the required
1.25% level until at least 2002 without Congressional action to provide
additional funding or merge the BIF and SAIF. The potential resulting disparity
in insurance premiums for commercial banks and thrifts could lead to a
competitive disadvantage for the thrift industry in the pricing of loans and
deposits and the incurrence of operating costs.
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
-19-
imposed by the FDIC. The 30-day period may be eliminated by the FDIC with the
approval of the OTS.
REGULATORY CAPITAL. Under OTS regulations implementing the capital
requirements imposed by FIRREA, savings institutions, such as the Bank, are
subject to 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, 1994, the Bank's tangible, core
and total risk-based regulatory capital ratios were 4.96%, 5.34% and 12.19%,
respectively, compared to the minimum requirements under FIRREA of 1.50%, 3.00%
and 8.00%, respectively, in effect at that date. If the OTS policy to exclude
net unrealized holding gains (losses) on debt securities classified as
available-for-sale from regulatory capital had been in effect on September 30,
1994, the Bank's tangible, core and total risk-based regulatory capital ratios
would have increased to 5.27%, 5.64% and 12.66%, respectively.
Under the minimum leverage ratio under FIRREA, Chevy Chase must maintain a
ratio of "core capital" to tangible assets of not less than 3.0%. However,
under the OTS "prompt corrective action" regulations, an institution that is not
in the highest supervisory category must maintain a minimum leverage ratio of
4.0% to be considered an "adequately capitalized" institution. See "Prompt
Corrective Action." "Core capital" generally includes common shareholders'
equity, noncumulative perpetual preferred stock and minority interests in
consolidated subsidiaries, less certain intangible assets, except that purchased
mortgage servicing rights ("PMSRs") and purchased credit card relationships
("PCCRs") may be included up to an aggregate amount of 50% of core capital.
PCCRs are also subject to a sublimit of 25% of core capital. For these
purposes, PMSRs and PCCRs are valued at the lesser of 90% of fair market value
or 100% of the current unamortized book value. At September 30, 1994, the Bank
had qualifying PMSRs of $13.2 million, which constituted 5.4% of core capital at
that date, and had no PCCRs. Prior to March 4, 1994, PCCRs were not includable
in core capital and PMSRs were includable, subject to a limit of 50% of core
capital, at the lowest of 90% of fair market value, 90% of original cost or 100%
of the current amortized book value.
The amount of qualifying supervisory goodwill that may be included in core
capital was limited to 0.75% from January 1, 1993 through December 31, 1993, and
is limited to 0.375% beginning January 1, 1994 and will be reduced to 0%
beginning January 1, 1995. Phase-outs from capital also apply 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
-20-
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.
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,
1994, the Bank had $43.0 million in general reserves on loans and leases, all of
which was includable as supplementary capital.
Subordinated debt may be included in supplementary capital with OTS
approval subject to a phase-out based on its 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
-21-
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. The Bank has a $10.0 million capital note
outstanding which is treated in accordance with the rules in effect at November
7, 1989, the date of issuance of the new regulation. At September 30, 1994, the
Bank had $160.0 million in maturing capital instruments, of which $152.9 million
was includable as supplementary capital. See "Deposits and Other Sources of
Funds - Borrowings."
FDICIA required OTS and the other 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. The OTS amended its
risk-based capital rules effective January 1, 1994 to incorporate interest-rate
risk measures to complement measures which already have been established for
credit risk. An institution that would experience a change in "portfolio
equity" in an amount in excess of 2.0% of the institution's assets as a result
of a 200 basis point increase or decrease in the general level of interest rates
is required to maintain additional amounts of risk-based capital based on the
lowest interest rate exposure at the end of the three previous quarters. At
September 30, 1994, the Bank was not required to maintain additional amounts of
risk-based capital under the interest rate risk component of the capital
regulations.
Effective January 17, 1995, the OTS will take into account concentration of
credit risk and risks arising from non-traditional activities, as well as a
thrift's ability to manage these risks, in evaluating whether the thrift should
be subject to an individual minimum capital requirement. Based upon its review
of the regulation, management does not believe that this change will cause the
OTS to increase the Bank's minimum capital requirements.
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, 1994, investments in
non-includable subsidiaries are subject to a 40% phase-out from all three FIRREA
capital requirements. This phase-out will increase to 60% on July 1, 1995 and
100% on July 1, 1996 in accordance with a delayed phase-in period approved by
the OTS pursuant to legislation enacted in October 1992.
-22-
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, 1994, the Bank's investments in, and extensions of credit to,
its non-includable subsidiaries totaled approximately $27.2 million, which was
$44.3 million less than the level of such investments in, and extensions of
credit to, its non-includable subsidiaries as of the regulatory "grandfather"
date of April 12, 1989. Of the $27.2 million, $10.0 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 increased from 60% to
100% effective July 1, 1994. The Bank's only equity investments at
September 30, 1994 are certain properties classified as real estate held for
sale which the Bank has agreed to treat as equity investments for regulatory
capital purposes. At September 30, 1994, the book value of these properties
after subsequent valuation allowances amounted to $38.6 million, of which $34.0
million was required to be deducted from total capital. The Bank had no land
loans or non-residential construction loans with loan-to-value ratios greater
than 80% at September 30, 1994.
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 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 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 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
-23-
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 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 Communities which are under active
development, 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 the Communities and (iv) sell any single-family permanent loans for
purchases of homes in the Communities 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.
The OTS has the authority to require an institution to maintain capital at
levels above the minimum levels generally required, but has not indicated 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 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
-24-
tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital
ratio of at least 10.0%, and (ii) is not subject to any written agreement,
order, capital directive or prompt corrective action directive issued by the OTS
to meet and maintain a specific capital level. An institution is considered
"adequately capitalized" if such capital ratios are at least 4.0% (3.0% if rated
in the highest supervisory 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 determined
that the institution is in an unsafe or unsound condition or has received and
has not corrected a less than satisfactory examination rating for asset quality,
management, earnings or liquidity.
At September 30, 1994, based on the Bank's understanding of regulations in
effect on that date, the Bank's leverage, tier 1 risk-based and total risk-based
regulatory capital ratios were 5.34%, 6.95% and 12.19%, 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, and
the Bank was not subject to any applicable written agreement, order or directive
to maintain a specific capital level. On a fully phased-in basis, at September
30, 1994, the Bank would exceed the capital standards established for
"adequately capitalized" institutions. If the OTS policy to exclude unrealized
holding gains (losses) on debt securities classified as available-for-sale from
regulatory capital had been in effect on September 30, 1994, the Bank's
leverage, tier 1 risk-based and total risk-based capital ratios would have been
5.64%, 7.35% and 12.66%, respectively.
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 it 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
-25-
and that the Bank maintain sufficient capital to meet the "well capitalized"
ratios under the OTS's prompt corrective action regulations. In addition, on
September 27, 1994, the OTS notified the Bank that it would not object to an
increase in the Bank's total assets of approximately $75 million for the quarter
ended September 30, 1994.
QUALIFIED THRIFT LENDER ("QTL") TEST. Insured savings institutions like
the Bank must meet a QTL test to avoid imposition of certain restrictions. The
QTL test requires thrifts to maintain a "thrift investment percentage" equal to
a minimum of 65%. The numerator of such percentage is the thrift's "qualified
thrift investments" and 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, 1994, the Bank had 78.2% of its portfolio assets invested
in qualified thrift investments. Additionally, the Bank met the QTL test in
each of the previous 12 months.
At least 55% of a thrift's "qualified thrift investments" must consist of
residential housing loans (including home equity loans and manufactured housing
loans), mortgage-backed securities and FHLB and Federal National Mortgage
Association 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) and loans for personal, family household or
educational purposes (which may not exceed 10% of portfolio assets). Intangible
assets, including goodwill, are specifically excluded from qualified thrift
investments.
An institution that 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.
-26-
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 currently
permissible for national banks (i.e., 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 received permission from the OTS to include a specified
percentage of the Bank's credit card portfolio as "housing-related" qualified
thrift investments if the Bank otherwise would not meet the 65% requirement. The
specified percentage is based on a statistical methodology approved by the OTS
which must be updated annually. The only time the Bank has needed to include
housing-relating credit card balances to meet the QTL test was in the quarter
ended March 31, 1989.
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 securitization and sales
activity to date has 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
-27-
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 (i.e., the excess of capital over 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 not be less than 4.0% and 8.0%, respectively;
(ii) dividends are earned and payable in accordance with the OTS 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, 1994, 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. In
December 1994, the OTS proposed to amend its capital distribution regulation to
simplify it and to conform it to the system of "prompt corrective action"
established by FDICIA. The proposal would replace the current "tiered" approach
with one that, in accordance with the OTS's "prompt corrective action" rule,
would allow associations to make only those capital distributions that would not
cause capital to drop below the level required to remain adequately capitalized.
Those associations that are held by a savings and loan holding company, such as
the Bank, or that receive a composite supervisory rating lower than "2" would
continue to be required to notify the OTS prior to making any capital
distributions. Those associations that are
-28-
undercapitalized or that would be undercapitalized following a capital
distribution, or that are not undercapitalized but are in "troubled condition,"
could make a capital distribution only upon application to and approval by the
OTS. The proposal would delete the current numerical restrictions on the amount
of permissible capital distributions.
In May 1988, in connection with the merger of a Virginia thrift into the
Bank, the Saul Company and the Trust entered into a capital maintenance
agreement in which they agreed not to cause the Bank without prior written
approval of its federal regulator to pay "dividends" in any fiscal year in
excess of 50% of the Bank's net income for that fiscal year, provided that any
dividends permitted under such limitation could be deferred and paid in a
subsequent year. However, under the OTS capital distribution rule, with the
OTS's written approval, the Bank could substitute the requirements of the
proposed rule for any more stringent requirements imposed on it by a previous
written agreement.
The Bank also is subject to other limitations on its ability to pay
dividends. The indenture pursuant to which $150 million principal amount of
the Bank's 9 1/4% Subordinated Debentures due 2005 was issued in 1993 (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) 662/3% 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, minus the
aggregate amount of any restricted payments made by the Bank. Notwithstanding
these restrictions on dividends, provided no event of default has occurred or is
continuing under the Indenture, 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.
-29-
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. See "Deposits and
Other Sources of Funds - Borrowings."
LENDING LIMITS. Since FIRREA, thrift institutions have been subject to the
same loans-to-one-borrower limits that apply to national banks. 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 $73.9 million at
September 30, 1994, and no group relationships exceeded this limit at that date.
SAFETY AND SOUNDNESS STANDARDS. FDICIA, as amended in September 1994,
requires the federal financial institution 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 agencies have
discretion to impose the standards through either regulations or guidelines. Any
institution that fails to meet a standard that is imposed through regulation
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 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. Based on its 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.
DISPOSITION OF ADC INVESTMENTS. Acquisition, development and construction
("ADC") loans classified as investments in real estate for accounting purposes
are considered as ownership interests in real estate and, therefore, are not
authorized investments for the Bank to hold directly. The OTS has directed
-30-
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, 1994, the Bank had only one ADC loan, with a
book value of $8.9 million, before valuation allowances of $2.0 million,
classified as an investment in real estate.
REGULATORY ASSESSMENTS. Pursuant to authority under FIRREA, the OTS has
adopted the following fees to fund its operations: (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 has been subject to this
50% "premium assessment" since October 1, 1991. As a result, the semi-annual
assessment for the six-month period ending December 31, 1994 was $525,268,
comprising a general assessment of $350,179 and a premium assessment of
$175,089.
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. Also, as a SAIF-insured institution, the Bank is subject to
limitations on its ability to buy or sell deposits from or to, or to combine
with, a BIF-insured institution. Despite these restrictions, SAIF-insured
thrifts may be acquired by banks or by bank holding companies under certain
circumstances.
FIRREA substantially strengthened the enforcement powers of the federal
agencies regulating financial institutions and increased the maximum penalties
for violation of laws and regulations to as much as $1 million per day.
FDICIA imposes numerous oversight requirements on financial institutions.
Among other things, FDICIA requires the Bank's management to submit an annual
report on the condition of the Bank to the FDIC and the OTS.
Federally chartered thrifts like Chevy Chase generally are permitted to
establish new branches anywhere in the United States, provided that they
(i) meet their regulatory capital requirement; (ii) either have a satisfactory
record under the OTS's regulations implementing the Community Reinvestment Act
-31-
("CRA") or have committed to improve their investment-related practices and
performance to the satisfaction of the OTS; (iii) 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 (iv) meet the domestic
building and loan test or the asset composition test with respect to each state
outside of its home state where the association has established branches.
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. Prior to December 20, 1994, the
first $4.0 million of a depository institution's transaction accounts were
subject to a 0% reserve requirement. The next $47.9 million in net transaction
accounts were subject to a 3.0% reserve requirement and any net transaction
accounts over $51.9 million were subject to a 10.0% reserve requirement.
Effective December 20, 1994, the FRB increased the amount of transaction
accounts subject to a 0% reserve requirement from $4.0 million to $4.2 million
and increased the "low reserve tranche" from $47.9 million to $49.8 million.
The Bank met its reserve requirements for each period during the year ended
September 30, 1994. The balances maintained 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
-32-
undercapitalized institutions through the discount window.
COMMUNITY REINVESTMENT ACT. Under the Community Reinvestment Act 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. 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.
The Bank is committed to fulfilling its CRA obligation by providing access
to a full range of credit-related products and services to all segments of its
community. However, in September 1994, the OTS issued a final CRA evaluation
which criticized several aspects of the Bank's CRA performance and changed the
Bank's rating from "satisfactory" to "needs to improve." The OTS evaluation,
which was based on an examination dated May 17, 1993, focused largely on the
Bank's lending performance during 1991 and 1992. Management believes that the
OTS evaluation failed to give sufficient weight to the Bank's subsequent lending
performance under CRA after it emerged from the effects of the recession in
those years. See "Single-Family Residential Real Estate Lending."
In September 1994, the federal bank regulatory agencies issued for public
comment proposed revisions to the CRA regulations that are designed to focus the
CRA examination process on an institution's actual performance in meeting the
credit needs of low- and moderate-income neighborhoods rather than on its CRA
compliance procedures. Specifically, an institution would be evaluated on the
basis of its lending and investment in, and provision of services, to low- and
moderate-income areas. Institutions like the Bank, with more than $250 million
in assets, would be required to report additional data concerning consumer and
small business loans. If these revised regulations are adopted as proposed,
they would be effective as of July 1, 1996.
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.
-33-
RECENT ACCOUNTING PRONOUNCEMENTS. Statement of Financial Accounting
Standards No. 119, "Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments" ("SFAS 119"), was issued in October 1994. SFAS
119 requires companies to disclose the amount, nature and terms of derivative
financial instruments. Because SFAS 119 addresses only disclosure-related
issues, its adoption will not have an impact on the financial condition or
results of operations of the Bank. Adoption of SFAS 119 is required for fiscal
years ending after December 15, 1994. The Bank will be required to adopt SFAS
119 by September 30, 1995.
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 3.9%
in September 1994, compared to the national rate of 5.6%.
Chevy Chase historically has relied on retail deposits originated in its
branch network as its primary funding source. See "Deposits and Other Sources of
Funds." Chevy Chase's principal market for deposits consists of Montgomery and
Prince George's Counties in Maryland and, to a lesser extent, Fairfax County in
Virginia. Approximately 25.3% of the Bank's deposits at September 30, 1994 were
obtained from depositors residing outside of Maryland, primarily in Northern
Virginia. Chevy Chase had the largest market share of deposits in Montgomery
County at June 30, 1994, according to published industry statistics. The per
capita income of each 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 1994 (3.1%) was below the national rate (5.6%) and state rates (5.2%
for Maryland and 4.9% for Virginia) for the same month.
The Bank historically has concentrated its lending activities in the
Washington, D.C. metropolitan area. See "Lending Activities."
-34-
INVESTMENT 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
qualifying types of investments. See "Regulation - Liquidity Requirements." To
meet these requirements, the Bank maintains a portfolio of cash, federal funds
and 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 available-for-sale are reported
at fair value, with unrealized gains and losses reported as a net amount in a
separate component of stockholders' equity, net of the related income tax
effect.
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-to-maturity,
available-for-sale or trading.
LENDING ACTIVITIES
LOAN PORTFOLIO COMPOSITION. At September 30, 1994, the Bank's loan
portfolio totaled $2.5 billion, which represented 53.7% 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, and
exclude mortgage-backed securities.) Loans collateralized by single-family
residences constituted 55.2% 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.
-35-
Loan Portfolio
(Dollars in thousands)
September 30,
-------------------------------------------------------------------------------------------------------
1994 1993 1992 1991 1990
------------------- ------------------- ------------------- ------------------- -------------------
% of % of % of % of % of
(Dollars in thousands) Balance Total Balance Total Balance Total Balance Total Balance Total
----------- ------- ----------- ------- ----------- ------- ----------- ------- ----------- -------
Residential (1) $1,369,571 53.8 % $1,287,333 53.6 % $ 933,867 41.6 % $1,345,409 41.7 % $1,031,628 32.2 %
Home equity (1) 34,708 1.4 60,549 2.5 223,148 9.9 289,976 9.0 711,363 22.2
Commercial and
multifamily 84,210 3.3 94,079 3.9 61,522 2.7 69,097 2.1 89,759 2.8
Real estate
construction and
ground 52,350 2.0 62,637 2.6 92,215 4.1 133,852 4.2 277,061 8.6
Credit card (1) 650,199 25.5 754,520 31.4 872,672 38.9 1,302,008 40.4 883,722 27.6
Automobile 289,346 11.4 106,725 4.4 19,910 0.9 16,924 0.5 115,083 3.6
Other 66,851 2.6 38,048 1.6 42,019 1.9 67,659 2.1 96,476 3.0
----------- ------- ----------- ------- ----------- ------- ----------- ------- ----------- -------
2,547,235 100.0 % 2,403,891 100.0 % 2,245,353 100.0 % 3,224,925 100.0 % 3,205,092 100.0 %
----------- ======= ----------- ======= ----------- ======= ----------- ======= ----------- =======
Less:
Unearned premiums
and discounts 1,438 1,543 2,589 6,002 7,037
Deferred loan
origination fees
(costs) (10,604) (3,472) 1,889 6,612 7,721
Reserve for loan
losses 50,205 68,040 78,818 89,745 58,339
----------- ----------- ----------- ----------- -----------
41,039 66,111 83,296 102,359 73,097
----------- ----------- ----------- ----------- -----------
Total loans
receivable $2,506,196 $2,337,780 $2,162,057 $3,122,566 $3,131,995
=========== =========== =========== =========== ===========
<FN>
(1) Includes loans held for sale and/or securitization.
-36-
The Bank will continue to adjust the composition of its loan portfolio in
response to a variety of factors, including regulatory requirements and asset
and liability management objectives. 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,
1994. The entire balance of loans held for sale and/or securitization is shown
in the year ending September 30, 1995, because such loans are expected to be
sold in less than one year.
-37-
Contractual Principal Repayments
(In thousands)
Principal Approximate Principal Repayments
Balance Due in Years Ending September 30,
Outstanding at -------------------------------------------------------------------------------
September 30,
2010 and
1994 (1) 1995 1996 1997 1998-1999 2000-2004 2005-2009 Thereafter
-------------- --------- --------- --------- ---------- ---------- ---------- ----------
Residential $ 1,335,645 $ 26,574 $ 25,035 $ 26,022 $ 54,959 $ 236,383 $ 170,021 $ 796,651
Home equity 34,708 914 1,625 5,688 509 6 5,859 20,107
Commercial and multifamily 84,210 7,630 9,887 8,472 20,539 35,637 2,045 -
Real estate construction and ground 52,350 45,766 6,584 - - - - -
Credit card (2) 535,199 104,050 87,324 69,638 103,077 116,956 54,154 -
Other 356,197 79,851 76,723 81,333 118,290 - - -
Loans held for sale 33,926 33,926 - - - - - -
Loans held for securitization
and sale 115,000 115,000 - - - - - -
-------------- --------- --------- --------- ---------- ---------- ---------- -----------
Total loans receivable (3) $ 2,547,235 $413,711 $207,178 $191,153 $ 297,374 $ 388,982 $ 232,079 $ 816,758
============== ========= ========= ========= ========== ========== ========== ===========
Fixed-rate loans $ 534,384 $ 77,622 $ 85,580 $ 89,166 $ 139,655 $ 94,802 $ 11,932 $ 35,627
Adjustable-rate loans 1,863,925 187,163 121,598 101,987 157,719 294,180 220,147 781,131
Loans held for sale 33,926 33,926 - - - - - -
Loans held for securitization
and sale 115,000 115,000 - - - - - -
------------- --------- --------- --------- ---------- ---------- ---------- ----------
Total loans receivable (3) $ 2,547,235 $413,711 $207,178 $191,153 $ 297,374 $ 388,982 $ 232,079 $ 816,758
============== ========= ========= ========= ========== ========== ========== ==========
<FN>
(1) Of the total amount of loans outstanding at September 30, 1994 which were due after one year, an aggregate principal balance of
approximately $456.8 million had fixed interest rates and an aggregate principal balance of approximately $1.7 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).
-38-
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,
1994, principal repayments of $265.4 million are contractually due to the Bank
within the next year. Of the $265.4 million, $77.6 million is contractually due
on fixed-rate loans and $186.8 million is contractually due on adjustable-rate
loans.
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.
-39-
Origination, Purchase and Sale of Real Estate Loans
(In thousands)
For the Year Ended September 30,
-----------------------------------------------------
1994 1993 1992
------------- ------------- -------------
Real estate loan originations and purchases: (1)
Residential and home equity $ 1,570,155 $ 1,758,484 $ 1,246,367
Commercial and multifamily 9,582 42,718 5,350
Real estate construction and ground 47,693 41,675 40,943
------------- ------------- -------------
Total originations and purchases 1,627,430 1,842,877 1,292,660
------------- ------------- -------------
Principal repayments (389,847) (346,645) (251,865)
Sales (2) (800,506) (785,255) (568,955)
Loans transferred to real estate acquired in
settlement of loans or in-substance foreclosures (4,106) (23,158) (43,046)
Other (869) - (1,809)
------------- ------------- -------------
(1,195,328) (1,155,058) (865,675)
Transfers to mortgage-backed securities (3) (396,189) (493,973) (954,567)
------------- ------------- -------------
Increase (decrease) in real estate loans $ 35,913 $ 193,846 $ (527,582)
============= ============= =============
<FN>
(1) Excludes unfunded commitments.
(2) Includes securitization and sale of home equity credit line receivables of $181.9 millon, $340.4 million
and $253.6 million for the years ended September 30, 1994, 1993 and 1992, respectively.
(3) Represents real estate loans which were pooled and exchanged for FHLMC, FNMA and private label, AA-rated
mortgage-backed securities.
-40-
As a federally chartered savings institution, the Bank has general
authority to make loans secured by real estate located throughout the United
States. Approximately 95.0% of the Bank's real estate loans at September 30,
1994 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, or directly through Chevy Chase Mortgage, a division of the
Bank. Commercial, real estate construction and ground and home equity credit
line loans are originated directly by the Bank.
The Bank maintains 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 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, 1994, approximately $256.6 million of loans settled
under the correspondent program.
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 1994, sales of mortgage loans originated or purchased for sale by the
Bank totaled $851.6 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 Federal Home Loan Mortgage Corporation ("FHLMC") and Federal
National Mortgage Association ("FNMA") guidelines in order to ensure the
saleability of the loan 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, 1994, the Bank had $33.6 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
-41-
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 participation or whole
loan purchaser. At September 30, 1994, the Bank was servicing residential
permanent loans totaling $1.5 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. In
accordance with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities," mortgage-backed
securities held for sale in conjunction with mortgage banking activities are
classified as trading securities. As a result, the Consolidated Statements of
Cash Flows in this report reflect significant proceeds from the sales of
securities, even though there are no balances of trading securities at
September 30, 1994. Fixed-rate loans are designated as held for sale in the
Consolidated Balance Sheets in this report.
SINGLE-FAMILY RESIDENTIAL REAL ESTATE LENDING. The Bank originates a
variety of loans secured by single-family residential structures. At
September 30, 1994, $1.4 billion (or 55.2%) of the Bank's loan portfolio
consisted of loans secured by first or second mortgages on such properties,
including $22.9 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, 1994, 44.4% of the Bank's loans
consisted of ARMs scheduled to have interest rate adjustments within one to five
years. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Banking - Asset and Liability
Management." 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.
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
-42-
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 in
the interest rate over the term of the loan ranging from 6.0% to 9.0%.
The Bank has established a number of programs to meet the credit needs of
the various communities which it serves. During fiscal 1994, the Bank announced
a five-year commitment of $1.0 billion to meet the credit needs of low- and
moderate-income borrowers. In March 1993, the Bank established the Chevy Chase
Community Development Loan Fund, which provided $25.0 million of mortgage
financing at below-market rates to low- and moderate-income families in the
Washington, D.C. metropolitan area. In August 1994, the Bank established the
Community Development Loan Fund Program II to provide an additional $140.0
million of mortgage financing at below-market rates to low- and moderate-income
families in certain areas of Washington, D.C. and Prince George's County,
Maryland. During fiscal 1994, the Bank dedicated $53.0 million to support the
District of Columbia's Home Purchase Assistance Program, which furnishes
assistance to low- and moderate-income first-time home buyers. The Bank's
settlement agreement with the Department of Justice requires the Bank, among
other things, to provide $7.0 million over a five-year period in subsidies for
below-market mortgage loans to residents of designated census tracts in
Washington, D.C. and Prince George's County, Maryland. See "Legal Proceedings."
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%. Except for any
amortization of principal that may occur as a result of monthly payments, there
are no required payments of principal until maturity. 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 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 $181.9 million, $340.4 million and
$253.6 million of home equity credit line receivables in fiscal 1994, fiscal
1993 and fiscal 1992, respectively, to trusts for securitization and sale to
investors.
-43-
Gains of $9.5 million, $16.8 million and $15.1 million 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. Aggregate balances of
residential construction, commercial construction, ground and commercial and
multifamily loans decreased 12.9% in fiscal 1994 to $136.6 million at
September 30, 1994 from $156.7 million at September 30, 1993. In its past five
fiscal years, the Bank has de-emphasized 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 and fiscal 1994, 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 when a home is under contract for sale by the
builder to a consumer.
CREDIT CARD LENDING. Since June 1985, Chevy Chase has been providing
retail credit through its credit card program, which offers VISA-R- and
MasterCard-R- 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 25.5% of Chevy Chase's total loans at September 30,
1994. According to statistics published in SHESHUNOFF S&L QUARTERLY, Chevy
Chase is the third largest issuer of credit cards among thrift institutions,
based on total credit card loans outstanding at June 30, 1994. At September 30,
1994, credit card loans outstanding totaled $650.2 million and managed credit
card receivables, including receivables owned by the Bank and receivables
securitized, sold and serviced by the Bank, totaled $2.6 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
-44-
in Maryland, Virginia or the District of Columbia, the Bank's primary market
area.
The Bank historically has obtained new credit card accounts through various
methods, including direct-mail. 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. In fiscal 1993, as a result of the improvement in the Bank's financial
condition, 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. Certain data processing and
administrative functions associated with the servicing of the credit card
accounts are performed on behalf of the Bank by First Data Resources
Incorporated from its facilities in Omaha, Nebraska.
Changes in credit card use and payment patterns by cardholders, including
increased defaults, may result from a variety of social, legal and economic
factors. Chevy Chase currently offers introductory periodic interest rates for
varying initial periods which, at the conclusion of such periods, revert to the
Bank's regular variable interest rate. If account holders choose to utilize
competing sources of credit, the rate at which new receivables are generated may
be reduced and certain purchase and payment patterns with respect to the
receivables may be affected. 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 Analysis
of Financial Condition and Results of Operations - Financial Condition - Banking
- - Asset Quality - Delinquent Loans" and " - Reserves for Losses."
Certain issuers of credit cards have adjusted 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 currently
offers 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.
-45-
Securitizations of credit card receivables and 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.
In fiscal 1994, 1992, 1991 and 1990, the Bank sold approximately 400,000 credit
card relationships at a premium over their receivables balances of $96.5
million, $14.9 million, $273.4 million and $646.0 million, respectively. No
such sales occurred during fiscal 1993. The Bank transferred $1.4 billion,
$350.0 million, $280.0 million and $450.0 million of credit card receivables in
fiscal 1994, 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.
-46-
Chevy Chase plans to securitize an additional $850 million of credit card
receivables during the first and second quarters of fiscal 1995. Certain of
these receivables at September 30, 1994 were classified as loans held for
securitization and sale in the Consolidated Balance Sheets in this report.
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.
CONSUMER AND OTHER LENDING. 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 largest area of growth has been in automobile loans, which
increased $182.6 million during fiscal 1994 due to the Bank's expansion of its
automobile lending program. The Bank's portfolio of automobile loans and other
consumer loans totaled $289.3 million and $66.9 million, respectively, at
September 30, 1994. Automobile loans and other consumer loans (other than
credit card loans) accounted for 14.0% of total loans at that date.
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.
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
-47-
statements of any guarantors, and tax returns of guarantors of construction and
commercial real estate loans.
In an effort to minimize the increased risk of loss associated with
construction and development loans, Chevy Chase considers the reputation of the
borrower and the contractor, reviews pre-construction sale and leasing
information, and requires an independent inspecting engineer or architect to
review the progress of multifamily and commercial real estate projects. In
addition, the Bank generally requires personal guarantees of developers for all
development loans and, if a general contractor is used by the developer, may
require the posting of a performance bond.
The Bank generally lends 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 occasionally may 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. Currently, the Bank generally does not originate a
second mortgage loan (excluding home equity credit line loans) 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. In February 1994, the Bank
increased the maximum loan-to-value ratio for home equity credit line loans to
90% from 80% provided that private mortgage insurance is obtained for the amount
over 80% of the value of the underlying property. Loan-to-value ratios are
determined at the time a loan is originated. Consequently, subsequent declines
in the value of the loans' collateral could expose the Bank to losses.
Pursuant to FDICIA, OTS regulations require 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.
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
-48-
any residential loan (including home equity credit line loans) 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. Beginning with the resumption of active
solicitation of new accounts in fiscal 1993, the Bank generates new accounts
through various methods, including direct-mail. 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.
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 creditworthiness. 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
-49-
evaluation comparable to that performed during the initial underwriting.
Management reviews credit losses on a monthly basis and adjusts the Bank's
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
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. Income from these
activities varies with the volume and type of loans originated and sold.
The following table sets forth certain information relating to the Bank's
servicing income as of or for the years indicated.
As of or For the Year Ended September 30,
-----------------------------------------
1994 1993 1992
----------- ----------- -----------
(In thousands)
Residential................. $1,495,120 $2,022,033 $1,168,506
Credit card................. 1,953,792 841,828 689,227
Home equity................. 485,428 530,092 457,206
Automobile.................. 9,506 29,625 64,156
---------- ---------- ----------
Total amount of loans
serviced for others (1).. $3,943,846 $3,423,578 $2,379,095
========== ========== ==========
Loan servicing fee
income(2)................. $ 75,471 $ 46,083 $ 39,924
========== ========== ==========
<FN>
- --------------------
(1) The Bank's basis in its servicing rights at September 30, 1994, 1993 and
1992 was $40.5 million, $48.0 million and $42.6 million, respectively.
(2) In each of the years ended September 30, 1994, 1993 and 1992, loan
servicing fee income as a percentage of net interest income before
provision for loan losses was 44.7%, 25.4% and 21.2%, 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
-50-
with increases or decreases in securitized balances of these loan types. The
substantial increase in loan servicing fee income in fiscal 1994 from the level
achieved in fiscal 1993 was principally attributable to an increase in
securitized credit card receivables outstanding and decreased charge-offs, which
combined to increase the amount of servicing income earned on credit card
securitizations. 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 1994, the Bank securitized and sold $1.4 billion of credit card
receivables and $181.9 million of home equity credit line receivables. In
fiscal 1994, the Bank also sold the rights to service mortgage loans with an
aggregate principal balance of $383.9 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 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.
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
accredit 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
-51-
originated for the Bank's portfolio are accredit 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 accredit to
income but instead are used in determining the gain or loss on the sale of the
loans.
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 balance of a credit card loan (the largest category
of the Bank's consumer loans) is considered 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,
-52-
1994.
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 current events or facts that
may ultimately lead to future losses. The Bank's actual losses may vary from
management's 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 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
-53-
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 generally 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, 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.
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
collateral or guarantees, if applicable.
REO is carried at the lower of cost or fair value. 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
-54-
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 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.
In December 1993, the Federal Financial Institution Examination Council,
which is composed of the OTS and the other federal banking agencies, issued new
guidelines regarding the appropriate levels of general reserves that should be
maintained by insured institutions. Although the Bank believes that its levels
of general reserves at September 30, 1994 comply with the guidelines, 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 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. Deposit programs include Super Statement Savings,
-55-
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 383 ATMs,
including 121 ATMs located in Safeway Inc. stores and 45 ATMs located in
Superfresh Food Markets. The Bank also 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 is a member of
the regional "MOST"-R- ATM network which offers over 5,900 locations in the
middle-Atlantic region. The Bank is also a member of the "PLUS"-R- ATM network,
which offers over 190,000 locations worldwide.
The Bank obtains deposits primarily from customers residing in Montgomery
and Prince George's Counties in Maryland and Northern Virginia. Approximately
25.3% of the Bank's deposits at September 30, 1994 were obtained from depositors
residing outside of Maryland, with approximately 11.3% 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.
-56-
Deposit Analysis
(Dollars in thousands)
September 30,
------------------------------------------------------------------------------------------------------
1994 1993 1992 1991 1990
------------------- ------------------- ------------------- ------------------- ------------------
% of % of % of % of % of
Balance Total Balance Total Balance Total Balance Total Balance Total
---------- ------- ---------- ------- ---------- ------- ---------- ------- ---------- -------
Demand and NOW accounts $ 918,227 22.9 % $ 835,084 21.6 % $ 743,214 19.0 % $ 729,559 17.1 % $ 574,016 13.1 %
Money market deposit accounts 1,104,730 27.6 1,196,690 30.9 1,292,779 33.0 1,364,390 32.0 1,702,699 38.9
Statement savings accounts 1,201,141 30.0 941,289 24.3 690,328 17.6 595,181 14.0 390,710 8.9
Jumbo certificate accounts 85,110 2.1 56,218 1.5 42,423 1.1 128,288 3.0 206,496 4.7
Other certificate accounts 641,857 16.0 790,465 20.4 1,099,833 28.1 1,400,853 32.9 1,461,632 33.4
Other deposit accounts 57,696 1.4 50,277 1.3 47,381 1.2 44,759 1.0 43,034 1.0
---------- ------- ---------- ------- ---------- ------- ---------- ------- --------- -------
Total deposits 4,008,761 100.0 % 3,870,023 100.0 % 3,915,958 100.0 % 4,263,030 100.0 % 4,378,587 100.0 %
======= ======= ======= ======= =======
Deferred premium on
certificate accounts - - - 3 7
---------- ---------- ---------- ---------- ----------
Total $4,008,761 $3,870,023 $3,915,958 $4,263,033 $4,378,594
========== ========== ========== =========== ==========
- ------------------------------------------------------------------------------------------------------------------------------------
Average Cost of Deposits
Year Ended September 30,
------------------------------------------------
1994 1993 1992
------ ------ ------
Demand and NOW accounts 2.74% 2.47% 3.15%
Money market accounts 3.24% 3.17% 4.16%
Statement savings and
other deposit accounts 3.37% 3.25% 4.03%
Certificate accounts 3.96% 4.33% 5.63%
Total deposit accounts 3.31% 3.35% 4.45%
====== ====== ======
-57-
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, the
Bank has experienced some fluctuations in deposit flows. Chevy Chase's ability
to attract and maintain deposits and its cost of funds will continue to be
significantly affected by market conditions and its pricing strategy. The 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,
------------------------------------------
1994 1993 1992
------------ ------------ ------------
(In thousands)
Deposits................ $ 12,308,342 $ 10,801,085 $ 11,173,419
Withdrawals from
accounts.............. (12,305,196) (10,985,541) (11,721,253)
------------ ------------ ------------
Net cash to (from)
accounts.............. (3,146) (184,456) (547,834)
Interest credited to
accounts.............. 135,592 138,521 200,759
------------ ------------ ------------
Net increase (decrease)
in deposit balances... $ 138,738 $ (347,075) $ (347,075)
============ ============ ============
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, 1994 which will mature during
the fiscal years indicated.
-58-
Weighted Average Interest Rates of Deposits
As of September 30, 1994
(Dollars in Thousands)
Demand, NOW
and Money Market Statement Passbook and Other Certificate
Deposit Accounts Savings Accounts Core Accounts Accounts Total
-------------------- -------------------- -------------------- -------------------- ---------------------
Maturing During Weighted Weighted Weighted Weighted Weighted
Year Ending Average Average Average Average Average
September 30, Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
- --------------------- ----------- -------- ----------- -------- ----------- -------- ----------- -------- ----------- ---------
1995 $2,022,957 3.30 % $1,201,141 3.49 % $ 57,696 2.99 % $ 482,344 3.79 % $3,764,138 3.42 %
1996 - - - - - - 119,421 4.47 119,421 4.47
1997 - - - - - - 41,023 5.09 41,023 5.09
1998 - - - - - - 34,116 5.39 34,116 5.39
1999 - - - - - - 50,063 5.45 50,063 5.45
----------- ----------- ----------- ----------- -----------
Total $2,022,957 3.30 % $1,201,141 3.49 % $ 57,696 2.99 % $ 726,967 4.16 % $4,008,761 3.51 %
=========== =========== =========== =========== ===========
-59-
The following table summarizes maturities of certificate accounts in
amounts of $100,000 or greater as of September 30, 1994.
Year Ending September 30, Amount Weighted Average Rate
- ------------------------- ------ ---------------------
(Dollars in thousands)
1995....................... $ 51,794 4.24%
1996....................... 7,172 5.03%
1997....................... 1,899 5.92%
1998....................... 2,969 5.41%
1999....................... 5,999 5.38%
-------- ----
Total ................... $ 69,833 4.52%
======== ====
The following table represents the amounts of deposits by various interest
rate categories as of September 30, 1994 maturing during the fiscal years
indicated.
-60-
Maturities of Deposits by Interest Rates
As of September 30, 1994
(In thousands)
Accounts Maturing During Year Ending September 30,
-----------------------------------------------------------------------------
Interest Rate 1995 1996 1997 1998 1999 Total
- ---------------- ----------- ---------- ---------- ---------- ---------- -----------
Demand deposits (0%) $ 94,600 $ - $ - $ - $ - $ 94,600
0.00% to 1.99% 445 - - - - 445
2.00% to 2.99% 29,327 - - - - 29,327
3.00% to 3.99% 2,750,393 32,412 - - - 2,782,805
4.00% to 4.99% 847,290 64,012 18,584 1,416 - 931,302
5.00% to 5.99% 36,504 5,964 11,561 32,629 44,134 130,792
6.00% to 7.99% 4,980 17,025 10,878 23 5,929 38,835
8.00% to 9.99% 599 8 - 48 - 655
----------- ---------- ---------- ---------- ---------- -----------
Total $3,764,138 $ 119,421 $ 41,023 $ 34,116 $ 50,063 $4,008,761
=========== ========== ========== ========== ========== ===========
-61-
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.
Under the credit policies of the FHLB of Atlanta, 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. The
Bank had a $100.0 million FHLB advance outstanding at September 30, 1994, which
accrued interest at an annual rate of 4.77%.
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 Statements of Financial Condition in this
report. These arrangements are, in effect, borrowings by the Bank secured by
the securities sold. There were no repurchase agreements outstanding at
September 30, 1994.
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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,
------------------------
1994 1993
--------- ---------
Securities sold under repurchase agreements: (Dollars in thousands)
Balance at year-end.................................. $ -- $ 83,151
Average amount outstanding during the year........... 103,299 265,176
Maximum amount outstanding at any month-end.......... 202,256 478,534
Weighted average interest rate during year (1)....... 3.78% 3.28%
Weighted average interest rate on year-end balances.. -- % 3.23%
<FN>
- --------------------
(1) The weighted average interest rate during the year is computed daily using
a daily rate and balance.
On November 23, 1993, the Bank sold $150 million principal amount of its
9-1/4% Subordinated Debentures due 2005 (the "Debentures"). Interest on the
Debentures is payable semiannually on December 1 and June 1 of each year. The
OTS has approved the inclusion of the principal amount of the Debentures in the
Bank's supplementary capital for regulatory capital purposes. On or after
December 1, 1998, the Debentures will be redeemable, in whole or in part, at any
time at the option of the Bank. Under the OTS capital regulations, redemption
of the Debentures prior to their stated maturity would be subject to prior
approval of the OTS unless the Debentures are redeemed with the proceeds of, or
replaced by, a like amount of "a similar or higher quality" capital instrument.
In December 1986, the Bank issued an unsecured ten-year subordinated
capital note in the original principal amount of $10.0 million to BACOB 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
-63-
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, 1994, 2.0% and 3.0% of the Bank's assets was equal to $93.3
million and $139.9 million, respectively, and the Bank had $55.8 million
invested in its service corporation subsidiaries, $36.0 million of which was in
the form of conforming loans. 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. With prior
written approval from the OTS, the Bank may also establish operating
subsidiaries to engage in any activities in which the Bank may engage 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")
continues to engage in certain real estate development activities as the result
of activities commenced prior to the enactment of FIRREA. As a result of the
stringent capital requirements that FIRREA applies to investments in
subsidiaries, such as Manor, that engage in activities impermissible for
national banks, Manor has not entered, and does not intend to enter, into any
new real estate development arrangements.
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" 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, 1994, Chevy Chase owned 25
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 $292.1
million at September 30, 1994. The Bank's investments in these subsidiaries are
not subject to the 3.0% service corporation investment limit discussed above.
See "Regulation - Regulatory Capital."
-64-
OPERATING SUBSIDIARY. CCB Holding Corporation is a Delaware corporation
created by the Bank as an operating subsidiary in September 1994 in connection
with its asset securitization activities. The subsidiary owns a seller
certificate issued by a credit card trust formed by the Bank and certain other
related assets.
EMPLOYEES
The Bank and its subsidiaries had 2,407 full-time and 686 part-time
employees at September 30, 1994. 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 loans 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. See
"Executive Compensation and Other Information" for a discussion of certain
compensation programs available to the Bank's executive officers. None of the
Bank's employees is represented by a collective bargaining agent. The Bank
believes that its employee relations are good.
COMPETITION
Chevy Chase encounters strong competition both in attracting deposits and
making 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 access
-65-
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 with 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 12
depository institutions in its deposit-taking activities, with approximately ten
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,
1994, according to published industry statistics, Chevy Chase had the largest
market share (approximately 19.3%) 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.
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.
Interstate banking laws enacted by Congress and various states 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.
PROPERTIES
REAL ESTATE
A list of the investment properties of the Real Estate Trust is set forth
under "Business - Real Estate - Real Estate Investments."
At September 30, 1994, the Trust conducted its business from its executive
offices at 8401 Connecticut Avenue, Chevy Chase, Maryland. The Trust sells its
unsecured notes due one
-66-
year to ten years from date of issue from a sales office located at 7200
Wisconsin Avenue, Suite 903, Bethesda, Maryland. The Saul Company leases both
office facilities on behalf of the Trust.
BANKING
At September 30, 1994, the Bank conducted its business from its executive
offices at 8401 Connecticut Avenue, Chevy Chase, Maryland; its operations
centers at 6200 Chevy Chase Drive, Laurel, Maryland, 7215 Corporate Court,
Frederick, Maryland, 5300 Spectrum Drive, Frederick Maryland and 5310 Spectrum
Drive, Frederick Maryland; its office facilities at 7700 Old Georgetown Road,
Bethesda, Maryland; and 81 full-service offices located in Maryland, Virginia
and the District of Columbia. On that date, the Bank owned the building and
land for 13 of its branch offices and leased its remaining 68 branch offices.
Chevy Chase leases the office facilities at 8401 Connecticut Avenue, 6200 Chevy
Chase Drive and 7215 Corporate Court and the land at 7700 Old Georgetown Road.
Chevy Chase owns the building at 7700 Old Georgetown Road. In addition, the
Bank leases office space in which its subsidiaries are housed. The office
facility leases have various terms expiring from 1995 to 2019 and the ground
leases have terms expiring from 2029 to 2080. See Note 17 to the Consolidated
Financial Statements in this report for lease expense and commitments.
At November 30, 1994, the Bank had received OTS approval to open three
additional branches. The branches, one each in Maryland, Virginia and the
District of Columbia, are scheduled to open during fiscal 1995.
At September 30, 1994, the net book value of the Bank's office facilities
(including leasehold improvements) was $92.7 million. See Note 16 to the
Consolidated Financial Statements in this report.
The Bank currently plans to build a facility in Frederick, Maryland to
consolidate the Bank's employees and operations in that area. At September 30,
1994, the Bank had invested $2.5 million in the land and $1.4 million for
capital expenditures relating to this facility.
In fiscal 1991, the Bank purchased an historic office building and the
underlying land in downtown Washington, D.C. with plans to establish a deposit
branch office and a trust office in the building. Although the Bank terminated
its trust business in fiscal 1991, it still plans to establish a branch in the
building.
The Bank owns additional assets, including furniture
-67-
and data processing equipment. At September 30, 1994, these other assets had a
net book value of $51.7 million. The Bank also has operating leases, primarily
for certain automobiles and data processing equipment and software. The leases
for automobiles are generally for periods of less than four years; the leases
for the data processing equipment and software have month-to-month or
year-to-year terms.
LEGAL PROCEEDINGS
In the normal course of business, the Trust is involved in certain
litigation, including litigation arising out of the collection of loans, the
enforcement or defense of the priority of its security interests, and the
continued development and marketing of certain of its real estate properties.
In the opinion of management, litigation which is currently pending will not
have a material adverse impact on the financial condition or future operations
of the Trust.
On August 22, 1994, Chevy Chase and its subsidiary, B. F. Saul Mortgage
Company (together, the "Companies"), entered into a settlement agreement with
the United States Department of Justice (the "Department") arising out of the
Department's allegations that the Companies had violated the Federal Fair
Housing and Equal Credit Opportunity Acts by failing to market their products
sufficiently to residents of majority African-American neighborhoods in the
Washington, D.C. metropolitan area.
The Companies adamantly denied the allegations. However, to avoid costs of
protracted litigation and to enable management to refocus its attention on the
normal business of banking, the Companies agreed to a settlement which commits
them to continue the types of lending practices, branching strategies and
promotional programs that are designed to increase the level of banking services
available to traditionally underserved areas of the Washington, D.C.
metropolitan area. Specifically, the Companies have agreed to invest $11.0
million in the African-American community of the Washington, D.C. metropolitan
area over a five-year period. This commitment obligates the Companies to
(i) provide $7.0 million over the five-year period in subsidies for below-market
mortgage loans to residents of designated majority African-American
neighborhoods in Washington, D.C. and Prince George's County, Maryland;
(ii) open two additional mortgage offices in majority African-American
neighborhoods in the metropolitan Washington, D.C. area; and (iii) open one new
deposit branch in the Anacostia area of Washington, D.C. The Companies also
have agreed over the same five-year
-68-
period, among other things, to continue efforts to increase their advertising
and promotional efforts targeted to residents of African-American neighborhoods,
to continue efforts to recruit African-Americans for loan production positions,
and to continue various employee training programs. The Companies view these
efforts as continuations of their existing programs.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended September 30, 1994.
-69-
MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
There currently is no established public trading market for the Trust's
Common Shares of Beneficial Interest (the "Common Shares"). At December 1,
1994, there were nine corporate or individual holders of Common Shares. All of
the holders of Common Shares at such date were affiliated with the Trust. See
"Security Ownership of Certain Beneficial Owners and Management."
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.
-70-
SELECTED FINANCIAL DATA
Year Ended September 30,
----------------------------------------------------------------------
(In thousands, except per share amounts and Other Data) 1994 1993 1992 1991 1990
- ----------------------------------------------------------------------------------------------------------------------------------
Statement of Operations Data:
Real Estate:
Revenues $66,044 $93,245 $100,179 $102,013 $104,299
Operating expenses 102,087 137,256 127,936 142,144 143,504
Equity in earnings (losses) of partnership investments 1,738 (668) (208) (212) (57)
Gain (loss) on sales of property 0 184 (546) 20,308 0
----------------------------------------------------------------------
Real estate operating loss (34,305) (44,495) (28,511) (20,035) (39,262)
----------------------------------------------------------------------
Banking:
Interest income 334,464 348,814 403,033 487,572 503,507
Interest expense 165,544 167,518 214,761 325,711 361,418
----------------------------------------------------------------------
Net interest income 168,920 181,296 188,272 161,861 142,089
Provision for loan losses (33,237) (62,513) (89,062) (147,141) (78,300)
----------------------------------------------------------------------
Net interest income after provision for loan losses 135,683 118,783 99,210 14,720 63,789
----------------------------------------------------------------------
Other income:
Credit card, loan servicing and deposit service fees 111,060 91,063 92,291 105,441 134,166
Earnings (loss) on real estate held for investment 835 (12,722) (50,649) (47,495) (53,290)
Gain on sales of assets 32,217 40,270 44,259 81,927 99,028
Gain on sale of mortgage servicing rights 5,833 4,828 3,750 9,137 0
Other 10,104 7,314 10,766 12,133 9,725
----------------------------------------------------------------------
Total other income 160,049 130,753 100,417 161,143 189,629
----------------------------------------------------------------------
Operating expenses 242,545 185,687 156,218 181,975 200,367
----------------------------------------------------------------------
Banking operating income (loss) 53,187 63,849 43,409 (6,112) 53,051
----------------------------------------------------------------------
Total Company:
Operating income (loss) before income taxes, 18,882 19,354 14,898 (26,147) 13,789
extraordinary items, cumulative effect of change in
accounting principle, and minority interest
Provision for income taxes 7,025 11,703 7,385 3,225 13,698
----------------------------------------------------------------------
Income (loss) before extraordinary items, cumulative
effect of change in accounting principle and
minority interest 11,857 7,651 7,513 (29,372) 91
Extraordinary items:
Adjustment for tax benefit of operating loss carryovers 0 7,738 3,817 0 0
Loss on early extinguishment of debt, net of taxes (11,315) 0 (132) 0 0
----------------------------------------------------------------------
Income (loss) before cumulative effect of change in
accounting principle and minority interest 542 15,389 11,198 (29,372) 91
Cumulative effect of change in accounting principle 36,260 0 0 0 0
----------------------------------------------------------------------
Income (loss) before minority interest 36,802 15,389 11,198 (29,372) 91
Minority interest held by affiliates (3,963) (6,582) (5,261) 2,113 (6,013)
Minority interest -- other (9,750) (4,334) 0 0 0
----------------------------------------------------------------------
Total company net income (loss) $23,089 $4,473 $5,937 ($27,259) ($5,922)
======================================================================
Net income (loss) available to common shareholders $17,669 ($947) $517 ($32,679) ($7,277)
Net income (loss) per common share:
Income (loss) before extraordinary items, cumulative
effect of change in accounting principle and
minority interest 1.33 0.46 0.43 (7.21) (0.26)
Extraordinary items:
Adjustment for tax benefit of operating loss carryovers 0.00 1.60 0.79 0.00 0.00
Loss on early extinguishment of debt, net of taxes (2.34) 0.00 (0.03) 0.00 0.00
----------------------------------------------------------------------
Income (loss) before cumulative effect of change in
accounting principle and minority interest (1.01) 2.06 1.19 (7.21) (0.26)
Cumulative effect of change in accounting principle 7.51 0.00 0.00 0.00 0.00
----------------------------------------------------------------------
Income (loss) before minority interest 6.50 2.06 1.19 (7.21) (0.26)
Minority interest held by affiliates (0.82) (1.36) (1.08) 0.44 (1.25)
Minority interest -- other (2.02) (0.90) 0.00 0.00 0.00
----------------------------------------------------------------------
Total company net income (loss) $3.66 ($0.20) $0.11 ($6.77) ($1.51)
======================================================================
- ----------------------------------------------------------------------------------------------------------------------------------
Continued on following page.
-71-
SELECTED FINANCIAL DATA
(Continued)
Year Ended September 30,
----------------------------------------------------------------------
(In thousands, except per share amounts and Other Data) 1994 1993 1992 1991 1990
- ----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet Data:
Assets:
Real estate assets $327,739 $220,556 $334,378 $346,088 $370,564
Income-producing properties, net 159,529 162,356 254,700 261,822 271,073
Land parcels 38,455 38,411 50,981 56,353 58,900
Banking assets 4,666,298 4,872,771 4,998,756 4,821,407 5,219,018
Total company assets 4,994,037 5,093,327 5,333,134 5,167,495 5,589,582
Liabilities:
Real estate liabilities 558,109 450,153 522,760 505,793 538,577
Mortgage notes payable 185,730 264,776 429,968 350,693 369,134
Notes payable - unsecured 40,288 38,661 50,417 86,532 108,512
Bank borrowings 0 0 0 38,273 36,645
Banking liabilities 4,413,832 4,634,001 4,885,189 4,747,715 5,106,446
Minority interest held by affiliates 35,632 34,495 27,912 22,651 24,764
Minority interest - other 74,307 74,307 0 0 0
Total company liabilities 5,081,880 5,192,956 5,435,861 5,276,159 5,669,787
Shareholders' deficit (87,843) (99,629) (102,727) (108,664) (80,205)
- ----------------------------------------------------------------------------------------------------------------------------------
Cash Flow Data:
Net cash flows provided by (used in) operating activities:
Real estate ($10,859) ($3,149) ($884) ($16,374) ($17,381)
Banking 2,218,262 1,137,686 1,026,705 1,521,024 (296,840)
----------------------------------------------------------------------
Total Company 2,207,403 1,134,537 1,025,821 1,504,650 (314,221)
----------------------------------------------------------------------
Net cash flows provided by (used in) investing activities:
Real estate (29,118) (2,999) (1,333) 25,731 (11,409)
Banking (1,777,281) (879,178) (1,224,100) (1,183,033) (16,611)
----------------------------------------------------------------------
Total Company (1,806,399) (882,177) (1,225,433) (1,157,302) (28,020)
----------------------------------------------------------------------
Net cash flows provided by (used in) financing activities:
Real estate 75,723 3,230 169 (41,709) 12,016
Banking (260,094) (190,850) 157,183 (348,624) 413,957
----------------------------------------------------------------------
Total Company (184,371) (187,620) 157,352 (390,333) 425,973
----------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 216,633 64,740 (42,260) (42,985) 83,732
- ----------------------------------------------------------------------------------------------------------------------------------
Other Data:
Hotels:
Number of hotels 9 9 9 9 9
Number of guest rooms 2,415 2,356 2,400 2,418 2,289
Average occupancy 62% 68% 63% 66% 65%
Average room rate $57.57 $54.02 $56.54 $57.88 $58.72
Shopping centers:
Number of properties N/A 23 23 23 23
Leasable area (square feet) N/A 4,408,000 4,416,000 4,809,000 4,707,000
Average occupancy N/A 95% 95% 95% 94%
Office properties:
Number of properties 9 10 10 10 8
Leasable area (square feet) 1,363,000 1,537,000 1,537,000 1,537,000 1,362,000
Leasing percentages 93% 85% 92% 90% 90%
Land parcels
Number of parcels 10 12 12 13 12
Total acreage 433 1,496 9,529 9,535 9,476
- ----------------------------------------------------------------------------------------------------------------------------------
-72-
The following table sets forth certain additional financial data with respect to
the Bank.
At or For Year Ended
September 30,
---------------------------------------
1994 1993 1992 1991 1990
---- ---- ---- ---- ----
SELECTED RATIOS:
Return on average assets . . 0.60% 0.77% 0.55% (0.20%) 0.61%
Return on average stockholders' 11.19% 19.31% 19.33% (7.57%) 25.26%
equity
Average stockholder's equity 5.34% 3.98% 2.84% 2.69% 2.41%
to average assets. . . . .
Net yield on interest-earning 4.06% 4.59% 4.98% 3.81% 3.30%
assets . . . . . . . . . .
Net loan charge-offs to average 1.89% 3.43% 4.15% 3.72% 1.86%
loans. . . . . . . . . . .
Non-performing assets, net to 5.40% 6.03% 8.48% 10.37% 7.58%
total assets. . . . . . .
Average interest-earning
assets to average interest-
bearing liabilities. . . . 90.81% 86.44% 82.76% 85.64% 91.5%
REGULATORY CAPITAL RATIOS:
Tangible . . . . . . . . . . 4.96% 4.60% 2.22% 1.58% 1.81%
Core (or leverage) . . . . . 5.34% 5.35% 3.22% 2.82% 3.03%
Tier 1 risk-based. . . . . . 6.95% 7.29% N/A N/A N/A
Total risk-based . . . . . . 12.19% 11.70% 7.72% 5.51% 6.52%
-73-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Trust has prepared its financial statements and other disclosures on a
fully consolidated basis. The term "Trust" used in the text and the financial
statements included herein refers to the combined entity, which includes B.F.
Saul Real Estate Investment Trust and its subsidiaries, including Chevy Chase
and Chevy Chase's subsidiaries. "Real Estate Trust" refers to B.F. Saul Real
Estate Investment Trust and its subsidiaries, excluding Chevy Chase and Chevy
Chase's subsidiaries. The operations conducted by the Real Estate Trust are
designated as "Real Estate," while the business conducted by Chevy Chase and its
subsidiaries is identified by the term "Banking."
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, 1994
consisted primarily 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 Holding
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 93%
leased at September 30,1994, compared to a lease rate of 77% at September 30,
1993. At September 30, 1994, the Real Estate Trust's office property portfolio
had a total gross leaseable area of approximately 1.36 million square feet. Of
the gross leaseable area at September 30, 1994, 521,000 square feet (38%) and
205,000 square feet (15%) is subject to leases whose terms expire in fiscal 1995
and fiscal 1996, respectively. Due to a decline in market lease rates for
office space over the past several years, the terms of certain of the new leases
may be less favorable to the Real Estate Trust than the terms of the expiring
leases. Based on discussions with current and prospective
-74-
tenants of space for which leases are scheduled to expire in fiscal 1995,
management currently expects that substantially all such space will be leased at
rates that are at least as high as the rates of the expiring leases.
For the fiscal year ended September 30, 1994, the nine hotel properties
then owned by the Real Estate Trust achieved a 62% occupancy rate, compared to
an occupancy rate of 63% in fiscal 1993. Two of the hotels experienced
increases in occupancy rates during fiscal 1994, six hotels registered lower
occupancy rates and the ninth hotel maintained the same occupancy rate. Average
room rates increased by $2.63 to $57.57 in fiscal 1994 from $54.94 in fiscal
1993.
BANKING
GENERAL. The Bank recorded operating income of $53.2 million in fiscal
1994, compared to operating income of $63.8 million in fiscal 1993. The
decline in income for fiscal 1994 was primarily attributable to increased
operating expenses, a decrease in net interest income, a decrease in credit
card fees and a decrease in gain on sale of investment securities. The
decrease in income was offset in part by a decrease in the provision for
loan losses and an increase in other (non-interest) income resulting
primarily from an increase in loan and deposit servicing fees and improved
results on real estate held for investment or sale.
On November 23, 1993, the Bank received net proceeds of $143.6 million from
the sale of $150.0 million principal amount of its 9 1/4% Subordinated
Debentures due 2005. On December 23, 1993 and December 24, 1993, the Bank
applied $134.2 million of such net proceeds to redeem its outstanding 13 1/2%
Subordinated Capital Debentures due July 15, 2002 and 15% Subordinated Capital
Debentures due November 15, 2003. The Bank incurred an extraordinary loss of
$6.3 million, after related income taxes, in connection with such redemption.
The OTS has approved the inclusion of the principal amount of the Debentures in
the Bank's supplementary capital for regulatory capital purposes.
At September 30, 1994, the Bank remained in compliance with all of its
regulatory capital requirements under FIRREA. The Bank's tangible, core and
risk-based regulatory capital ratios were 4.96%, 5.34% and 12.19%, respectively,
compared to the FIRREA requirements of 1.5%, 3.0% and 8.0%,
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respectively. Additionally, at September 30, 1994, the Bank's leverage, tier 1
risk-based and total risk-based capital ratios of 5.34%, 6.95% and 12.19%,
respectively, exceeded the corresponding ratios of 5.0%, 6.0% and 10.0% for
"well-capitalized" institutions established under the prompt corrective action
regulations of the OTS. On the basis of its balance sheet at September 30, 1994,
the Bank met the FIRREA-mandated fully phased-in capital requirements and, on a
fully phased-in basis, met the capital standards established for
"adequately-capitalized" institutions under the prompt corrective action
regulations. See "Capital."
During fiscal 1994, the Bank adopted four new Statements of Financial
Accounting Standards: Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" ("SFAS 109"), Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS
114"), Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" ("SFAS 115") and Statement of
Financial Accounting Standards No. 118, "Accounting by Creditors for Impairment
of a Loan - Income Recognition and Disclosures, an amendment of FASB Statement
No. 114 ("SFAS 118").
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 cumulative effect of this change in accounting
principle resulted in a $5.1 million increase in the Bank's net income and net
deferred tax asset.
Effective October 1, 1993, the Bank adopted, on a prospective basis, SFAS
114 and SFAS 118. SFAS 114 and SFAS 118 require that impaired loans be measured
based on the present value of expected future cash flows, discounted at the
loan's effective interest rate. As a practical expedient, impairment may be
measured based on the loan's observable market price, or the fair value of the
collateral, if the loan is collateral-dependent. When the measure of the
impaired loan is less than the recorded investment in the loan, the impairment
is recorded through a valuation allowance. In addition, SFAS 114 requires
impaired loans for which foreclosure is probable to be accounted for as loans
instead of REO. No additional reserves were required by adoption of this
pronouncement. Impaired loans that are also nonperforming are included in
nonperforming assets. See "Summary of Significant Accounting Policies" in the
Notes to the Consolidated Financial Statements in this report.
SFAS 115 requires companies to classify certain equity
-76-
securities and all debt securities into one of three categories on the date of
acquisition and the date of all subsequent financial statements. Under SFAS
115, securities are categorized as either "held-to-maturity,"
"available-for-sale" or "trading." In implementing SFAS 115, the Bank
determined that its entire investment security portfolio and its entire
mortgage-backed security portfolio be classified as available-for-sale at
October 1, 1993. The Bank implemented SFAS 115 effective October 1, 1993 and
recorded $16.3 million of net unrealized holding gains, net of related income
taxes, as a separate component of stockholders' equity as of that date. As a
result of an increase in market interest rates, at September 30, 1994, net
unrealized holding losses of $14.1 million are reported as a separate component
of stockholders' equity. The net unrealized holding gain (loss) on the Bank's
available-for-sale portfolio will fluctuate based on market interest rates and
the composition of the Bank's investment security and mortgage-backed security
portfolios and, at September 30, 1994, was fully deductable from tier 1 capital
for regulatory capital purposes pursuant to interim guidance issued by the OTS
in August 1993. In November 1994, the OTS revised its existing policy and
announced that, beginning as early as December 1994, savings associations may
exclude net unrealized holding gains (losses) on debt securities classified as
available-for-sale from regulatory capital for purposes of computing regulatory
capital ratios. If this revised policy had been in effect on September 30, 1994,
the Bank's tangible, core and total risk-based regulatory capital ratios would
have increased to 5.27%, 5.64% and 12.66%, respectively.
The Bank's assets are subject to review and classification by the OTS upon
examination. The OTS concluded its annual examination of the Bank in September
1994.
ASSET QUALITY. The improvement in the Bank's asset quality during recent
periods continued in fiscal 1994. The Bank will continue its efforts to resolve
problem real estate assets and enhance risk management efforts.
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.
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Non-Performing Assets
(Dollars in thousands)
September 30,
----------------------------------------------------------
1994 1993 1992 1991 1990
---------- ---------- ---------- ---------- ----------
Non-performing assets:
Non-accrual loans:
Residential $ 8,306 $ 9,108 $ 12,865 $ 17,913 $ 8,119
Commercial and multifamily - - 3,694 - -
Residential construction and ground - - 11,196 30,469 45,622
Commercial construction and ground - - 3,413 15,629 31,661
---------- ---------- ---------- ---------- ----------
Total non-accrual real estate loans 8,306 9,108 31,168 64,011 85,402
Credit card 16,229 20,557 26,780 33,682 23,798
Consumer and other 498 314 3,572 3,331 1,207
---------- ---------- ---------- ---------- ----------
Total non-accrual loans (1) 25,033 29,979 61,520 101,024 110,407
---------- ---------- ---------- ---------- ----------
Non-accrual real estate held for investment (1) 8,915 8,898 8,892 8,892 17,236
---------- ---------- ---------- ---------- ----------
Real estate acquired in settlement of loans 387,024 434,616 541,352 537,490 338,999
Reserve for losses on real estate acquired in settlement of loans (109,074) (101,462) (94,125) (53,337) (10,078)
---------- ---------- ---------- ---------- ----------
Real estate acquired in settlement of loans, net 277,950 333,154 447,227 484,153 328,921
---------- ---------- ---------- ---------- ----------
Total non-performing assets $ 311,898 $ 372,031 $ 517,639 $ 594,069 $ 456,564
========== ========== ========== ========== ==========
Reserve for losses on loans $ 50,205 $ 68,040 $ 78,818 $ 89,745 $ 58,339
Reserve for losses on real estate held for investment 9,899 10,182 14,919 4,161 2,800
Reserve for losses on real estate acquired in settlement of loans 109,074 101,462 94,125 53,337 10,078
---------- ---------- ---------- ---------- ----------
Total reserves for losses $ 169,178 $ 179,684 $ 187,862 $ 147,243 $ 71,217
========== ========== ========== ========== ==========
<FN>
(1) Before deduction of reserves for losses.
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Non-Performing Assets (Continued)
(Dollars in thousands)
September 30,
----------------------------------------------------------
1994 1993 1992 1991 1990
---------- ---------- ---------- ---------- ----------
Ratios:
Non-performing assets, net to total assets (3) 5.40% 6.03% 8.48% 10.37% 7.58%
Reserve for losses on real estate loans to non-accrual
real estate loans (1) 169.58% 219.29% 53.16% 23.72% 22.38%
Reserve for losses on credit card loans to non-accrual
credit card loans (1) 212.77% 228.08% 214.96% 209.73% 151.03%
Reserve for losses on consumer and other loans to
non-accrual consumer and other loans (1) 319.28% 376.11% 131.10% 117.68% 272.08%
Reserve for losses on loans to non-accrual loans (1) 200.56% 226.96% 128.12% 88.84% 52.84%
Reserve for losses on loans to total loans receivable (2) 1.97% 2.83% 3.52% 2.79% 1.83%
<FN>
(1) Before deduction of reserves for losses.
(2) Includes loans receivable and loans held for sale and/or securitization, before deduction of reserve for losses.
(3) Non-performing assets is presented after all reserves for losses on loans and real estate held for investment or sale.
-79-
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 (prior to the adoption of SFAS 114 in fiscal 1994).
Non-performing assets totaled $311.9 million, after valuation allowances on
REO of $109.1 million, at September 30, 1994, compared to $372.0 million, after
valuation allowances on REO of $101.5 million, at September 30, 1993. In
addition to the valuation allowances on REO, the Bank maintained $4.0 million
and $4.5 million of valuation allowances on its non-accrual loans and non-
accrual real estate held for investment at September 30, 1994 and September 30,
1993, respectively. The decrease in non-performing assets was attributable to
declines in non-accrual loans and REO of $4.9 million and $55.2 million,
respectively, during the year ended September 30, 1994.
The Bank's non-performing real estate assets, which include non-accrual
real estate loans, non-accrual REI and REO, totaled $295.2 million at
September 30, 1994 or 94.6% 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 $292.8 million at September 30, 1994,
reflecting both additional write-downs on non-performing assets during that
period and, in more recent periods, asset sales.
-80-
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%
December 31, 1993. . 345,968 3,493 342,475 (225,134) -39.7%
March 31, 1994 . . . 323,185 3,487 319,698 (247,911) -43.7%
June 30, 1994 . . . 310,506 3,620 306,886 (260,723) -45.9%
September 30, 1994 . 295,171 2,390 292,781 (274,828) -48.4%
<FN>
- --------------------
(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, 1994, 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. At September 30, 1994, $257.6
million or 87.3% of the Bank's total non-performing real estate assets related
to residential real estate properties, including the Bank's five planned unit
developments (the "Communities"). In general, the residential real estate market
was less significantly affected by the downturn in the early 1990s than the
commercial real estate market. The Bank has disposed of the majority of its
commercial REO and is seeking to effect the orderly disposition of the remainder
of its REO. See "REO" and "Disposition of REO."
NON-ACCRUAL LOANS. The Bank's non-accrual loans totaled $25.0 million at
September 30, 1994, a decrease of $5.0 million from $30.0 million at
September 30, 1993. At September 30, 1994, non-accrual loans consisted
primarily of $8.3 million of non-accrual real estate loans and $16.2 million of
non-accrual credit card loans. Non-accrual loans decreased primarily because of
net principal repayments and reductions of non-accrual credit card loans of $4.3
million.
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The reduction in non-accrual credit card loans reflects improved economic
conditions.
At September 30, 1994, the Bank had $16.2 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 $10.7 million of credit card loans classified for regulatory
purposes as substandard 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 ($10.7 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 $10.7 million, $4.3 million was current, $0.2 million was 30-
59 days past due and $6.2 million was 60-89 days past due at September 30, 1994.
All delinquent amounts are included in the table of delinquent loans. See
"Delinquent Loans."
NON-ACCRUAL REI. At September 30, 1994 and September 30, 1993, 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 made 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, 1994, the Bank's REO totaled $277.9 million, after
valuation allowances on such assets of $109.1 million. The principal component
of REO consists of the Communities, which had an aggregate book value of $211.4
million at that date. Four of the Communities are under active development.
During the year ended September 30, 1994, REO decreased
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$55.2 million. This decrease was primarily attributable to sales in the
Communities and other smaller residential properties and the sale of six
properties with an aggregate book value of $12.9 million after valuation
allowances. See "Disposition of REO."
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 $4.4
million in the year ended September 30, 1994, of which $4.3 million related to
the Bank's four active Communities.
DISPOSITION OF REO. During the year ended September 30, 1994, the Bank
received proceeds of approximately $112.2 million upon the disposition of REO
consisting of two office buildings ($5.3 million), 1,094 residential lots or
units in the Communities and other smaller residential properties ($88.0
million), approximately 21 acres of land in three of the Communities ($8.2
million), one industrial building ($5.7 million) and various single-family
residential properties ($5.0 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, such as the
general economic conditions in the Washington, D.C. metropolitan area. 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
homebuilders. The Bank is proceeding with lot development to meet the
requirements of existing and new contracts with builders. Second, the Bank
continues to seek and negotiate with potential purchasers of retail and
commercial ground in the Communities. Third, the Bank continues to seek
potential investors concerning the possibility of larger scale or bulk purchases
of ground at the Communities.
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The following table sets forth information about the Bank's REO at
September 30, 1994.
Balance Balance
Before All After Percent
Valuation Valuation Valuation of
Allowances Allowances Allowances Total
---------- ---------- ---------- -------
(Dollars in thousands)
Communities............... $291,365 $ 79,922 $211,443 76.0%
Residential ground and
construction............ 57,681 21,087 36,594 13.2
Retail centers............ 15,335 1,357 13,978 5.0
Commercial ground......... 21,251 6,638 14,613 5.3
Single-family residential
properties.............. 1,392 70 1,322 0.5
-------- -------- -------- -----
Total REO............. $387,024 $109,074 $277,950 100.0%
======== ======== ======== =====
At September 30, 1994, the Bank had executed contracts to sell seven of
these properties at their aggregate book value of $17.2 million at that date.
The four active Communities consist primarily of 12,936 residential lots or
units and 196.6 acres of land designated for retail use. At September 30, 1994,
9,125 residential units (70.5%) had been sold to builders, consisting of 6,872
units (53.1%) which had been settled and 2,253 units (17.4%) which were under
contract and pending settlement. At the same date, approximately 106.8 acres
(54.3%) of retail land had been sold to developers, including 20.5 acres which
were under contract and pending settlement. In addition, at September 30, 1994,
the Bank was engaged in discussions with potential purchasers regarding the sale
of additional residential units and retail land.
The rate of home sales in the Bank's four active Communities during fiscal
1994 (1,370) declined slightly from the rate in fiscal 1993 (1,522). The
decline resulted primarily from lower demand due to increased interest rates for
mortgage loans.
The Bank will continue to make financing available to homebuilders and home
purchasers in an attempt to facilitate sales of lots in the four Communities
under active
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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,
--------------------------------------
1994 1993 1992
-------- -------- --------
(In thousands)
Residential construction loans......... $ 13,367 $ 10,386 $ 3,138
Single-family permanent loans (1)...... 54,642 79,104 93,856
-------- -------- --------
Total.................. $ 68,009 $ 89,490 $ 96,994
======== ======== ========
<FN>
- --------------------
(1) Includes $4.4 million, $8.8 million and $13.3 million of loans classified
as held for sale at September 30, 1994, 1993 and 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 expects 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. Through September 30, 1994, the Bank had
originated $170.6 million and sold $166.2 million of such loans. At September
30, 1994, the remaining $4.4 million of such loans are classified as held for
sale and generally are expected to be sold in the first quarter of fiscal 1995.
The total pre-tax cost to the Bank of granting more favorable terms to the
borrowers was approximately $2.6 million, or 1.5% of the $170.6 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 has
continued to develop some of the Communities. The following table presents net
funds provided by development at the four active Communities for the years
indicated.
-85-
Year Ended September 30,
--------------------------------------
1994 1993 1992
-------- -------- --------
(In thousands)
Sales proceeds.............. $ 78,057 $ 66,291 $ 39,594
Development costs .......... 43,547 51,649 35,803
-------- -------- --------
Net funds provided
by development............ $ 34,510 $ 14,642 $ 3,791
======== ======== ========
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."
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, 1994, this property had a book
value of $30.8 million, after valuation allowances.
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 OTS has not objected to the
implementation of the Bank's budgets for additional investments in these
properties through September 30, 1994.
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. Bank does not anticipate any significant
increases in non-performing and potential problem assets.
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
-86-
borrowers or properties experiencing cash flow problems due primarily to the
downturn in recent years of the real estate markets in which the properties are
located.
At September 30, 1994, potential problem assets totaled $34.1 million
before valuation allowances of $11.2 million, as compared to $73.6 million,
before valuation allowances of $15.4 million at September 30, 1993. The $39.5
million decrease in potential problem assets is primarily attributable to $25.1
million of loans incurred by borrowers whose financial condition is such that
management no longer has serious doubts as to such borrowers' ability to comply
with present repayment terms. The repayment of two commercial permanent loans
with an aggregate principal balance of $5.2 million, the repayment of one
commercial construction loan with a principal balance of $1.2 million and other
net pay-downs of $8.0 million also contributed to the decrease in potential
problem assets.
DELINQUENT LOANS. At September 30, 1994, delinquent loans totaled $31.8
million (or 1.2% of gross loans) compared to $49.1 million (or 2.0% of gross
loans) at September 30, 1993. The following table sets forth information
regarding the Bank's delinquent loans at September 30, 1994.
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 .......... $ 3,817 $17,557 $21,374 0.8%
60-89 days .......... 457 9,969 10,426 0.4%
------- ------- ------- ----
Total ............. $ 4,274 $27,526 $31,800 1.2%
======= ======== ======= ====
<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 $4.3 million at
September 30, 1994 from $8.9 million at September 30, 1993. The $4.6 million
decrease was primarily attributable to the return to current status of loans
previously delinquent 30-59 days as a result of the improvement in general
economic conditions.
-87-
Non-mortgage loans (principally credit card loans) delinquent 30-89 days
decreased to $27.5 million at September 30, 1994 from $40.2 million at
September 30, 1993, primarily as a result of an improvement in general economic
conditions. Non-mortgage loans delinquent 30-89 days as a percentage of total
non-mortgage loans outstanding decreased to 2.7% at September 30, 1994 from 4.5%
at September 30, 1993.
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,
------------------------
1994 1993
------- -------
(In thousands)
Troubled debt
restructurings..... $29,141 $36,729
======= =======
At September 30, 1994, loans accounted for as troubled debt restructurings
included two commercial permanent loans with principal balances totaling $13.2
million and two residential ground loans with principal balances totaling $15.9
million. The decrease in loans accounted for as troubled debt restructurings
from September 30, 1993 resulted from the repayment of one commercial permanent
loan with a principal balance of $4.0 million, the repayment of one residential
ground loan with a principal balance of $2.5 million, the repayment of one
residential construction loan with a principal balance of $0.5 million and other
net pay-downs of $0.6 million. At September 30, 1994, the Bank had commitments
to lend $2.5 million of additional funds on loans that have been restructured.
REAL ESTATE HELD FOR INVESTMENT. At September 30, 1994, real estate held
for investment consisted of seven properties with an aggregate book value of
$52.7 million, net of accumulated depreciation of $13.6 million and valuation
allowances of $9.9 million. This category includes one office building (which
was approximately 82% leased at such date) and two apartment buildings (which
were fully leased at such date and are financed with bonds issued through 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, 1994, before valuation allowances
-88-
of $2.0 million, which has a profit participation feature. The loan, which is
secured by commercial land, is included in non-performing assets. The Bank has
discussions from time to time with potential investors concerning the possible
sale of certain of its real estate.
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.
-89-
Analysis of Reserve Balances on and Charge-offs of Loans
(Dollars in thousands)
Year Ended September 30,
-----------------------------------------------------
1994 1993 1992 1991 1990
--------- --------- --------- --------- ---------
Balance at beginning of year $ 68,040 $ 78,818 $ 89,745 $ 58,339 $ 41,934
--------- --------- --------- --------- ---------
Provision for loan losses 33,237 62,513 89,062 147,141 78,300
--------- --------- --------- --------- ---------
Charge-offs:
Residential 1,641 45 581 78
Commercial and multifamily 112 766 1,855 1,500 1,622
Ground 2,027 4,274 1,650 16,899 2,375
Residential construction - 1,971 3,564 517
Commercial construction 447 1,431 13,421 1,944
Credit card 59,874 78,445 103,158 89,294 64,493
Consumer and other 1,058 3,664 1,898 1,695 560
--------- --------- --------- --------- ---------
Total charge-offs 65,159 87,194 112,544 126,451 71,511
--------- --------- --------- --------- ---------
Recoveries:
Ground 120
Credit card 13,630 13,601 12,196 10,618 8,732
Other 457 302 359 98 764
--------- --------- --------- --------- ---------
Total recoveries 14,087 13,903 12,555 10,716 9,616
--------- --------- --------- --------- ---------
Charge-offs, net of recoveries 51,072 73,291 99,989 115,735 61,895
--------- --------- --------- --------- ---------
Balance at end of year $ 50,205 $ 68,040 $ 78,818 $ 89,745 $ 58,339
========= ========= ========= ========= =========
Provision for loan losses to average loans (1) 1.23% 2.93% 3.69% 4.72% 2.36%
Net loan charge-offs to average loans (1) 1.89% 3.43% 4.15% 3.72% 1.86%
Ending reserve for losses on loans to total loans (1) (2) 1.97% 2.83% 3.52% 2.79% 1.83%
<FN>
(1) Includes loans held for sale and/or securitization.
(2) Before deduction of reserves.
-90-
Components of Reserve for Losses on Loans by Type
(Dollars in thousands)
September 30,
-------------------------------------------------------------------------------------------------------
1994 1993 1992 1991 1990
-------------------- --------------------- ------------------- ----------------- -----------------
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 $ 1,384 53.8% $ 4,235 53.6% $ 2,335 41.6% $ 2,326 41.7% $ 1,263 32.2%
Home equity 133 1.4 250 2.5 504 9.9 597 9.0 470 22.2
Commercial and
multifamily 8,506 3.3 9,606 3.9 5,907 2.7 4,655 2.1 3,960 2.8
Residential construction 1,455 1.2 4,125 1.5 4,470 2.6 3,683 2.2 1,708 2.2
Commercial construction 245 0.2 345 0.4 729 0.5 1,754 0.7 1,407 1.9
Ground 2,362 0.6 1,412 0.7 2,624 1.0 2,168 1.3 10,305 4.5
Credit card 34,530 25.5 46,886 31.4 57,566 38.9 70,642 40.4 35,942 27.6
Consumer and other 1,590 14.0 1,181 6.0 4,683 2.8 2,997 2.6 1,132 6.6
-------- -------- -------- -------- --------
Subtotal 50,205 68,040 78,818 88,822 56,187
Unallocated - - - 923 2,152
-------- -------- -------- -------- --------
Total $50,205 $68,040 $78,818 $89,745 $58,339
======== ======== ======== ======== ========
-91-
Analysis of Reserve Balances on and Charge-offs of
Real Estate Held for Investment or Sale
(In thousands)
Year ended September 30,
-------------------------------------------------------------
1994 1993 1992 1991 1990
--------- ---------- ---------- ---------- ----------
Balance at beginning 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 -
--------- ---------- ---------- ---------- ----------
Provision for real estate losses:
Real estate held for investment (283) 1,470 12,673 4,724 45,586
Real estate held for sale 14,335 28,945 47,923 43,259 10,078
--------- ---------- ---------- ---------- ----------
Total 14,052 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 911 79 - - -
Residential ground - 259 348 - -
Commercial ground - 1,353 3,785 - -
Commercial permanent 5,812 761 - - -
Commercial construction - 19,156 - - -
--------- ---------- ---------- ---------- ----------
Total 6,723 21,608 7,135 - -
--------- ---------- ---------- ---------- ----------
Total charge-offs on real estate
held for investment or sale 6,723 27,815 9,050 3,363 42,786
--------- ---------- ---------- ---------- ----------
Balance at end of year:
Real estate held for investment 9,899 10,182 14,919 4,161 2,800
Real estate held for sale 109,074 101,462 94,125 53,337 10,078
--------- ---------- ---------- ---------- ----------
Total $118,973 $ 111,644 $ 109,044 $ 57,498 $ 12,878
========= ========== ========== ========== ==========
-92-
Components of Reserve for Losses
on Real Estate Held for Investment or Sale
(In thousands)
September 30,
-------------------------------------------------------------
1994 1993 1992 1991 1990
--------- ---------- ---------- ---------- ----------
Reserve for losses on real estate
held for investment:
Commercial and multifamily $ 7,793 $ 7,945 $ 8,037 $ 2,389 $ 839
Commercial construction 4,995 506 506
Ground 1,975 1,972 1,682 1,266 1,455
Other 131 265 205
--------- ---------- ---------- ---------- ----------
Total 9,899 10,182 14,919 4,161 2,800
--------- ---------- ---------- ---------- ----------
Reserve for losses on real estate
held for sale:
Residential 66 102 447 2,813 1,906
Home equity 4 53 21 4 3
Commercial and multifamily 142 4,678 1,705 1,564 96
Commercial construction 1,216 1,387 15,439 6,899 2,115
Residential construction 1,942 2,924 2,294 1,664 307
Ground 105,704 92,318 74,219 40,393 5,651
--------- ---------- ---------- ---------- ----------
Total 109,074 101,462 94,125 53,337 10,078
--------- ---------- ---------- ---------- ----------
Total reserve for losses on real
estate held for investment or sale $118,973 $ 111,644 $ 109,044 $ 57,498 $ 12,878
========= ========== ========== ========== ==========
-93-
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 $10.5 million from the level at
September 30, 1993 to $169.2 million at September 30, 1994. The $10.5 million
decrease was primarily attributable to decreased reserves on credit card loans
resulting partially from the securitization and sale of $1.4 billion of such
loans and the sale of credit card relationships with related receivable balances
of $96.5 million during fiscal 1994, and a decline in the ratio of credit card
charge-offs to outstanding credit card loans. Reserves for losses on real
estate loans also decreased, primarily because of the adoption of SOP 92-3
during fiscal 1993. The decreased reserves on credit card and real estate loans
were partially offset by increased reserves on real estate held for sale. The
$7.6 million increase in reserves on real estate held for sale was primarily
attributable to an increase of $13.2 million in the reserves on two of the five
Communities based upon updated internal analyses and computations of the fair
value of these assets. During the year ended September 30, 1994, the Bank
recorded net charge-offs of $11.0 million on loans secured by real estate and
real estate held for investment or sale and provided an additional $12.4 million
in valuation allowances on these assets.
The following table shows reserves for losses on performing and
non-performing assets at the dates indicated.
-94-
September 30, 1994
-------------------------------------------
Performing Non-Performing Total
---------- -------------- ------
(In thousands)
Reserves for losses on:
Loans:
Real estate.............. $13,670 $ 415 $ 14,085
Credit card.............. 32,907 1,623 34,530
Consumer and other....... 1,590 -- 1,590
------- --------- --------
Total reserve for
losses on loans........ 48,167 2,038 50,205
------- --------- --------
Real estate held for
investment............... 7,924 1,975 9,899
Real estate held for sale. - 109,074 109,074
------- --------- --------
Total reserve for losses on
real estate held for
investment or sale...... 7,924 111,049 118,973
------- --------- ---------
Total reserves for losses.. $56,091 $113,087 $169,178
======= ======== ========
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
======= ======== ========
-95-
Reserves for losses on loans secured by real estate and real estate held
for investment or sale totaled $133.1 million at September 30, 1994, which
constituted 32.9% of total non-performing real estate assets. This amount
represented a $1.5 million increase over the September 30, 1993 level of $131.6
million, or 29.1% 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. Reserves for losses on real estate held for sale at September 30, 1994
are in addition to approximately $63.3 million of cumulative charge-offs
previously taken against assets remaining in the Bank's portfolio at
September 30, 1994.
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, 1994
were $46.2 million, compared to $64.8 million for the year ended September 30,
1993. The decrease in net charge-offs resulted primarily from 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, the cardholder may enter into transactions (such
as retail purchases and cash advances) subsequent to a balance sheet date which
increase 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 $34.5 million at
September 30, 1994 from $46.9 million at September 30, 1993. This decrease was
attributable in part
-96-
to a lower reserve ratio resulting from a decline in the ratio of credit card
charge-offs to outstanding credit card loans. In addition, the securitization
and sale of $1.4 billion of credit card receivables and the sale of credit card
relationships with related receivable balances of $96.5 million in fiscal 1994
reduced the amount of credit card loans against which the Bank maintains the
reserve. The ratios of the reserve for such losses to non-performing credit
card loans and to outstanding credit card loans decreased to 212.8% and 5.3%,
respectively, at September 30, 1994 from 228.1% and 6.2%, respectively, at
September 30, 1993.
The reserve for losses on consumer and other loans increased to $1.6
million at September 30, 1994 from $1.2 million at September 30, 1993, primarily
because of an increase in automobile loan reserves. 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 decreased to 319.3% and 0.4%,
respectively, at September 30, 1994 from 376.1% and 0.8%, respectively, at
September 30, 1993.
-97-
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 the origination and retention of adjustable-rate residential
permanent loans, adjustable-rate home equity credit line loans and
adjustable-rate credit card loans, which generally have shorter terms and higher
yields than those of mortgage loans. At September 30, 1994, adjustable-rate
loans accounted for 78.8% of total loans. ARMs and home equity credit line loans
with rates adjustable in one year or less accounted for 12.2% of total loans,
and credit card loans accounted for 25.5% of total loans at September 30, 1994.
In recent periods, the Bank's policy has generally been to sell all of its
long-term fixed-rate mortgage production, thereby reducing its exposure to
market interest rate fluctuations typically associated with long-term fixed-rate
lending. The Bank retains in its portfolio the majority of its adjustable-rate
mortgage production.
A traditional measure of interest-rate risk within the banking industry is
the interest sensitivity "gap," which is the sum of all interest-earning assets
minus all interest-bearing liabilities subject to repricing within the same
period. 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 may result in an increase in the
Bank's net interest spread. This analysis assumes a parallel shift in interest
rates for instruments of different maturities and does not reflect the
possibility that retail deposit pricing changes may lag those of wholesale
market funds which, in a period of rising
-98-
interest rates, might serve to mitigate the decline in 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 available-for-sale portfolio when
replacing securities following normal portfolio maturation and turnover;
lengthening or shortening the maturity or repricing terms for any current period
asset securitizations; and altering the maturity or interest rate reset profile
of borrowed funds, if any, including funds borrowed from the FHLB of Atlanta.
The following table presents the interest rate sensitivity of the Bank's
interest-earning assets and interest-bearing liabilities at September 30, 1994,
which reflects management's estimate of mortgage loan prepayments and
amortization and provisions for adjustable interest rates. Adjustable and
floating rate loans are included in the period in which their interest rates are
next scheduled to adjust, and 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.
-99-
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, 1994
Mortgage loans:
Adjustable-rate $ 342,776 $ 142,089 $ 385,058 $ 351,263 $ 35,082 $1,256,268
Fixed-rate 10,481 9,666 50,211 35,503 110,116 215,977
Loans held for sale 33,598 - - - - 33,598
Home equity credit lines and second mortgages 40,855 - - 109 - 40,964
Credit card and other 588,731 36,904 139,268 118,633 11,057 894,593
Loans held for securitization and sale 115,000 - - - - 115,000
Mortgage-backed securities 295,344 349,479 375,461 3,673 1,568 1,025,525
Other investments 130,105 - 4,399 100 - 134,604
------------- ------------- ------------ ------------ ----------- -----------
Total interest-earning assets 1,556,890 538,138 954,397 509,281 157,823 3,716,529
Total non-interest earning assets - - - - 949,769 949,769
------------- ------------- ------------ ------------ ----------- -----------
Total assets $ 1,556,890 $ 538,138 $ 954,397 $ 509,281 $1,107,592 $4,666,298
============= ============= ============ ============ =========== ===========
Deposits:
Fixed maturity deposits $ 329,031 $ 153,313 $ 160,444 $ 84,179 $ - $ 726,967
NOW, statement and passbook accounts 1,611,108 41,244 137,367 93,495 199,250 2,082,464
Money market deposit accounts 1,104,730 - - - - 1,104,730
Borrowings:
Capital notes - subordinated 10,000 - - - 150,000 160,000
Other 109,273 108 24,211 588 6,486 140,666
------------- ------------- ------------ ------------ ----------- -----------
Total interest-bearing liabilities 3,164,142 194,665 322,022 178,262 355,736 4,214,827
Total non-interest bearing liabilities - - - - 199,005 199,005
Stockholders' equity - - - - 252,466 252,466
------------- ------------- ------------ ------------ ----------- -----------
Total liabilities & stockholders' equity $ 3,164,142 $ 194,665 $ 322,022 $ 178,262 $ 807,207 $4,666,298
============= ============= ============ ============ =========== ===========
Gap ($1,607,252) $343,473 $632,375 $331,019 ($197,913)
Cumulative gap ($1,607,252) ($1,263,779) ($631,404) ($300,385) ($498,298)
Cumulative gap as a percentage
of total assets (34.4)% (27.1)% (13.5)% (6.4)% (10.7)%
-100-
The one-year gap, as a percentage of total assets, was a negative 27.1% at
September 30, 1994, compared to a negative 26.3% at September 30, 1993. As
noted above, the Bank's negative one-year gap might 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.
At September 30, 1994, the Bank was not required to maintain additional
amounts of risk-based capital under the interest-rate risk component of the OTS
capital regulations. 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, 1994, the Bank recorded a net
deferred tax asset of $38.4 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 SFAS 109.
TAX SHARING PAYMENTS. During fiscal 1994, after receiving OTS approval,
the Bank made $9.6 million of tax sharing payments to the Real Estate Trust.
The Bank made an additional tax sharing payment of $5.0 million subsequent
to September 30, 1994. See "Business - Real Estate - Federal Taxation -
Consolidated Tax Returns; Tax Sharing Payments."
-101-
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 ("Unsecured Notes") sold to the public, the payment of interest
on its Senior Secured Notes and the payment of capital improvement costs. In the
past, the Real Estate Trust had funded such shortfalls through a combination of
external funding sources, primarily new financings (including the sale of
Unsecured 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 during most of
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 affected the availability of long-term
fixed-rate mortgage financing on satisfactory terms.
The Real Estate Trust's current program of public Unsecured Note sales was
initiated in the 1970's as a vehicle for supplementing other external funding
sources. In fiscal 1994, the Real Estate Trust sold $15.7 million of Unsecured
Notes. The table under "Recent Liquidity Trends" below provides information at
September 30, 1994 with respect to the maturities of Unsecured Notes outstanding
at such date.
As the owner, directly and through two wholly-owned subsidiaries, of a
21.5% limited partnership interest in Saul Holdings Partnership, the Real Estate
Trust shares in cash distributions from operations and from capital transactions
involving the sale or refinancing of the properties of Saul Holdings
Partnership. The partnership
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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 fiscal 1994, the Real Estate Trust
received total cash distributions of $4.6 million from Saul Holdings
Partnership.
RECENT LIQUIDITY TRENDS. The Real Estate Trust's liquidity position was
positively affected by the sale on March 30, 1994 of $175.0 million aggregate
principal amount of 11- 5/8% Senior Secured Notes due 2002 (the "Senior Secured
Notes"). After paying offering expenses of $8.9 million, third-party mortgage
indebtedness of $74.1 million, and affiliate indebtedness of $8.9 million, the
Real Estate Trust retained $83.1 million of the net proceeds of the offering for
application to general corporate purposes. Approximately $25.8 million was
deposited with the Trustee for the Senior Secured Notes to satisfy an initial
collateral requirement with respect to such securities. This collateral
requirement, which will remain in effect as long as any Senior Secured Notes are
outstanding, will be recalculated each calendar quarter based on the estimated
amount of one year's interest payments on then- outstanding Senior Secured Notes
and Unsecured Notes. Concurrently with the application of the net proceeds of
the offering to repay third-party mortgage indebtedness, the terms of certain of
the mortgage loans repaid in part were modified to waive deferred interest,
reduce interest rates and extend maturities. After the application of such net
proceeds and the modification of such loans, the final maturity of loans with
total balances of $111.1 million was 12 years and the final maturity of a loan
with a balance of $15.1 million was 15 years.
During the third and fourth quarters of fiscal 1994, the Trust purchased
573,900 shares of common stock of Saul Centers (representing 4.8% of such
company's outstanding common stock) for approximately $10.3 million. These
shares have been deposited with the Trustee for the Senior Secured Notes to
satisfy in part the collateral requirements for those securities, thereby
permitting release to the Trust of a portion of the cash on deposit with the
Trustee.
The Senior Secured Notes are secured, general obligations of the Trust
ranking pari passu with all other unsubordinated obligations of the Trust,
including the Unsecured Notes. The Senior Secured Notes are secured by a first-
priority perfected security interest in 80% of the issued and outstanding common
stock of the Bank, which 80% is owned by the Trust, and in the collateral
referred to above, which at September 30, 1994 consisted of cash and cash
equivalents of $21.2 million in addition to the Saul
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Centers common stock. The Indenture pursuant to which the Senior Secured Notes
were issued contains covenants that, among other things, restrict the ability of
the Trust and/or its subsidiaries (excluding, in most cases, the Bank and the
Bank's subsidiaries) to incur additional indebtedness, make investments, sell
assets or pay dividends and make other distributions to holders of the Trust's
capital stock.
The maturity schedule for the Real Estate Trust's outstanding mortgage and
other debt at September 30, 1994 is set forth in the following table:
Debt Maturity Schedule
(in thousands)
Notes Payable- Notes Payable-
Fiscal Year Mortgage Notes Secured Unsecured Total
- ---------------------------------------------------------------------------------
1995 $ 11,022 $ --- $ 7,242 $ 18,264
1996 6,100 --- 5,761 11,861
1997 23,455 --- 5,336 28,791
1998 6,935 --- 5,935 12,870
1999 16,600 --- 12,769 29,369
Thereafter 121,618 175,000 3,245 299,863
-------- -------- ------- --------
$185,730 $175,000 $40,288 $401,018
======== ======== ======= ========
Of the $185.7 million of mortgage debt outstanding at September 30, 1994,
$132.1 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 $4 million per year.
The Real Estate Trust had negative cash flow from operating activities of
$10.9 million, $3.1 million, $0.9 million and $16.4 million in fiscal 1994,
1993, 1992 and 1991, respectively, before tax sharing payments from the Bank of
$9.6 million in fiscal 1994, $5.0 million in fiscal 1993 and $29.6 million in
fiscal 1991. The Real Estate Trust's ability to meet its liquidity needs,
including debt service payments, will depend in significant part on its receipt
of dividends from the Bank and tax sharing payments from the Bank pursuant to
the tax sharing agreement among the Trust, the Bank and their subsidiaries. The
availability and amount of tax sharing payments and dividends in future periods
is dependent upon, among other things, the Bank's operating performance and
income, regulatory restrictions on such payments and (in the case of tax sharing
payments) the continued consolidation of the Bank and the Bank's subsidiaries
with the Trust for federal income tax purposes.
The Real Estate Trust believes that the improved financial condition and
operating results of the Bank in recent periods should enhance the prospects of
the Real Estate Trust to receive
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tax sharing payments and dividends from the Bank. As of September 30, 1994,
$12.0 million in tax sharing payments were due to the Real Estate Trust, of
which $5.0 million was paid in October 1994 with the approval of the OTS.
The Real Estate Trust to date has not received any cash dividends from the Bank.
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 on its common stock. OTS regulations tie
the Bank's ability to pay dividends to specific levels of regulatory capital and
earnings. See "Business - Banking - Regulation - Dividends and Other Capital
Distributions."
If the Real Estate Trust does not receive tax sharing payments or dividends
from the Bank in fiscal 1995, management estimates that the Real Estate Trust
will have adequate liquidity from other sources, including unencumbered cash
balances, debt service escrow balances related to the Senior Secured Notes, and
proceeds from the sale of Unsecured Notes, sufficient to fund its debt service
and other cash needs for fiscal 1995.
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 average monthly
liquidity ratio for the month ended September 30, 1994 was 18.6%, compared to
24.3% for the month ended September 30, 1993. Additionally, the Bank met the
liquidity level requirements for each month of fiscal 1994. The decline in the
Bank's liquidity ratio was primarily attributable to scheduled and unscheduled
principal paydowns on unpledged securities, which reduced the level of
qualifying collateral.
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
investment securities and (iv) borrowed funds (including funds borrowed from the
FHLB of Atlanta). The Bank's holdings of readily marketable securities
constitute another important source of liquidity. At September 30, 1994, the
Bank's portfolio included mortgage loans, U.S. Government securities and
mortgage-backed securities with outstanding principal balances of $908.2
million, $4.4 million and $1.0 billion, respectively. The estimated borrowing
capacity of available mortgage loans, U.S. Government securities and
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mortgage-backed securities that could be pledged to the FHLB of Atlanta and
various security dealers totaled $1.4 billion at September 30, 1994, after
market-value and other adjustments.
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 $1.4 billion of credit card receivables
and sold credit card relationships with related receivable balances of $96.5
million during fiscal 1994. In addition, during fiscal 1994, the Bank
securitized and sold $181.9 million of home equity credit 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 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, 1994, 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 $12.2 billion, repay
borrowings of $3.1 billion, fund existing and continuing loan commitments
(including real estate held for investment or sale) of $2.9 billion, purchase
investments and loans of $547.9 million and meet operating expenses, before
depreciation and amortization, of $215.4 million. These commitments were funded
primarily through proceeds from customer deposits and sales of certificates of
deposit of $12.3 billion, proceeds from borrowings of $2.7 billion, proceeds
from sales of loans, securities and real estate
-106
of $2.4 billion, and principal and interest collected on investments, loans,
mortgage-backed securities and trading 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 $2.4 billion of outstanding trust certificate balances at
September 30, 1994, the primary recourse to the Bank was approximately $65.9
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, 1994, recourse to the Bank under these arrangements was
approximately $5.9 million. See Note 28 to the Consolidated Financial
Statements in this report.
The Bank's commitments at September 30, 1994 are set forth in the following
table:
(In thousands)
Commitments to originate loans $ 61,440
----------
Loans in process (collateralized loans):
Home equity ................................. 543,067
Real estate construction..................... 33,494
Commercial and multifamily .................. 429
----------
576,990
----------
Loans in process (unsecured loans):
Credit cards................................. 6,769,539
Overdraft lines.............................. 41,773
Commercial................................... 1,612
----------
6,812,924
----------
Total commitments to extend credit....... 7,451,354
Letters of credit ............................. 62,597
Recourse arrangements on asset-backed
securitizations ............................. 65,907
Recourse arrangements on mortgage-backed
securities .................................. 5,874
----------
Total commitments ....................... $7,585,732
==========
Based on historical experience, the Bank expects to
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fund substantially less than the total amount of its outstanding credit card and
home equity credit line commitments, which together accounted for 96.4% of
commitments at September 30, 1994.
At September 30, 1994, repayments of borrowed money scheduled to occur
during the next 12 months were $2.5 million. Certificates of deposit maturing
during the next 12 months amounted to $482.3 million, of which a substantial
portion is expected to remain with the Bank.
There were no material commitments for capital expenditures at
September 30, 1994.
The Bank's liquidity requirements in years subsequent to fiscal 1994 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 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, 1994, the Bank was in compliance with all of its
regulatory capital requirements under FIRREA, and its capital ratios exceeded
the ratios established for "well-capitalized" institutions under OTS prompt
corrective action regulations. On the basis of its September 30, 1994 balance
sheet, the Bank also would meet the fully phased-in capital requirements under
FIRREA that will apply as certain deductions from capital are phased in and,
after giving effect to those deductions, would meet the capital standards for
"adequately-capitalized" institutions under the prompt corrective action
regulations.
The following table shows the Bank's regulatory capital levels at
September 30, 1994 in relation to the regulatory requirement 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.
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Regulatory Capital
(Dollars in thousands)
Minimum Excess
Actual Capital Requirement Capital
------------------------- --------------------- ---------
As a % As a %
Amount of Assets (3) Amount of Assets Amount
--------- --------- --------- --------- ---------
Capital per financial statements $289,956
Adjustments for tangible and core capital:
Intangible assets (50,484)
Non-includable subsidiaries (1) (9,990)
---------
Total tangible capital 229,482 4.96% $ 69,369 1.50% $160,113
Supervisory goodwill 17,342 ========= ========= ========= =========
---------
Total core capital (2) 246,824 5.34% $184,984 4.00% $ 61,840
--------- ========= ========= ========= =========
Total tier 1 risk-based capital (2) 246,824 6.95% $142,077 4.00% $104,747
--------- ========= ========= ========= =========
Adjustments for risk-based capital:
Subordinated capital debentures 152,900
Reserve for general loan losses 42,973
---------
Total supplementary capital 195,873
---------
Total available capital 442,697
Equity investments (1) (34,009)
---------
Total risk-based capital (2) $408,688 12.19% $284,154 8.00% $124,534
========= ========= ========= ========= =========
<FN>
(1) Reflects an aggregate offset of $5.5 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%.
(3) If the OTS policy to exclude net unrealized holding gains (losses) from
regulatory capital had been in effect on September 30, 1994, the Bank's
tangible, core, tier 1 risk-based and total risk-based regulatory capital
ratios would have increased to 5.27%, 5.64%, 7.35% and 12.66%,
respectively.
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The Bank's stockholders' equity, and therefore its regulatory capital, was
adversely affected in fiscal 1994 by a decrease of $30.4 million, after related
income taxes, in the market value of the Bank's securities classified as
available-for-sale. As market interest rates fluctuate, the market value of the
Bank's available-for-sale portfolio, and therefore its stockholders' equity,
also will fluctuate. As a result of the OTS's recent reversal of its policy,
however, such fluctuations no longer will affect the Bank's levels of regulatory
capital. See "Business - Banking - Regulation - Regulatory Capital."
In November 1994, the OTS announced its policy to exclude net unrealized
holding gains (losses) on debt securities classified as available-for-sale from
regulatory capital for purposes of computing regulatory capital ratios. Savings
associations are required to adopt the revised policy by June 1995, but may
elect to adopt the revised policy beginning in December 1994. This new policy
replaces the interim OTS policy issued in August 1993, pursuant to which net
unrealized holding gains (losses) were fully includable in tier 1 capital for
regulatory capital purposes. If this policy had been in effect on September 30,
1994, the Bank's tangible, core and total risk-based regulatory capital ratios
would have increased to 5.27%, 5.64% and 12.66%, respectively.
REGULATORY ACTION AND REQUIREMENTS. The Bank is subject to an amended
written agreement with the OTS, dated October 1993, 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 also 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 such quarter without prior written approval from the 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 up to $500 million. In addition, on September
27, 1994, the OTS notified the Bank that it would not object to an increase in
the Bank's total assets of approximately $75.0 million for the quarter ended
September 30, 1994.
The Bank is subject to a requirement to obtain OTS approval for changes in
directors and senior executive officers and the imposition of higher FDIC
insurance premiums. In January 1994, the OTS approved the appointment of three
additional directors to the Bank's Board of
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Directors.
CAPITAL MAINTENANCE STRATEGIES. 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, 1994, the Bank met the FIRREA-mandated fully
phased-in capital requirements with tangible, core (or leverage), and total
risk-based capital ratios of 4.65%, 4.65% and 11.26%, respectively, which
exceeded the FIRREA requirements of 1.5%, 3.0% and 8.0%, respectively. At
September 30, 1994, the Bank had $27.2 million, after subsequent valuation
allowances, of extensions of credit to, and investment in, subsidiaries engaged
in activities impermissible for national banks ("non-includable subsidiaries")
which were subject at September 30, 1994 to a 40% phase-out from all three
FIRREA capital requirements. This phase-out will increase to 60% on July 1,
1995 and 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, 1994, the Bank also had two equity investments with an aggregate
balance, after subsequent valuation allowances, of $38.6 million which were
subject to a 100% phase-out from total capital for risk-based capital purposes,
effective July 1, 1994. Pursuant to OTS guidelines, $5.5 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 Bank will continue to attempt to reduce 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 limit 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
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otherwise) prior to the end of its applicable five-year holding period and is
unable to obtain an extension of such five-year holding period from the OTS, the
Bank could be required to deduct the then-current book value of such REO
property from risk-based capital. Although there can be no assurances in this
regard, management believes it will be able to receive the necessary extensions.
The following table sets forth the Bank's REO at September 30, 1994, after
valuation allowances of $109.1 million, by the fiscal year in which the property
was acquired through foreclosure.
Fiscal Year (In thousands)
1990 (1)..................$129,152
1991...................... 106,318
1992...................... 15,860
1993...................... 7,450
1994...................... 19,170
--------
Total REO...............$277,950
========
<FN>
____________________
(1) Includes REO with an aggregate net book value of $34.0 million, which
the Bank agreed to treat as equity investments for regulatory capital purposes.
At September 30, 1994, the Bank had $48.3 million in supervisory goodwill,
of which $17.3 million was includable in core capital pursuant to statutory
provisions limiting the includable amount of supervisory goodwill to an amount
not to exceed 0.375% of tangible assets 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. Adverse
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.
PROMPT CORRECTIVE ACTION. Under the OTS prompt corrective action
regulations, an institution is categorized as "well capitalized" if it has a
leverage (or core capital) ratio of at least 5.0%, a tier 1 risk-based capital
ratio of at least 6.0%, a total risk-based capital ratio of at least 10.0% and
is not subject to any written agreement, order, capital directive or prompt
corrective action directive to meet and maintain a specific capital level. At
September 30, 1994, the Bank's leverage, tier 1 risk-based
-112-
and total risk-based capital ratios were 5.34%, 6.95% and 12.19%, respectively,
which exceeded the ratios established for "well-capitalized" institutions, and
the Bank was not subject to any applicable written agreement, order or directive
to meet and maintain a specific capital level. 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 nonperforming 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. 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." On a fully phased-in basis at
September 30, 1994, the Bank's regulatory capital ratios would meet the ratios
established for "adequately capitalized" institutions.
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 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
-113-
its deposits and borrowings. In the last three fiscal years, non-interest
income from securitizations of credit card and home equity credit line
receivables and gains on sales of credit card accounts (or "relationships"),
loans and mortgage-backed securities have had a significant effect on net
income. In addition to interest paid on its interest-bearing liabilities, the
Bank's principal expenses are operating expenses.
FISCAL 1994 COMPARED TO FISCAL 1993
REAL ESTATE
The following table sets forth, for the fiscal years ended September 30,
1994, 1993 and 1992, direct operating results for the Real Estate Trust's (i)
shopping center and office properties, (ii) commercial properties portfolio,
which presents the shopping center and office property results on a combined
basis, and (iii) hotel properties. On August 26, 1993, the Real Estate Trust
transferred its 22 shopping center properties and one of its office properties
to Saul Holdings Partnership and a subsidiary limited partnership of Saul
Holdings Partnership in exchange for a 21.5% limited partnership interest in
Saul Holdings Partnership (the "Saul Centers Transaction"). See "Business -
Real Estate - Investment in Saul Holdings Limited Partnership" and Note 2 to the
Consolidated Financial Statements in this report. As a result of the Saul
Centers Transaction, the fiscal 1994 operating results of commercial properties,
which did not include the Transferred Properties, and the fiscal 1993 operating
results, which included such commercial properties for less than the entire
fiscal year, are not entirely comparable to the results of the prior
corresponding periods.
-114-
Year Ended September 30,
----------------------------------------
1994(1) 1993(1) 1992
----------------------------------------
(In thousands)
OFFICE PROPERTIES
Revenue
Base rent . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,345 $ 16,975 $ 19,101
Expense recoveries. . . . . . . . . . . . . . . . . . . . . . . 967 1,272 1,916
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503 410 566
-----------------------------------------
Total revenues . . . . . . . . . . . . . . . . . . . . . . 16,815 18,657 21,583
-----------------------------------------
Direct operating expenses
Real estate taxes . . . . . . . . . . . . . . . . . . . . . . . 1,383 1,508 1,733
Repairs and maintenance . . . . . . . . . . . . . . . . . . . . 1,792 1,718 1,695
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,324 2,261 2,326
Payroll . . . . . . . . . . . . . . . . . . . . . . . . . . . . 566 548 549
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . 256 282 296
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 651 906 1,105
-----------------------------------------
Total direct operating expenses. . . . . . . . . . . . . . 6,972 7,223 7,704
-----------------------------------------
Income after direct operating expenses . . . . . . . . . . . . . . . $ 9,843 $ 11,434 $ 13,879
-----------------------------------------
-----------------------------------------
SHOPPING CENTERS
Revenue
Base rent . . . . . . . . . . . . . . . . . . . . . . . . . . . $ -- $ 19,635 $ 21,284
Percentage rent . . . . . . . . . . . . . . . . . . . . . . . . -- 4,488 4,857
Expense recoveries. . . . . . . . . . . . . . . . . . . . . . . -- 2,231 2,608
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 725 1,157
-----------------------------------------
Total revenues . . . . . . . . . . . . . . . . . . . . . . -- 27,079 29,906
-----------------------------------------
Direct operating expenses
Real estate taxes . . . . . . . . . . . . . . . . . . . . . . . -- 1,977 2,053
Repair and maintenance. . . . . . . . . . . . . . . . . . . . . -- 1,186 1,152
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 929 951
Payroll . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 891 924
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 304 347
Ground rent . . . . . . . . . . . . . . . . . . . . . . . . . . -- 429 467
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 769 818
-----------------------------------------
Total direct operating expenses. . . . . . . . . . . . . . -- 6,485 6,712
-----------------------------------------
Income after direct operating expenses . . . . . . . . . . . . . . . $ -- $ 20,594 $ 23,194
-----------------------------------------
-----------------------------------------
COMMERCIAL PROPERTIES
(COMBINED RESULTS OF
SHOPPING CENTERS AND OFFICE PROPERTIES)
Revenue
Base rent . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,345 $ 36,610 $ 40,385
Percentage rent . . . . . . . . . . . . . . . . . . . . . . . . -- 4,488 4,857
Expenses recoveries . . . . . . . . . . . . . . . . . . . . . . 967 3,503 4,524
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503 1,135 1,723
-----------------------------------------
Total revenues . . . . . . . . . . . . . . . . . . . . . . 16,815 45,736 51,489
-----------------------------------------
Direct operating expenses
Real estate taxes . . . . . . . . . . . . . . . . . . . . . . . 1,383 3,485 3,786
Repairs and maintenance . . . . . . . . . . . . . . . . . . . . 1,792 2,904 2,847
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,324 3,190 3,277
Payroll . . . . . . . . . . . . . . . . . . . . . . . . . . . . 566 1,439 1,473
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . 256 586 643
Ground rent . . . . . . . . . . . . . . . . . . . . . . . . . . -- 429 467
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 651 1,675 1,923
-----------------------------------------
Total direct operating expenses. . . . . . . . . . . . . . 6,972 13,708 14,416
-----------------------------------------
Income after direct operating expenses . . . . . . . . . . . . . . . $ 9,843 $ 32,028 $ 37,073
-----------------------------------------
-----------------------------------------
<FN>
- ---------------------
(1) Reflects the Real Estate Trust's transfer, in August 1993, of 22 shopping
center properties and one office property to Saul Holdings Partnership and
a subsidiary limited partnership of Saul Holdings Partnership.
-115-
Year Ended September 30,
-----------------------------------
1994 1993 1992
-----------------------------------
(In thousands)
HOTELS
Revenue
Room sales. . . . . . . . . . . . . . . . . . $ 31,676 $ 30,517 $ 31,715
Food sales. . . . . . . . . . . . . . . . . . 8,696 8,885 8,703
Beverage sales. . . . . . . . . . . . . . . . 2,648 2,985 3,258
Other . . . . . . . . . . . . . . . . . . . . 3,026 2,998 2,952
-----------------------------------
Total Revenue. . . . . . . . . . . 46,046 45,385 46,628
-----------------------------------
Direct operating expenses
Payroll . . . . . . . . . . . . . . . . . . . 14,989 14,887 15,145
Cost of sales . . . . . . . . . . . . . . . . 4,269 4,729 4,862
Utilities . . . . . . . . . . . . . . . . . . 3,181 3,027 2,957
Repairs and maintenance . . . . . . . . . . . 2,468 2,426 2,447
Advertising and promotion . . . . . . . . . . 2,276 2,301 2,331
Property taxes. . . . . . . . . . . . . . . . 943 1,194 1,084
Insurance . . . . . . . . . . . . . . . . . . 583 543 544
Other . . . . . . . . . . . . . . . . . . . . 5,165 4,390 4,593
-----------------------------------
Total direct operating expenses. . 33,874 33,497 33,963
-----------------------------------
Income after direct operating expenses. . . $ 12,172 $ 11,888 $ 12,665
-----------------------------------
-----------------------------------
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The Real Estate Trust recorded a loss before depreciation and amortization
of debt expense of $24.0 million and an operating loss of $34.3 million for
fiscal 1994, compared to a loss before depreciation and amortization of debt
expense of $29.0 million and an operating loss of $44.5 million for fiscal 1993.
The improvement was largely attributable to the decline in interest expense
resulting from refinancings and the Saul Centers Transaction and to the absence
in fiscal 1994 of a charge comparable to the charge for abandoned development
costs of $13.1 million in fiscal 1993.
Income after direct operating expenses from commercial properties, which
included only office properties in fiscal 1994, decreased $22.2 million (69.3%)
from such income in fiscal 1993, which included income from both shopping
centers and office properties. Because of the Saul Centers Transaction, the
Real Estate Trust received no income from shopping centers in the current year.
Income after direct operating expenses from commercial properties in the
portfolio during both years increased $61,000 (0.6%). The performance of the
office portfolio in fiscal 1994 was adversely affected by a reduction in rental
income during the first half of the year, although office rents largely
recovered in the last two quarters. Income after direct operating expenses for
office properties increased $442,000 (19.8%) in the fourth quarter of fiscal
1994 from the level in the prior corresponding period.
Income after direct operating expenses from hotel properties increased
$284,000 (2.4%) in fiscal 1994. Room sales increased by $1,159,000 (3.8%) as a
result of increases in average room rates. This increase was offset in part by
a decrease in average occupancy rates. The lower occupancy rates contributed to
a decrease of $526,000 (4.4%) in food and beverage sales. Total revenues
increased by $661,000 (1.5%), while expenses were higher by $377,000 (1.1%).
Interest expense decreased $11.1 million (22.0%) in fiscal 1994, largely as
result of the transfer of the mortgage debt associated with the properties
conveyed in the Saul Centers Transaction. Primarily for the same reason,
average balances of the Real Estate Trust's outstanding borrowings declined to
$358.4 million in fiscal 1994 from $452.7 in the prior year.
Amortization of debt expense decreased $1.8 million (60.2%) and
depreciation decreased $3.4 million (27.1%), primarily as a result of the
transfer of properties in the Saul Centers Transaction.
-117-
Advisory, management and leasing fees paid to related parties declined
$456,000 (6.3%) in fiscal 1994. The advisory fee in fiscal 1994 was $250,000
per month from October 1993 through March 1994 and $292,000 per month from April
1994 through September 1994, compared to $97,000 per month from October through
December 1992 and $157,000 per month from January through September 1993. The
effect of this increase was offset by decreases in management and leasing fees,
which resulted principally from the transfer of properties in the Saul Centers
Transaction.
General and administrative expense decreased $92,000 (4.3%) in fiscal 1994,
largely because of a reduction in overhead expense. Legal expense increased
slightly from the fiscal 1993 level.
The fiscal 1994 write-down of real estate to net realizable value reflects
a $1.4 million reduction in the carrying value of a hotel property. The Real
Estate Trust reduced the carrying value of the asset based on management's
evaluation of the hotel's location, recent operating history and unlikely
prospects for a near-term recovery.
Equity in earnings (losses) of unconsolidated entities represents the Real
Estate Trust's share of earnings or losses in its partnership investments. For
fiscal 1994, the Real Estate Trust recorded earnings of $1.7 million, compared
to a loss of $0.7 million in the prior year.
BANKING
OVERVIEW. The Bank recorded operating income of $53.2 million for the year
ended September 30, 1994 ("fiscal 1994"), compared to operating income of $63.8
million for the year ended September 30, 1993 ("fiscal 1993"). The decline in
income for fiscal 1994 was primarily attributable to a $56.9 million increase in
operating expenses, a $14.4 million decrease in total net interest income, a
$10.6 million decrease in credit card fees and an $8.9 million decrease in gain
on sale of investment securities. The decrease in income for the year was
offset in part by a $29.3 million decrease in the provision for loan losses and
a $29.8 million increase in other (non-interest) income resulting primarily from
a $30.6 million increase in loan and deposit servicing fees and improved results
on real estate held for investment or sale.
-118-
The Bank's net income for the 1994 period reflected a $6.3 million
extraordinary loss, net of related income taxes, resulting from the Bank's
redemption of $128.5 million principal amount of subordinated capital debentures
in December 1993. See Note 23 to the Consolidated Financial Statements in this
report.
The Bank adopted SFAS 109 effective October 1, 1993. The cumulative effect
of this change in accounting principle of $5.1 million was recognized as a
benefit in the operating results for fiscal 1994.
NET INTEREST INCOME. Net interest income, before the provision for loan
losses, decreased $12.4 million (or 6.8%) in fiscal 1994, 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 - Asset
and Liability Management."
The Bank would have recorded interest income of $9.1 million in fiscal 1994
if the Bank's non-accrual assets and restructured loans had been current in
accordance with their original terms. Interest income of $2.7 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. See "Financial
Condition - Asset Quality - Non-performing Assets."
The following table sets forth, for the periods indicated, information
regarding the total amount of income from interest-earning assets and the
resulting yields, the interest expense associated with interest-bearing
liabilities, expressed in dollars and rates, and the net interest spread and net
yield on interest-earning assets.
-119-
Net Interest Margin Analysis
(Dollars in thousands)
Year Ended September 30,
-----------------------------------------------------------------------------------------
1994 1993 1992
September 30, ----------------------------- ----------------------------- ----------------------------
1994 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) 8.90 % $2,706,132 $255,328 9.44 % $2,136,157 $240,443 11.26 % $2,411,405 $307,740 12.76 %
Mortgage-backed
securities 6.09 1,229,898 70,937 5.77 1,508,948 95,085 6.30 1,115,975 83,504 7.48
Federal funds sold 5.08 25,242 963 3.82 14,283 427 2.99 25,919 1,063 4.10
Trading securities - 15,655 1,019 6.51 - - - - - -
Investment securities 4.38 4,594 302 6.57 125,255 8,086 6.46 64,569 4,159 6.44
Other interest-earning
assets 4.91 175,971 5,915 3.36 168,432 4,773 2.83 163,453 6,567 4.02
----------- --------- ----------- --------- ----------- ---------
Total 7.98 4,157,492 334,464 8.04 3,953,075 348,814 8.82 3,781,321 403,033 10.66
------------- --------- ------ --------- ------ --------- ------
Non-interest earning
assets:
Cash 116,388 104,195 106,297
Real estate held for
investment or sale 356,993 466,717 564,325
Property and equipment,
net 138,489 141,690 151,350
Cost in excess of net
assets acquired, net 8,110 11,117 14,161
Other assets 163,766 172,178 172,888
----------- ----------- -----------
Total assets $4,941,238 $4,848,972 $4,790,342
=========== =========== ===========
Liabilities and
stockholders' equity:
Interest-bearing
liabilities:
Deposit accounts:
Demand deposits 2.95 $ 847,158 23,176 2.74 $ 750,816 18,569 2.47 $ 714,736 22,523 3.15
Savings deposits 3.47 1,208,041 40,720 3.37 860,280 27,980 3.25 689,882 27,800 4.03
Time deposits 4.17 751,299 29,723 3.96 964,926 41,813 4.33 1,347,438 75,914 5.63
Money market deposits 3.84 1,149,671 37,305 3.24 1,242,175 39,430 3.17 1,332,776 55,384 4.16
----------- --------- ----------- --------- ----------- ---------
Total deposits 3.59 3,956,169 130,924 3.31 3,818,197 127,792 3.35 4,084,832 181,621 4.45
Borrowings 7.63 622,010 34,620 5.57 755,111 39,726 5.26 484,377 33,140 6.84
----------- --------- ----------- --------- ----------- ---------
Total liabilities 3.88 4,578,179 165,544 3.62 4,573,308 167,518 3.66 4,569,209 214,761 4.70
------------- --------- ------ --------- ------ --------- ------
Non interest-bearing
items:
Non-interest bearing
deposits 61,895 46,670 38,489
Other liabilities 37,059 36,145 46,534
Stockholders' equity 264,105 192,849 136,110
----------- ----------- -----------
Total liabilities and
stockholders' equity $4,941,238 $4,848,972 $4,790,342
=========== =========== ===========
Net interest income $168,920 $181,296 $188,272
Net interest spread (2) ========= 4.42 % ========= 5.16 % ========= 5.96 %
Net yield on interest- ======= ======= =======
earning assets (3) 4.06 % 4.59 % 4.98 %
Interest-earning assets ======= ======= =======
to interest-bearing
liabilities 90.81 % 86.44 % 82.76 %
======= ======= =======
<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 ($4,093), $19 and $2,315 of
amortized loan fees, premiums and discounts in interest income for the
years ended September 30, 1994, 1993 and 1992.
(2) Equals weighted average yield on total interest-earning assets less
weighted average rate on total interest-bearing liabilities.
(3) Equals net interest income divided by the average balances of total
interest-earning assets.
-120-
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.
-121-
Volume and Rate Changes in Net Interest Income
(In thousands)
Year Ended September 30, 1994 Year Ended September 30, 1993
Compared to Compared to
Year Ended September 30, 1993 Year Ended September 30, 1992
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) $ 57,693 $(42,808) $ 14,885 $(33,153) $(34,144) $(67,297)
Mortgage-backed securities (16,598) (7,550) (24,148) 26,187 (14,606) 11,581
Federal funds sold 394 142 536 (397) (239) (636)
Trading securities 1,019 - 1,019 - - -
Investment securities (7,920) 136 (7,784) 3,914 13 3,927
Other interest-earning assets 220 922 1,142 196 (1,990) (1,794)
--------- --------- ---------- --------- --------- ---------
Total interest income 34,808 (49,158) (14,350) (3,253) (50,966) (54,219)
--------- --------- ---------- --------- --------- ---------
Interest expense:
Deposit accounts 4,650 (1,518) 3,132 (11,245) (42,584) (53,829)
Borrowings (7,335) 2,229 (5,106) 15,490 (8,904) 6,586
--------- --------- ---------- --------- --------- ---------
Total interest expense (2,685) 711 (1,974) 4,245 (51,488) (47,243)
--------- --------- ---------- --------- --------- ---------
Increase (decrease) in
net interest income $ 37,493 $(49,869) $ (12,376) $ (7,498) $ 522 $ (6,976)
========= ========= ========== ========= ========= =========
<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.
-122-
Interest income in fiscal 1994 decreased $14.4 million from the level in
fiscal 1993 as a result of lower average yields earned by the Bank on the
principal categories of its interest-earning assets. The effect of the lower
average yields on interest income was offset in part by higher average balances
of loans receivable and, to a lesser extent, trading securities and other
interest-earning assets.
The Bank's net interest spread declined to 4.42% in fiscal 1994 from 5.16%
in fiscal 1993. The decline reflected the effects of marketing strategies which
included the offering of lower introductory rates for certain loan products,
primarily credit card and home equity credit line loans, and the increased
origination of credit card loans; the higher level of asset securitization
activities; and the downward adjustment of interest rates on certain of the
Bank's adjustable-rate products to reflect previous declines in market interest
rates to which the loan rates on such products are indexed.
Interest income on loans, the largest category of interest-earning assets,
increased by $14.9 million (or 6.2%) from fiscal 1993. The increase in interest
income on loans was attributable to higher average balances of the loan
portfolio. Average balances of single-family residential permanent loans
increased $326.7 million (or 33.0%) as a result of increased origination of such
loans during the current year. Interest income on these loans increased $17.1
million (or 23.6%) from fiscal 1993. Average balances of credit card loans
increased $82.3 million (or 9.9%)in fiscal 1994, largely as a result of new
account originations in connection with the Bank's resumption of active national
solicitation of credit card accounts. An increase of $11.1 million (or 132.0%)
in interest income on consumer loans (other than credit card loans) was
attributable to increased originations of automobile loans, which resulted in an
increase in the average balances of such consumer loans to $236.5 million from
$89.7 million. Average balances of commercial permanent loans increased $14.4
million (or 18.0%), primarily as a result of an increase in loans made to
purchasers of certain of the Bank's REO in connection with the sales of such
REO. Average balances of home equity credit line loans declined in fiscal 1994,
largely as a result of the Bank's securitization and sale activity. The
securitization and sale of $194.2 million, $146.2 million and $181.9 million of
home equity credit line receivables in December 1992, September 1993 and
September 1994, respectively, contributed to a decline of $19.5 million (or
12.6%) in average balances of home equity credit line receivables, which was
largely responsible for a $1.5 million decline in interest income.
-123-
Lower average yields on the loan portfolio partially offset the effect of
higher average balances. The average yield on the loan portfolio in fiscal 1994
decreased by 182 basis points (to 9.44% from 11.26%) from the average yield in
fiscal 1993. Special introductory and promotional interest rates to new and
existing credit card holders contributed to a decline in the average yield on
credit card loans to 14.65% from 17.68% and to a decline of $13.2 million in
interest income on these loans. The average yield on home equity credit line
loans decreased to 6.96% from 7.05%, primarily as a result of introductory rates
offered on new home equity credit line loans. The average yield on
single-family residential loans declined to 6.81% from 7.33%, as customers
continued to refinance higher rate mortgage loans into mortgage loans with lower
rates.
Interest income on mortgage-backed securities decreased $24.1 million
because of lower average interest rates and lower average balances. The reduced
mortgage-backed security balances in fiscal 1994 reflected the effects of the
sale of $127.8 million of such securities during fiscal 1993. Average interest
rates on these securities declined to 5.77% from 6.30%, primarily as a result of
the prepayment of higher rate mortgage-backed securities and the purchase of
mortgage-backed securities with lower rates.
Interest income on investment securities decreased $7.8 million as a result
of the sale in June 1993 of U.S. Government securities with a book balance of
$172.9 million, which resulted in lower average balances of such securities in
fiscal 1994.
Interest expense decreased $2.0 million (or 1.2%) for the year ended
September 30, 1994 because of a decline of $5.1 million in interest expense on
borrowings. The decrease in interest paid on borrowings was primarily
attributable to a $4.2 million decrease in interest expense on repurchase
agreement transactions and a $2.0 million decrease in interest expense on the
Bank's subordinated debentures. A decrease of $160.8 million (or 60.6%) in the
average balances of repurchase agreements contributed to the reduced interest
expense on repurchase agreement transactions. The decline in interest expense
on the Bank's subordinated debentures reflected the effects of the refinancing
of two outstanding debenture issues in the first quarter of fiscal 1994 with the
proceeds of a new, lower-rate debenture issue. As a result of such refinancing,
the annual interest rate paid by the Bank on its debentures decreased to 10.02%
in fiscal 1994 from 13.55% in fiscal 1993. See Note 23 to the Consolidated
Financial Statements in this report.
-124-
The decrease in interest expense on borrowings was partially offset by a
$3.1 million increase in interest expense on deposits, the largest category of
interest-bearing liabilities. Interest expense on deposits increased
principally as a result of an increase of $138.0 million in average deposit
balances. See "Financial Condition - Asset and Liability Management."
PROVISION FOR LOAN LOSSES. The Bank's provision for loan losses decreased
to $33.2 million in fiscal 1994 from $62.5 million in the prior fiscal year.
The decrease was primarily attributable to a decrease of $20.3 million in the
provision for losses on credit card loans. The lower provision resulted in part
from a decline in net charge-offs of credit card loans in fiscal 1994. In
addition, the securitization and sale of $850 million of credit card receivables
in the fourth quarter of fiscal 1994 and of $200.0 million and $300.0 million of
credit card receivables in the March 1994 and June 1994 quarters, respectively,
reduced the amount of such receivables against which the Bank maintains the
reserve. The provision for losses on real estate loans decreased $10.2 million,
reflecting the Bank's implementation of SOP 92-3 during the December 1992
quarter. See "Financial Condition - Asset Quality - Reserves for Losses."
OTHER INCOME. The increase in other (non-interest) income to $160.0
million in fiscal 1994 from $130.8 million in fiscal 1993 was primarily
attributable to an increase in loan and deposit servicing fees. In addition,
the Bank recorded earnings on real estate held for investment or sale, compared
to a loss in fiscal 1993. The positive effect of these items on other income
was partially offset by a decrease in credit card fees and a decrease in gain on
sale of investment securities.
An increase of $21.8 million in excess servicing fees and $4.4 million of
servicing fees earned by the Bank for servicing its portfolios of securitized
credit card loans contributed to an increase of $30.6 million (or 46.9%) in loan
and deposit servicing fees. Such excess servicing fees and servicing fees have
increased in recent periods as a result of greater securitization activity by
the Bank. The increase in loan and deposit servicing fees also reflected a $4.6
million increase in excess servicing fees related to home equity credit line
securitizations. The excess servicing fee level rose because of a decrease in
the average prepayment rate with respect to the underlying home equity credit
line receivables. See "Excess Servicing Assets" in "Summary of Significant
Accounting Policies - The Bank" in the Notes to the Consolidated Financial
Statements in this report.
-125-
The improved results on real estate held for investment or sale were
primarily attributable to a decrease of $16.4 million in the provision for
losses on such assets. The Bank's implementation of SOP 92-3 in the quarter
ended December 31, 1992 resulted in $19.0 million of additional provisions for
real estate losses in that period which was required to reduce the book value of
the Bank's foreclosed assets to fair value. An increase of $2.0 million in the
gain recorded on sales of the Bank's REO properties also contributed to the
earnings on real estate held for investment or sale. These results were
partially offset by a $3.0 million decrease in the operating income generated by
the Bank's REO properties.
Credit card fees, consisting of membership fees, late charges, interchange
fees and cash advance charges, decreased $10.6 million (41.1%) in fiscal 1994
from the level in fiscal 1993. The decrease was primarily attributable to a
$12.9 million increase in rebate expense on credit card retail purchases, which
the Bank incurred in connection with promotional activities undertaken beginning
in 1993. The decrease was partially offset by an increase in interchange fees
and cash advance charges as a result of increased account activity. The
increased number of accounts reflected the increase in new account originations
in connection with the Bank's resumption of active national solicitation of new
credit card accounts.
Gain on sale of investment securities decreased by $8.9 million as a result
of the sale in the June 1993 quarter of U.S. Government securities with a book
value of $172.9 million.
OPERATING EXPENSES. Operating expenses for the year ended September 30,
1994 increased $56.9 million (30.6%) from the level in fiscal 1993. The main
components of the higher operating expenses were increases in marketing
expenses, salaries and employee benefits, and data processing expenses. The
$34.1 million increase in marketing expenses was primarily incurred in
connection with the Bank's expanded marketing program for its credit card
products and services initiated in June 1993 with the resumption of active
national solicitation of new credit card accounts. See "Business - Lending -
Credit Card Lending." The $17.7 million increase in salaries and employee
benefits resulted primarily from the addition of staff to the Bank's credit card
operations and discretionary bonuses paid to substantially all employees in
December 1993. The $8.5 million increase in data processing expense was
principally attributable to an increase in the number of credit card accounts
outstanding and the activity generated by such accounts during fiscal 1994. In
order to take
-126-
advantage of additional opportunities to enhance profitability, the Bank may be
required to incur increased expenditures for salaries and employee benefits,
loan expenses and marketing expenses, which will contribute to higher operating
expenses in future periods.
FISCAL 1993 COMPARED TO FISCAL 1992
REAL ESTATE
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 of debt expense. 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.
Income after direct operating expenses from commercial properties, which
included 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 (1.2%) from the fiscal
1992 level, while income from office buildings declined by $2.4 million (7.6%).
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 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 Real
Estate Trust's office buildings 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
$2.1 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.
-127-
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 Trust's outstanding borrowings declined to $452.7 million in fiscal 1993
from $478.9 million in fiscal 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 paid to related parties increased
$0.2 million (2.2%) in fiscal 1993 as 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 determined that it would not be in the best interests of the Trust to
continue development and that the costs expended had no continuing value to the
Real Estate Trust.
BANKING
OVERVIEW. The Bank recorded operating income of $63.8 million for fiscal
1993, compared to operating income of $43.4 million for the year ended
September 30, 1992 ("fiscal 1992"). The increase in operating income for fiscal
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
-128-
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%) in fiscal 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 - Asset
and Liability Management."
The Bank would have recorded additional net interest income of $7.4 million
in fiscal 1993 if the Bank's non-accrual assets and restructured loans had been
current in accordance with their original terms.
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.
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
-129-
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 - 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 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 investment 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
-130-
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 fiscal 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 - Asset
Quality - Reserves for Losses."
OTHER INCOME. The increase in other (non-interest) income to $130.8
million in fiscal 1993 from $100.4 million in 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 in fiscal 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.
-131-
Loan servicing fees increased $6.2 million in fiscal 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 - 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 - Asset Quality -
Reserve 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 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
-132-
increases in long-term interest rates. In addition, the Bank recognized
aggregate gains of aggregate $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 - Capital - Regulatory Action
and Requirements."
OPERATING EXPENSES. Operating expenses in fiscal 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 marketing areas. The remaining increase
was attributable to the increase in the level of the Bank's contributions to its
employee profit sharing plan. The $10.5 million increase in marketing 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 -
Lending - Credit Card Lending." The $12.2 million increase in loan expenses
was due primarily to a $10.6 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 - Lending - Loan
Servicing."
-133-
FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION
CONTENTS
PAGE
(a) Reports of Independent Public Accountants . . . . . . . . . . . . . F-2
(b) Consolidated Balance Sheets
September 30, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . F-4
(c) Consolidated Statements of Operations - Three Years
Ended September 30, 1994, 1993 and 1992 . . . . . . . . . . . . . . F-5
(d) Consolidated Statements of Shareholders' Deficit - Three
Years Ended September 30, 1994, 1993 and 1992 . . . . . . . . . . . F-7
(e) Consolidated Statements of Cash Flows - Three Years
Ended September 30, 1994, 1993 and 1992 . . . . . . . . . . . . . . F-8
(f) Notes to Consolidated Financial Statements. . . . . . . . . . . . . F-10
The selected quarterly financial data included in Note 34 of Notes to the
Consolidated Financial Statements referred to above are incorporated herein by
reference.
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Trustees and Shareholders of
B.F. Saul Real Estate Investment Trust:
We have audited the accompanying consolidated balance sheet of B.F. Saul Real
Estate Investment Trust (the "Trust") and subsidiaries as of September 30, 1994,
and the related consolidated statement of operations, shareholders' deficit and
cash flows for the year then ended. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of B.F. Saul Real Estate
Investment Trust and subsidiaries as of September 30, 1994, and the results of
their operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.
As explained in the Organization and Summary of Significant Accounting Policies
in the notes to the financial statements, effective October 1, 1993, the Trust
changed its method of accounting for income taxes, impaired loans and
investments in securities and mortgage-backed securities.
Washington, D.C. ARTHUR ANDERSEN LLP
December 19, 1994
F-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Trustees and Shareholders of
B.F. Saul Real Estate Investment Trust:
We have audited the accompanying consolidated balance sheet of B.F. Saul
Real Estate Investment Trust as of September 30, 1993, and the related
consolidated statements of operations, shareholders' deficit, and cash flows for
the years ended September 30, 1993 and 1992. 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 the results of its
operations and its cash flows for the years ended September 30, 1993 and 1992,
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-3
CONSOLIDATED BALANCE SHEETS
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
September 30
-------------------------
(IN THOUSANDS) 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
REAL ESTATE
Income-producing properties
Commercial $ 110,895 $ 109,513
Hotel 112,160 111,484
Other 4,585 3,985
------------ ------------
227,640 224,982
Accumulated depreciation (68,111) (62,626)
------------ ------------
159,529 162,356
Land parcels 38,455 38,411
Cash and cash equivalents 30,445 2,710
Other assets 99,310 17,079
------------ ------------
Total real estate assets 327,739 220,556
- ------------------------------------------------------------------------------------------------------------------------------------
BANKING
Cash and due from banks 166,752 178,508
Interest-bearing deposits 14,345 4,691
Federal funds sold and securities purchased under agreements to resell 191,000 --
Loans held for sale 33,598 176,504
Loans held for securitization and sale 115,000 300,000
Investment securities (market value $4,364 and $4,822, respectively) 4,364 4,789
Mortgage-backed securities (market value $1,025,525 and $1,528,060, respectively) 1,025,525 1,501,192
Loans receivable (net of reserve for losses of $50,205 and $68,040, respectively) 2,357,598 1,861,276
Federal Home Loan Bank stock 31,940 31,150
Real estate held for investment or sale (net of reserve for losses of $118,973 and $111,644, respectively) 330,655 388,459
Property and equipment, net 144,408 135,800
Cost in excess of net assets acquired, net 6,582 9,383
Excess servicing assets, net 25,198 27,573
Purchased mortgage servicing rights, net 15,304 20,472
Other assets 204,029 232,974
------------ ------------
Total banking assets 4,666,298 4,872,771
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 4,994,037 $ 5,093,327
- ------------------------------------------------------------------------------------------------------------------------------------
LIABILITIES
REAL ESTATE
Mortgage notes payable $ 185,730 $ 264,776
Notes payable - secured 175,000 --
Notes payable - unsecured 40,288 38,661
Deferred gains - real estate 112,883 109,543
Other liabilities and accrued expenses 44,208 37,173
------------ ------------
Total real estate liabilities 558,109 450,153
- ------------------------------------------------------------------------------------------------------------------------------------
BANKING
Deposit accounts 4,008,761 3,870,023
Securities sold under repurchase agreements and other short-term borrowings 8,907 88,266
Bonds payable 24,030 24,605
Notes payable 7,729 7,925
Federal Home Loan Bank advances 100,000 412,000
Custodial accounts 19,523 25,925
Amounts due to banks 30,373 26,723
Other liabilities 54,509 40,034
Capital notes -- subordinated 160,000 138,500
------------ ------------
Total banking liabilities 4,413,832 4,634,001
- ------------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Minority interest held by affiliates 35,632 34,495
Minority interest -- other 74,307 74,307
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 5,081,880 5,192,956
- ------------------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' 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 (134,793) (157,882)
Net unrealized holding loss (11,303) --
------------ ------------
(45,995) (57,781)
Less cost of 1,814,688 common shares of beneficial interest in treasury (41,848) (41,848)
------------ ------------
TOTAL SHAREHOLDERS' DEFICIT (87,843) (99,629)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 4,994,037 $ 5,093,327
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-4
CONSOLIDATED STATEMENTS OF OPERATIONS
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
For the Year Ended September 30
--------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------------------------
REAL ESTATE
INCOME
Commercial properties $ 16,815 $ 45,736 $ 51,489
Hotels 46,046 45,385 46,628
Other 3,183 2,124 2,062
------------ ------------ ------------
Total income 66,044 93,245 100,179
- -------------------------------------------------------------------------------------------------------------------------------
EXPENSES
Direct operating expenses:
Commercial properties 6,972 13,708 14,416
Hotels 33,874 33,497 33,963
Land parcels and other 1,383 1,623 1,814
Interest expense 39,370 50,470 51,326
Amortization of debt expense 1,206 3,029 1,698
Depreciation 9,082 12,457 13,400
Advisory, management and leasing fees - related parties 6,793 7,249 7,093
General and administrative 2,027 2,119 4,226
Abandoned development costs -- 13,104 --
Write-down of real estate to net realizable value 1,380 -- --
------------ ------------ ------------
Total expenses 102,087 137,256 127,936
- -------------------------------------------------------------------------------------------------------------------------------
Equity in earnings (losses) of unconsolidated entities 1,738 (668) (208)
Gain (loss) on sales of property -- 184 (546)
- -------------------------------------------------------------------------------------------------------------------------------
REAL ESTATE OPERATING LOSS $ (34,305) $ (44,495) $ (28,511)
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
BANKING
INTEREST INCOME
Loans $ 255,328 $ 240,443 $ 307,740
Mortgage-backed securities 70,937 95,085 83,504
Trading securities 1,019 -- --
Investment securities 302 8,086 4,159
Other 6,878 5,200 7,630
------------ ------------ ------------
Total interest income 334,464 348,814 403,033
- -------------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Deposit accounts 130,924 127,792 181,621
Short-term borrowings 11,439 13,333 12,169
Long-term borrowings 23,181 26,393 20,971
------------ ------------ ------------
Total interest expense 165,544 167,518 214,761
------------ ------------ ------------
Net interest income 168,920 181,296 188,272
Provision for loan losses (33,237) (62,513) (89,062)
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 135,683 118,783 99,210
- -------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME
Credit card fees 15,242 26,405 34,611
Loan servicing fees 75,471 46,083 39,924
Deposit servicing fees 20,347 18,575 17,756
Gain on sale of investment securities, net -- 8,895 --
Gain on sales of trading securities, net 1,695 -- --
Earnings (loss) on real estate held for investment or sale, net 835 (12,722) (50,649)
Gain on sales of credit card relationships, loans and
mortgage-backed securities, net 30,522 31,375 44,259
Gain on sales of mortgage servicing rights, net 5,833 4,828 3,750
Other 10,104 7,314 10,766
------------ ------------ ------------
Total other income 160,049 130,753 100,417
- -------------------------------------------------------------------------------------------------------------------------------
Continued on following page.
F-5
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
For the Year Ended September 30
--------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------------------------
BANKING (CONTINUED)
OPERATING EXPENSES
Salaries and employee benefits $ 87,390 $ 69,739 $ 62,725
Loan expenses 12,069 22,001 7,799
Property and equipment 25,729 24,039 24,481
Marketing expenses 49,242 13,157 4,632
Data processing expenses 30,766 22,249 22,801
Deposit insurance premiums 11,527 11,273 9,736
Amortization of cost in excess of net assets acquired 2,801 2,863 3,143
Other 23,021 20,366 20,901
------------ ------------ ------------
Total operating expenses 242,545 185,687 156,218
- -------------------------------------------------------------------------------------------------------------------------------
BANKING OPERATING INCOME $ 53,187 $ 63,849 $ 43,409
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPANY
Operating income before income taxes, extraordinary items,
cumulative effect of change in accounting principle,
and minority interest $ 18,882 $ 19,354 $ 14,898
Provision for income taxes 7,025 11,703 7,385
------------ ------------ ------------
Income before extraordinary items, cumulative effect
of change in accounting principle and minority interest 11,857 7,651 7,513
Extraordinary items:
Adjustment for tax benefit of operating loss carryovers -- 7,738 3,817
Loss on early extinguishment of debt, net of taxes (11,315) -- (132)
------------ ------------ ------------
Income before cumulative effect of change in accounting
principle and minority interest 542 15,389 11,198
Cumulative effect of change in accounting principle 36,260 -- --
------------ ------------ ------------
Income before minority interest 36,802 15,389 11,198
Minority interest held by affiliates (3,963) (6,582) (5,261)
Minority interest -- other (9,750) (4,334) --
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPANY NET INCOME $ 23,089 $ 4,473 $ 5,937
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) AVAILABLE TO COMMON
SHAREHOLDERS $ 17,669 $ (947) $ 517
NET INCOME (LOSS) PER COMMON SHARE
Income before extraordinary items, cumulative effect
of change in accounting principle and minority interest $ 1.33 $ 0.46 $ 0.43
Extraordinary items:
Adjustment for tax benefit of operating loss carryovers -- 1.60 0.79
Loss on early extinguishment of debt, net of taxes (2.34) -- (0.03)
------------ ------------ ------------
Income (loss) before cumulative effect of change in accounting
principle and minority interest (1.01) 2.06 1.19
Cumulative effect of change in accounting principle 7.51 -- --
------------ ------------ ------------
Income before minority interest 6.50 2.06 1.19
Minority interest held by affiliates (0.82) (1.36) (1.08)
Minority interest -- other (2.02) (0.90) --
------------ ------------ ------------
NET INCOME (LOSS) PER COMMON SHARE $ 3.66 $ (0.20) $ 0.11
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-6
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
For the Year Ended September 30
-----------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
PREFERRED SHARES OF BENEFICIAL INTEREST -- --
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
Beginning and end of year 92,943 92,943 92,943
------------- ------------- -------------
DEFICIT
Beginning of year (157,882) (160,980) (166,917)
Net income 23,089 4,473 5,937
Dividend distributions:
Real Estate Trust:
Redeemable preferred (per share: 1993 - $550.00) -- (1,375) --
------------- ------------- -------------
End of year (134,793) (157,882) (160,980)
------------- ------------- -------------
Net unrealized holding losses (11,303) -- --
------------- ------------- -------------
TREASURY SHARES
Beginning and end of year (1,814,688 shares) (41,848) (41,848) (41,848)
- ---------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' DEFICIT $ (87,843) $ (99,629) $ (102,727)
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
For the Year Ended September 30
-----------------------------------------------------
(IN THOUSANDS) 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
REAL ESTATE
Net income (loss) $ 7,239 $ (21,857) $ (15,108)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation 9,082 12,457 13,400
(Gain) loss on sales of property -- (184) 546
Abandoned development costs -- 13,104 --
Write-down of real estate to net realizable value 1,380 -- --
(Increase) decrease in accounts receivable and
accrued income (516) 98 2,906
Increase in deferred tax asset (19,028) -- --
Increase (decrease) in accounts payable and
accrued expenses (5,473) 7,047 11,594
Increase in tax sharing receivable (12,015) (22,984) (13,567)
Amortization of debt expense 1,206 3,029 1,698
Equity in (earnings) losses of unconsolidated
entities (1,738) 668 208
Loss on early extinguishment of debt 4,982 -- 132
Other 4,022 5,473 (2,693)
----------------- ----------------- -----------------
(10,859) (3,149) (884)
----------------- ----------------- -----------------
BANKING
Net income 15,850 26,330 21,045
Adjustments to reconcile net income to net cash
provided by operating activities:
Accretion of premiums, discounts and deferred loan
fees (1,301) (7,896) (17,775)
Depreciation and amortization 18,292 16,191 15,773
Amortization of cost in excess of net assets
acquired and purchased mortgage
servicing rights 8,857 14,963 4,704
Loss on extinguishment of debt 10,476 -- --
Provision for loan losses 33,237 62,513 89,062
Net fundings of loans held for sale and/or
securitization (874,917) (903,941) (768,149)
Proceeds from sales of trading securities 688,811 -- --
Proceeds from sales of loans and securities held
for sale and/or securitization 2,276,391 1,946,826 1,708,234
Equity earnings from investments in limited
partnerships 100 (1,694) (391)
Gain on sale of investment securities, net -- (8,895) --
Provision for losses on real estate held for
investment or sale 14,052 30,415 60,596
(Gain) loss on sales of real estate held for
investment or sale, net (11,466) (9,503) 244
Gain on sales of trading securities, net (1,695) -- --
Gain on sales of credit card relationships, loans
and mortgage-backed securities, net (30,522) (31,375) (44,259)
Gain on sales of mortgage servicing rights, net (5,833) (4,828) (3,750)
Minority interest held by affiliates 3,963 6,582 5,261
Minority interest - other 9,750 4,334 --
Decrease in excess servicing assets 2,375 1,976 3,016
(Increase) decrease in other assets 25,441 (41,710) (42,621)
Increase (decrease) in other liabilities and
accrued expenses 18,125 9,635 (19,709)
Increase in tax sharing payable 12,015 22,984 13,567
Other, net 6,261 4,779 1,857
----------------- ----------------- -----------------
2,218,262 1,137,686 1,026,705
----------------- ----------------- -----------------
Net cash provided by operating activities 2,207,403 1,134,537 1,025,821
- ---------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
REAL ESTATE
Capital expenditures - properties (6,717) (7,465) (6,193)
Property sales 0 3,780 4,908
Equity investment in unconsolidated entities (9,769) (150) (58)
Notes receivable - affiliates (12,675) -- --
Other investing activities 43 836 10
----------------- ----------------- -----------------
(29,118) (2,999) (1,333)
----------------- ----------------- -----------------
BANKING
Proceeds from maturities of investment securities 300 -- 140,000
Proceeds from sales of loans -- 4,954 7,834
Net proceeds from sales of real estate 94,308 150,115 44,287
Net proceeds from sales of mortgage servicing rights 5,833 5,978 4,790
Net fundings of loans receivable (1,700,831) (463,919) (73,984)
Principal collected on mortgage-backed securities 447,666 447,951 133,152
Purchases of investment securities -- (4,682) (173,414)
Purchases of mortgage-backed securities (291,335) (664,284) (1,157,759)
Purchases of loans receivable (256,608) (259,770) (115,557)
Purchases of property and equipment (22,503) (4,602) (3,373)
Purchases of mortgage servicing rights (888) (20,716) (1,604)
Disbursements for real estate held for investment or
sale (58,063) (74,320) (28,652)
Other investing activities, net 4,840 4,117 180
----------------- ----------------- -----------------
(1,777,281) (879,178) (1,224,100)
----------------- ----------------- -----------------
Net cash used in investing activities (1,806,399) (882,177) (1,225,433)
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
Continued on following page.
F-8
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
B. F. SAUL REAL ESTATE INVESTMENT TRUST
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
For the Year Ended September 30
-----------------------------------------------------
(IN THOUSANDS) 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
REAL ESTATE
Proceeds from mortgage financing $ 461 $ 2,603 $ 35,070
Principal curtailments and repayments of mortgages (66,169) (6,175) (10,191)
Proceeds from sales of secured notes 175,000 -- --
Proceeds from sales of unsecured notes 9,619 6,184 --
Repayments of unsecured notes (7,992) (17,940) (17,115)
Financing proceeds placed in liquidity maintenance escrow (25,792) -- --
Costs of obtaining financings (9,404) (1,170) (4,674)
Proceeds from the issuance of redeemable preferred stock -- 21,507 --
Other financing activities, net -- (1,779) (2,921)
----------------- ----------------- -----------------
75,723 3,230 169
----------------- ----------------- -----------------
BANKING
Proceeds from customer deposits and sales of certificates of deposit 12,308,342 10,801,085 11,173,419
Customer withdrawals of deposits and payments for maturing
certificates of deposit (12,169,604) (10,847,020) (11,520,494)
Net increase (decrease) in securities sold under repurchase
agreements (81,504) (363,216) 446,367
Advances from Federal Home Loan Bank 824,300 744,000 480,000
Repayments of advances from Federal Home Loan Bank (1,136,300) (607,000) (405,000)
Proceeds from other borrowings 461,385 59,580 62,583
Repayments of other borrowings (460,011) (59,658) (64,277)
Cash dividends paid on preferred stock (9,750) (1,896) --
Repayment of capital notes - subordinated (134,153) -- --
Net proceeds received from capital notes - subordinated 143,603 -- --
Net proceeds from sale of preferred stock -- 71,869 --
Other financing activities, net (6,402) 11,406 (15,415)
----------------- ----------------- -----------------
(260,094) (190,850) 157,183
----------------- ----------------- -----------------
Net cash provided by (used in) financing activities (184,371) (187,620) 157,352
----------------- ----------------- -----------------
Net increase (decrease) in cash and cash equivalents 216,633 64,740 (42,260)
Cash and cash equivalents at beginning of year 185,909 121,169 163,429
----------------- ----------------- -----------------
Cash and cash equivalents at end of year $ 402,542 $ 185,909 $ 121,169
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (net of amount capitalized) $ 213,888 $ 215,427 $ 275,184
Income taxes (93) 6,522 5,170
Supplemental schedule of noncash investing and financing activities:
Rollovers of notes payable - unsecured 6,062 5,681 --
Loans receivable exchanged for mortgage-backed securities -- 51,956 646,785
Loans held for sale exchanged for trading securities 396,189 -- --
Loans held for sale exchanged for mortgage-backed
securities held for sale -- 442,017 307,782
Mortgage-backed securities transferred to loans and securities
held for sale -- 131,390 442,412
Loans receivable transferred to loans held for securitization
and sale 1,446,924 440,361 350,000
Investment securities transferred to loans and securities held
for sale -- 173,036 --
Loans made in connection with the sale of real estate 16,401 54,061 7,766
Loans receivable transferred to real estate acquired in settlement
of loans 4,106 23,158 43,046
Real estate acquired in settlement of loans transferred to loans
receivable 15,008 -- --
Loans held for sale transferred to loans receivable 3,507 -- --
Debt forgiveness 13,317 -- --
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
B.F. Saul Real Estate Investment Trust and its wholly owned subsidiaries
(collectively, the "Real Estate Trust") operate as a Maryland real estate
investment trust. The principal business activity of the Real Estate Trust is
the ownership and development of income-producing properties. 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.
B.F. Saul Real Estate Investment Trust also owns 80% of the outstanding common
stock of Chevy Chase Bank, F.S.B., and its subsidiaries (the "Bank" or the
"Corporations"), whose assets accounted for approximately 93% of the
consolidated assets of the B.F. Saul Real Estate Investment Trust and its
consolidated subsidiaries (the "Trust") at September 30, 1994. The Bank is a
federally chartered and federally insured stock savings bank. The B. F. Saul
Real Estate Investment Trust is a thrift holding company by virtue of its
ownership of a majority interest in the Bank and is subject to regulation by the
Office of Thrift Supervision ("OTS"). The accounting and reporting practices of
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 the Real
Estate Trust and the Bank. 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.
INCOME TAXES
The Real Estate Trust files a consolidated federal income tax return which
includes operations of all 80% or more owned subsidiaries.
In February 1992, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 109 "Accounting for Income Taxes"
("SFAS 109"). SFAS 109 establishes financial accounting and reporting standards
for the effects of income taxes that result from the Trust's activities during
the current and preceding years. It requires an asset and liability approach in
accounting for income taxes versus the deferred method previously used under
Accounting Principals Board Opinion No. 11, "Accounting for Income Taxes"
("APB 11"). The Trust adopted SFAS 109 on October 1, 1993 and recorded a
cumulative effect of a change in accounting principle of approximately
$36.3 million.
Under SFAS 109, deferred income taxes are recorded using enacted tax laws and
rates for the years in which taxes are expected to be paid. To the extent that
realization of such assets is more likely than not, SFAS 109 provides for the
recognition of deferred tax assets based on tax loss and tax credit
carryforwards. At September 30, 1994, the Trust's net deferred tax asset, after
$7.0 million in valuation allowances, was $55.2 million.
Income tax provisions for fiscal years 1993 and 1992 were determined under
APB 11 and have not been restated to reflect adoption of SFAS 109.
F-10
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. For fiscal years 1994,
1993 and 1992, the weighted average number of shares used in the calculation was
4,826,910.
RECLASSIFICATIONS
Certain reclassifications have been made to the consolidated financial
statements for the years ended September 30, 1993 and 1992 to conform with the
presentation used for the year ended September 30, 1994.
F-11
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - REAL ESTATE TRUST
CASH EQUIVALENTS
The Real Estate Trust considers all highly liquid, temporary investments with an
original maturity of three months or less to be cash equivalents.
PROPERTIES
Income-producing properties are stated at the lower of depreciated cost (except
those which were acquired through foreclosure or equivalent proceedings, the
carrying amounts of which are based on the lower of cost or fair value at the
time of acquisition) or net realizable value based on management's intent and
ability to hold such properties on a long term basis. Under the net realizable
value approach, management evaluates, on an ongoing basis, the recoverability of
the investment in each property by analyzing cash flow after capital
improvements to determine that such cash flow is sufficient to recover the
recorded investment in the property over its expected useful life.
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. Expenditures for
repairs and maintenance are charged to operations as incurred.
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. Subtantially completed
portions of a project are accounted for as separate projects.
Depreciation is calculated using the straight-line method and estimated useful
lives of 31.5 to 47 years for buildings and up to 20 years for certain other
improvements. Tenant improvements 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 scheduled 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.
F-12
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments.
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short-term maturity
of these instruments.
LIABILITIES
The carrying amount of Mortgage notes payable approximates their fair value
since most of the debt has been financed in recent periods at prevailing market
interest rates. 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, 1994 and 1993 the fair value of Notes payable - unsecured was
$42.1 and $41.6 million, respectively.
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 up to $116.1 million if those
partnerships fail to make payments with respect to specified debt. 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. See Note 2.
F-13
C. 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.
CASH AND CASH EQUIVALENTS:
For purposes of reporting cash flows, cash and cash equivalents include cash
and due from banks, interest-bearing deposits, federal funds sold and
securities purchased under agreements to resell.
The Bank is required to maintain reserve balances with the Federal Reserve
Bank. Average reserves maintained at the Federal Reserve Bank were $20.6,
$21.8 and $30.2 million during the years ended September 30, 1994, 1993 and
1992, respectively.
LOANS HELD FOR SALE:
The Corporations engage in mortgage banking activities. At September 30, 1994
and 1993, 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 sold or will be exchanged for
mortgage-backed securities and then sold. Gains and losses on sales of whole
loans held for sale are determined using the specific identification method.
See "Trading Securities" and Note 28.
LOANS HELD FOR SECURITIZATION AND SALE:
The Corporations periodically sell receivables through asset-backed
securitizations, in which receivables are transferred to a trust, and the
Corporations sell certificates to investors representing ownership interests
in the trust.
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 securitization and sale are reported at the lower of
aggregate cost or aggregate market value for each asset type.
F-14
INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES:
Effective October 1, 1993, the Bank adopted Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115") which was issued in May 1993. SFAS 115 requires
institutions to classify and account for debt and equity securities in one of
three categories as follows:
1. Debt securities that an institution has the positive intent and ability to
hold to maturity are classified as held-to-maturity and reported at
amortized cost.
2. Debt and equity securities that are purchased and held principally for the
purpose of selling them in the near term and mortgage-backed securities
held for sale in conjunction with mortgage banking activities are
classified as trading securities and reported at fair value, with
unrealized gains and losses included in earnings. See "Trading
Securities."
3. Debt and equity securities not classified as either held-to-maturity or
trading securities are classified as available-for-sale and reported at
fair value, with unrealized gains and losses excluded from earnings and
reported as a net amount in a separate component of stockholders' equity,
net of the related income tax effect.
At September 30, 1994, all investment securities and mortgage-backed
securities held by the Bank are classified as available-for-sale and recorded
at fair value. At September 30, 1994, net unrealized holding losses in the
amount of $14.1 million, net of the related income tax effect, are included as
a separate component of stockholders' equity. See Notes 9 and 10.
Premiums and discounts on investment securities and mortgage-backed securities
available-for-sale are amortized or accreted using the level-yield method.
Realized gains and losses are determined using the specific identification
method.
Prior to October 1, 1993, the Bank's investment and mortgage-backed securities
were held for investment and stated at cost, adjusted for amortization of
premiums and accretion of discounts. These securities were carried at
amortized cost because the Bank had the ability to hold such securities until
maturity and it was management's intent to hold such securities for the
foreseeable future. When management determined that certain securities might
be sold in response to changes in interest rates, changes in prepayment risks
or the need to increase regulatory capital, such securities were transferred
from the held for investment category to the held for sale category. Such
held for sale securities were transferred in and carried at the lower of
aggregate cost or aggregate market value. Gains and losses resulting from the
sale of investment and mortgage-backed securites were determined using the
specific identification method.
Prior to October 1, 1993, securities to be held for indefinite periods of
time, including securities that management intended to use as part of its
asset-liability management, or that could be sold in response to changes in
interest rates, changes in prepayment risks, the need to increase regulatory
capital or other similar factors, were classified as held for sale and were
carried at the lower of aggregate cost or aggregate market value. Gains and
losses on sales of securities held for sale were determined using the specific
identification method.
F-15
TRADING SECURITIES:
As part of its mortgage banking activities, the Corporations exchange loans
held for sale for mortgage-backed securities and then sell the mortgage-backed
securities to third party investors in the month of issuance. In accordance
with SFAS 115, these mortgage-backed securities are classified as trading
securities. Proceeds from sales of trading securities were $688.8 million
during the year ended September 30, 1994. The Bank realized net gains on the
sale of trading securities of $1.7 million for the year ended September 30,
1994. Gains and losses on sales of trading securities are determined using
the specific identification method. There were no securities classified as
trading securities at September 30, 1994.
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 (costs)
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 a reduction of income on a straight-line basis over the
privilege period which is generally one year.
IMPAIRED LOANS:
Effective October 1, 1993, the Bank adopted, on a prospective basis, Statement
of Financial Accounting Standards No. 114, "Accounting by Creditors for
Impairment of a Loan" ("SFAS 114"), which was issued in May 1993, and
Statement of Financial Accounting Standards No. 118, "Accounting by Creditors
for Impairment of a Loan - Income Recognition and Disclosures, an amendment of
FASB Statement No. 114", which was issued in October 1994. Under SFAS 114, a
loan is impaired when, based on all current information and events, it is
probable that a creditor will be unable to collect all amounts due according
to the contractual terms of the agreement, including all scheduled principal
and interest payments. SFAS 114 requires that impaired loans be measured
based on the present value of expected future cash flows, discounted at the
loan's effective interest rate. As a practical expedient, impairment may be
measured based on the loan's observable market price, or, if the loan is
collateral-dependent, the fair value of the collateral. When the measure of
the impaired loan is less than the recorded investment in the loan, the
impairment is recorded through a valuation allowance. In addition, SFAS 114
changes the method of accounting for loans for which foreclosure is probable
and requires that such impaired loans be accounted for as loans. The Bank
also classifies certain credit card loans for which customers have agreed to
modified payment terms, as impaired loans in accordance with SFAS 114.
The Bank evaluates each impaired real estate loan individually to determine
the income recognition policy. Generally, payments received are applied in
accordance with the contractual terms of the note or as a reduction of
principal.
F-16
The Bank recognizes interest income on impaired credit card loans using the
current interest rate of the loan and the accrual method. When loans become
90 days past due, all accrued interest is reserved and the loan is placed on
non-accrual status. Interest income on non-accrual credit card loans is
recognized when received by the Bank.
At September 30, 1994, the Bank had no impaired real estate loans and had
impaired credit card loans with a carrying value of $35.3 million, before
reserves for losses of $3.5 million on all such impaired credit card loans.
The Bank calculates its reserve for losses on all credit card loans based upon
historical charge-offs and repayment experience and the age of the portfolio.
The average recorded investment in impaired real estate and credit card loans
for the year ended September 30, 1994 was $39.0 million. The Bank
recognized interest income of $2.4 million on its impaired loans for the year
ended September 30, 1994.
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/or 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.
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 all of which
are owned by one of the Bank's subsidiaries. Real estate held for investment
is carried at the lower of aggregate cost or net realizable value. Also
included in real estate held for investment is a loan to a developer with a
50% profit participation feature. This investment in a real estate venture,
which was non-performing at September 30, 1994, is accounted for as an
acquisition, development and construction ("ADC") arrangement.
F-17
REAL ESTATE HELD FOR SALE:
Real estate held for sale consists of real estate acquired in settlement of
loans ("REO") and 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 the development and improvement of property,
including interest, are capitalized, whereas costs relating to the holding of
property are expensed. Capitalized interest amounted to $4.4, $10.2 and
$13.2 million for the years ended September 30, 1994, 1993 and 1992,
respectively.
Prior to October 1, 1993 and the implementation of SFAS 114, real estate held
for sale also included in-substance foreclosures. In-substance foreclosures
included those investments for which the Bank had determined that (i) the
debtor had little or no equity in the collateral, considering the current fair
value of the collateral (ii) proceeds for repayment of the loan could be
expected to come only from the operation or sale of the collateral and
(iii) the debtor had 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 was doubtful that the debtor would be able to
rebuild equity in the collateral or otherwise repay the loan in the
foreseeable future.
Effective December 31, 1992, OTS regulations required that foreclosed assets
be carried at the lower of cost or fair value which 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. SOP 92-3 requires that foreclosed assets held
for sale, including assets classified as in-substance foreclosed (prior to the
implementation of SFAS 114), 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 is considered to be held for sale. The
adoption of SOP 92-3 caused the Bank to revise its method of accounting for
real estate held for sale. 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 reduced 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.
F-18
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 generally
over a period of 15 years. Accumulated amortization was $31.0 and
$28.2 million at September 30, 1994 and 1993, 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
revenues from the mortgage servicing rights purchased. Amortization of these
assets amounted to $6.1, $12.1 and $1.6 million for the years ended September
30, 1994, 1993 and 1992, respectively. Accumulated amortization was $37.7 and
$31.6 million at September 30, 1994 and 1993, respectively. During fiscal
1994, 1993 and 1992, the Bank capitalized $0.9, $20.7 and $1.6 million,
respectively, related to the acquisition of mortgage servicing rights. In
fiscal 1993, the Bank sold approximately $1.2 million of rights to service
mortgage loans with principal balances of approximately $76.1 million and
recognized a loss of $0.4 million. There were no sales of previously
purchased mortgage servicing rights during the years ended September 30, 1994
and 1992.
In fiscal 1994, 1993 and 1992, the Bank sold the rights to service mortgage
loans with principal balances of approximately $383.9, $476.1, and
$255.7 million, respectively, which were originated by the Corporations in
connection with mortgage banking activities, and recognized gains of $5.8,
$5.2 and $3.8 million, respectively.
Management periodically evaluates the carrying value of purchased mortgage
servicing rights taking into consideration current portfolio factors such as
prepayment rates. The Bank's analyses are performed on a discounted basis
based on pools of loans with similar characteristics. Any adjustments to the
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 $13.5, $21.4 and $20.0 million for
the years ended September 30, 1994, 1993 and 1992, respectively. Accumulated
amortization was $65.9 and $52.5 million at September 30, 1994 and 1993,
respectively. Excess servicing assets capitalized in fiscal 1994, 1993 and
1992 of $11.1, $19.5 and $16.9 million respectively, were the result of the
servicing retained upon the securitization and sale of home equity credit line
receivables. See Note 15.
Management periodically evaluates the carrying value of excess servicing
assets taking into consideration current portfolio factors such as prepayment
rates. The Bank's analyses are performed on a discounted basis based on pools
of loans with similar characteristics. Any adjustments to the carrying value
of such assets as a result of this evaluation are included in the amortization
for the respective period.
F-19
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED:
Statement of Financial Standards No. 119, "Disclosure about Derivative
Financial Instruments and Fair Value of Financial Instruments" ("SFAS 119"),
was issued in October 1994. SFAS 119 requires companies to disclose the
amount, nature and terms of derivative financial instruments. Because SFAS
119 addresses only disclosure related issues, its adoption will not have an
impact on the financial condition or results of operations of the Bank.
Adoption of SFAS 119 is required for fiscal years ending after December 15,
1994. The Bank will be required to adopt SFAS 119 by September 30, 1995.
F-20
1. LIQUIDITY AND CAPITAL RESOURCES - REAL ESTATE TRUST
Historically, the Real Estate Trust's total cash requirements have exceeded the
cash generated by its operations. As described below, this condition persisted
in 1994 and is expected to continue 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 ("Unsecured Notes") sold to the public (see Note 4),
interest payable on the Senior Secured Notes (as defined below), 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 sale of Unsecured Notes), refinancings of maturing
mortgage debt, asset sales and tax sharing payments from the Bank.
The Real Estate Trust had negative cash flow from operating activities of $10.9,
$3.1, $0.9 and $16.4 million in fiscal 1994, 1993, 1992 and 1991, respectively,
before tax sharing payments from the Bank of $9.6, $5.0 and $29.6 million in
fiscal 1994, 1993 and 1991, respectively. The Real Estate Trust's ability to
meet its liquidity needs, including debt service payments, will depend in
significant part on its receipts of tax sharing payments from the Bank (pursuant
to the tax sharing agreement dated June 28, 1990, as amended, among the Trust,
the Bank and their subsidiaries) and dividends from the Bank. The availability
and amount of dividends and tax sharing payments in future periods, however is
dependent upon, among other things, the Bank's operating performance and income,
regulatory restrictions on such payments and (in the case of tax sharing
payments) the continued consolidation of the Bank and the Bank's subsidiaries
with the Trust for federal income tax purposes.
Management anticipates that the Trust will continue to file a consolidated
federal income tax return and that the Bank will operate in a profitable manner
sufficient to generate tax sharing payments. Based on recent activity,
management anticipates that such tax sharing payments will be approved by the
OTS sufficient to enable the Real Estate Trust to meet its debt service and
other liquidity needs. As of September 30, 1994, the Bank owed the Real Estate
Trust $12.0 million in tax sharing payments of which $5.0 million was paid in
October 1994 with the approval of the OTS. Nonetheless, should further tax
sharing payments not be paid during the next twelve months, management estimates
that the Real Estate Trust has adequate liquidity including unencumbered cash
balances and debt service escrow balances related to the Senior Secured Notes
and Unsecured Notes sufficient to fund its cash flow requirements including debt
service.
The Real Estate Trust's liquidity position was positively affected by the
issuance on March 30, 1994 of $175.0 million aggregate principal amount of 11
5/8% Senior Secured Notes due 2002 (the "Senior Secured Notes"). After paying
offering expenses of $8.9 million, third-party mortgage indebtedness of
$74.1 million, and affiliate indebtedness of $8.9 million, the Real Estate Trust
retained $83.1 million of the net proceeds of the offering for application to
general corporate purposes, including a loan to an affiliate of $15.0 million.
Of this amount, approximately $25.8 million was deposited with the Trustee for
the Senior Secured Notes to satisfy one of the initial collateral requirements
with respect to such securities. See Note 4. Concurrently with the application
of the net proceeds of the offering to repay third-party mortgage indebtedness,
the terms of certain of the mortgage loans repaid in part were modified to waive
deferred interest, reduce interest rates and extend maturities. After the
application of such net proceeds and the modification of such loans, the final
maturity of loans with total balances of $111.1 million was 12 years and the
final maturity of a loan with a balance of $15.1 million was 15 years.
F-21
During the third and fourth quarters of fiscal 1994, the Trust purchased 573,500
shares of common stock of Saul Centers, Inc. (representing 4.8% of such
company's outstanding common stock) for approximately $10.3 million. These
shares have been deposited with the Trustee for the Senior Secured Notes to
satisfy in part the collateral requirements for those securities, thereby
permitting release to the Trust of a portion of the cash on deposit with the
Trustee.
The Senior Secured Notes are secured, general obligations of the Trust ranking
pari passu with all other unsubordinated obligations of the Trust, including the
Unsecured Notes. The Senior Secured Notes are secured by a first-priority
perfected security interest in 80% of the issued and outstanding common stock of
the Bank, which 80% is owned by the Trust. The Indenture pursuant to which the
Senior Secured Notes were issued contains convenants that, among other things,
restrict the ability of the Trust and/or its subsidiaries (excluding, in most
cases, the Bank and the Bank's subsidiaries) to incur additional indebtedness,
make investments, sell assets or pay dividends and make other distributions to
holders of the Trust's capital stock.
The Real Estate Trust's current program of public Unsecured Note sales was
initiated in the 1970's as a vehicle for supplementing other external funding
sources. Unsecured Note sales were suspended in June 1990, but resumed in
November 1992. The Real Estate Trust is currently selling Unsecured Notes
principally to pay outstanding Unsecured Notes as they mature. In paying
maturing Unsecured Notes with proceeds of new Unsecured Note sales, the Real
Estate Trust effectively is refinancing its outstanding Unsecured Notes with
similar new unsecured debt at lower interest rates currently prevailing in
today's market. To the degree that the Real Estate Trust does not sell new
Unsecured Notes in an amount sufficient to finance completely the scheduled
repayment of outstanding Unsecured Notes as they mature, it will be required to
finance such repayments from other sources of funds.
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 or on behalf of 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 during the period October 1, 1993 through September 30, 1994,
additional tax sharing payments of $9.6 million to the Real Estate Trust. As of
September 30, 1994, the estimated tax sharing payment due to the Real Estate
Trust from the Bank was $12.0 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. Nonetheless, the OTS must be notified
regarding dividends declared or paid.
As the owner, directly and through a wholly owned subsidiary, of a 21.5% limited
partnership interest in Saul Holdings Limited Partnership (see Note 2), 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 Limited Partnership. The partnership agreement of Saul Holdings
Limited Partnership provides for quarterly cash distributions to the partners
out of net cash flow. During fiscal 1994, the Real Estate Trust received total
cash distributions in the amount of 4.6 million from Saul Holdings Limited
Partnership.
F-22
While the Real Estate Trust's ability to satisfy its liquidity requirements is
contingent on future events, which include the sale of new Notes in an amount
sufficient to finance scheduled maturities of outstanding unsecured Notes and
the Bank's ability to pay tax sharing payments and dividends, the Real Estate
Trust believes it will be able to consummate the transactions described above as
well as explore other financing opportunities in order to raise sufficient
proceeds to fund its liquidity requirements.
2. SAUL HOLDINGS LIMITED PARTNERSHIP - 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. The Real Estate Trust has pledged 62% of
its interest in Saul Holdings to the Bank.
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 as well as at September 30, 1994, the
maximum potential obligations of the Real Estate Trust and its subsidiaries
under this agreement totalled approximately $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 Difference"). In the
event Saul Centers, as general partner of the Partnerships, causes the
Partnerships to dispose of one or more of such properties, a disproportionately
large share of the total gain for federal income tax purposes would be allocated
to the Real Estate Trust or its subsidiaries 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 the 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, could cause the Real Estate Trust or its
subsidiaries to have taxable constructive distributions without the receipt of
any corresponding amounts of cash. Currently, management does not intend to
seek a release of or a reduction in the guarantees or to convert its limited
partner units in Saul Holdings into shares of Saul Centers common stock.
F-23
At the date of transfer of the Real Estate Trust properties to Saul Holdings,
liabilities exceeded assets transferred by approximately $104.3 million on an
historical cost basis. The assets and liabilities were recorded by Saul Holdings
and Saul Centers at their historical cost rather than market value because of
affiliated ownership and common management and because the assets and
liabilities were the subject of the business combination between Saul Centers
and Saul Holdings, newly formed entities with no prior operations.
Immediately subsequent to the business combination and initial public offering
of common stock by Saul Centers, Saul Centers had total owners' equity of
approximately $16.4 million of which approximately $3.5 million related to the
Real Estate Trust's 21.5% ownership interest. Recognition by the Real Estate
Trust of the change in its investment in the properties of approximately
$107.8 million, from a deficit of $104.3 million to $3.5 million, has been
deferred due to the Real Estate Trust's guarantee of $116.1 million under the
Saul Centers reimbursement agreement. The deferred gain of $107.8 million is
included in "Deferred gains - real estate" in the financial statements. The gain
will be recognized in future periods to the extent the Real Estate Trust's
obligations are terminated under the reimbursement agreement.
The management of Saul Centers has adopted a strategy of maintaining a ratio of
total debt to total asset value, as estimated by management, of fifty percent or
less. The management of Saul Centers has concluded at September 30, 1994 that
the total debt of Saul Centers remains below fifty percent of total asset value.
As a result, the Real Estate Trust has concluded at September 30, 1994 that
fundings under the reimbursement agreement are remote.
In addition to the deferred gains, as of September 30, 1994, the Real Estate
Trust's investment in the consolidated entities of Saul Centers consisted of the
following.
(In thousands)
--------------
Saul Holdings:
Distributions in excess of allocated net income $ (2,641)
Saul Centers:
Acquisition of common shares 10,295
Distributions in excess of allocated net income (188)
--------------
$ 7,466
==============
The $7.5 million balance is included in "Other assets" in the financial
statements.
F-24
The Condensed Consolidated Balance Sheet at September 30, 1994 and 1993, and the
Condensed Consolidated Statement of Operations for October 1, 1993 through
September 30, 1994 and for August 27, 1993 through September 30, 1993 of Saul
Centers follow.
SAUL CENTERS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS)
September 30,
--------------------------------------
1994 1993
------------------ ------------------
ASSETS
Real estate investments $286,575 $262,408
Accumulated depreciation (81,307) (72,931)
Other assets 47,667 21,245
------------------ ------------------
TOTAL ASSETS $252,935 $210,722
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable $237,517 $192,299
Other liabilities 17,062 5,603
------------------ ------------------
Total liabilities 254,579 197,902
Total stockholders' equity (1,644) 12,820
------------------ ------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $252,935 $210,722
================== ==================
SAUL CENTERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS)
For the Twelve August 27, 1993
Months Ended through
September 30, 1994 September 30, 1993
------------------ ------------------
REVENUE
Base rent $42,757 $3,854
Other revenue 13,192 1,014
------------------ ------------------
TOTAL REVENUE 55,949 4,868
------------------ ------------------
EXPENSES
Operating expenses 14,496 1,137
Interest expense 12,213 1,122
Amortization of deferred debt expense 2,599 275
Depreciation and amortization 9,101 806
General and administrative 2,789 181
------------------ ------------------
TOTAL EXPENSES 41,198 3,521
------------------ ------------------
Operating income before extraordinary item and minority interest 14,751 1,347
Extraordinary item - loss on early extinguishment of debt (3,341) (3,519)
------------------ ------------------
Net income (loss) before minority interest 11,410 (2,172)
Minority interest (3,524) 586
------------------ ------------------
NET INCOME (LOSS) $7,886 ($1,586)
================== ==================
F-25
3. INVESTMENT PROPERTIES - REAL ESTATE TRUST
The following table summarizes the cost basis of income-producing properties and
land parcels together with their related debt.
Buildings and Leasehold Related
No. Land Improvements Interests Total Debt
--------- ---------------- ------------------ ----------------- ----------------- -----------------
(Dollars in thousands)
September 30, 1994
Income-producing properties
Office & industrial 8 $5,670 $105,225 $- $110,895 $85,433
Hotels 9 8,862 103,298 - 112,160 74,911
Other 7 3,575 861 149 4,585 395
--------- ---------------- ------------------ ----------------- ----------------- -----------------
24 $18,107 $209,384 $149 $227,640 $160,739
========= ================ ================== ================= ================= =================
Land parcels 10 $38,455 $ - $- $38,455 $28,572
========= ================ ================== ================= ================= =================
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
========= ================ ================== ================= ================= =================
4. 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 2009 and accrue interest at annual rates from
6.6% to 10.0%. Certain mortgages contain a number of restrictions, including
cross default provisions.
The Real Estate Trust obtained a $5.0 million secured loan from an affiliate in
August 1992. Interest accrued at prime plus 1.5%. The loan was repaid during
fiscal 1994.
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 2). 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. During fiscal 1994, the Trust Notes were repaid and the
collateral was released.
F-26
On March 30, 1994, the Real Estate Trust issued $175.0 million aggregate
principal amount of its Senior Secured Notes. The Senior Secured Notes are
general obligations of the Real Estate Trust ranking pari passu with all other
unsubordinated obligations of the Trust and are secured by a first priority
perfected security interest in 80% (8,000 shares) of the issued and outstanding
common stock of the Bank and by certain other assets of the Trust as described
herein. After paying offering expenses of $8.9 million, third-party mortgage
indebtedness of $74.1 million, and affiliate indebtedness of $8.9 million, the
Real Estate Trust retained $83.1 million of the net proceeds of the offering for
application to general corporate purposes, including a loan to an affiliate of
$15.0 million. Of the remaining amount, approximately $25.8 million was
deposited with the Trustee for the Senior Secured Notes to satisfy one of the
initial collateral requirements with respect to such securities. This collateral
requirement, which will remain in effect as long as any Senior Secured Notes are
outstanding, will be recalculated each calendar quarter based on the estimated
amount of one year's interest payments on then outstanding Senior Secured Notes
and Unsecured Notes. Concurrently with the application of the net proceeds of
the offering to repay third-party mortgage indebtedness, the terms of certain of
the mortgage loans repaid in part were modified to waive deferred interest,
reduce interest rates and extend maturities. After the application of such net
proceeds and the modification of such loans, the final maturity of loans with
total balances of $111.1 million was 12 years and the final maturity of a loan
with a balance of $15.1 million was 15 years. During the third and fourth
quarters of fiscal 1994, the Real Estate Trust purchased 573,500 shares of
common stock of Saul Centers (representing 4.8% of such company's outstanding
stock) for approximately $10.3 million. These shares have been deposited with
the Trustee for the Senior Secured Notes to satisfy in part the collateral
requirements for those securities, thereby permitting release to the Trust of
a portion of the cash on deposit with the Trustee.
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, 1994 and 1993 were 11.1% and
12.7%, respectively. During fiscal 1993 and fiscal 1994, the Real Estate Trust
sold notes amounting to approximately $11.9 and $15.7 million, respectively.
The maturity schedule for the Real Estate Trust's outstanding debt at September
30, 1994 for the fiscal years commencing October 1, 1994 is set forth in the
following table.
Debt Maturity Schedule
(In thousands)
- --------------------------------------------------------------------------------------------------------------
Mortgage Notes Payable Notes Payable
Notes Secured Unsecured Total
------------------ ------------------ ------------------ ------------------
Fiscal Year
1995 $11,022 $ -- $7,242 $18,264
1996 6,100 -- 5,761 11,861
1997 23,455 -- 5,336 28,791
1998 6,935 -- 5,935 12,870
1999 16,600 -- 12,769 29,369
Thereafter 121,618 175,000 3,245 299,863
------------------ ------------------ ------------------ ------------------
Total $185,730 $175,000 $40,288 $401,018
- --------------------------------------------------------------------------------------------------------------
F-27
5. LONG-TERM LEASE OBLIGATIONS - REAL ESTATE TRUST
The Real Estate Trust has one noncancelable long-term lease which 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
$6.1 million.
The Consolidated Statements of Operations contain minimum ground rent expense of
$102,000, $286,000 and $312,000 in fiscal 1994, 1993 and 1992, respectively. In
addition to the minimum ground rent payments, real estate taxes on the land are
an obligation of the Real Estate Trust.
6. 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 1994, 1993, and
1992 amounted to $15.9, $38.0 and $41.7 million, respectively. Overage rent for
these periods amounted to $0.3, $2.7 and $3.0 million, respectively. Future
minimum rentals as of September 30, 1994 under noncancelable leases are as
follows:
Fiscal Year (In thousands)
------------------ ------------------
1995 $15,081
1996 8,334
1997 5,851
1998 4,022
1999 2,331
Thereafter 731
7. 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 $97,000 during the period October 1991 through December 1992,
$157,000 during the period January 1993 through September 1993, $250,000 during
the period October 1993 through March 1994, and $292,000 during the period April
1994 through September 1994. The advisory contract has been extended until
September 30, 1995, and will continue thereafter unless cancelled by either
party at the end of any contract year. Certain loan agreements prohibit
termination of this contract.
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 $4.5, $7.7 and
$8.7 million in fiscal 1994, 1993 and 1992, 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.
F-28
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 $157,000 and $118,000 in fiscal 1994 and
1993, respectively. There were no such payments in fiscal 1992.
A subsidiary of Saul Co. is a general insurance agency which receives
commissions and countersignature fees in connection with the Real Estate Trust's
insurance program. Such commissions and fees amounted to approximately
$157,000, $221,000 and $229,000 in fiscal 1994, 1993 and 1992, respectively.
The Real Estate Trust had a working capital loan from the Saul Co. of
approximately $3.3 million as of September 30, 1993, bearing interest of 1/2
percent over prime per annum. The funds were used for general operating purposes
and the loan was satisfied in March 1994. Interest paid on this loan in fiscal
1994, 1993, and 1992 amounted to $139,000, $365,000 and $15,000, respectively.
In April 1994 the Real Estate Trust made a loan to the Saul Company of $15.0
million bearing interest at 1/2 percent over prime and due on demand.
Subsequent to year-end the loan balance was reduced to $12.7 million. Interest
received on this loan in fiscal 1994 amounted to $565,000.
TRANSACTIONS WITH OTHER AFFILIATES
The Real Estate Trust obtained a $5.0 million secured loan from The Klingle
Corporation in August 1992. The loan was repaid during fiscal 1994. It accrued
interest at a rate of prime plus 1.5%. The Real Estate Trust incurred interest
expense of $193,000, $365,000, and $15,000 during fiscal 1994, 1993, and 1992,
respectively.
REMUNERATION OF TRUSTEES AND OFFICERS
For fiscal years 1994, 1993, and 1992, the Real Estate Trust paid the Trustees
$76,000, $79,000 and $88,000, 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 $1.3, $1.2 and
$2.1 million, excluding expense reimbursements, during fiscal 1994, 1993, and
1992, 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 45% 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.
The gain has continued to be deferred in accordance with the accounting policy
for gain recognition described in Note 2.
F-29
SAUL HOLDINGS LIMITED PARTNERSHIP
See Note 2 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 earnings for fiscal 1994 was $2.4 million. 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 $51,000, $460,000 and $533,000, in fiscal
1994, 1993 and 1992, respectively.
8. LOANS HELD FOR SECURITIZATION AND SALE - THE BANK
At September 30, 1994 and 1993, loans held for securitization and sale are
composed of credit card receivables.
F-30
9. INVESTMENT SECURITIES - THE BANK
At September 30, 1994, all investment securities are classified as
available-for-sale in accordance with SFAS 115. Gross unrealized holding gains
and losses on the Bank's investment securities at September 30, 1994 are as
follows:
Gross Gross
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
(In thousands) Cost Gains Losses Value
- -------------------------------------------------- ------------------- ------------------- ------------------- -------------------
SEPTEMBER 30, 1994
U.S. Government securities $ 4,399 $ - $ (135) $ 4,264
Other securities 100 - - 100
------------------- ------------------- ------------------- -------------------
Total $ 4,499 $ - $ (135) $ 4,364
=================== =================== =================== ===================
As discussed in Summary of Significant Accounting Policies - The Bank, at
September 30, 1993, investment securities were carried at amortized cost.
Gross unrealized gains and losses for the Bank's investment securities at
September 30, 1993 were as follows:
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
=================== =================== =================== ===================
A comparison of amortized cost and fair value for investment securities, along
with the contractual maturity dates, by category of investments at September 30,
1994, is as follows:
Aggregate
Amortized Fair
(In thousands) Cost Value
- ------------------------------------------------------------------------------------------ ------------------- -------------------
SEPTEMBER 30, 1994
Investment securities available-for-sale:
U.S. Government securities
Maturing within one year $ - $ -
Maturing after one year, but within five years 4,399 4,264
------------------- -------------------
Total U.S. Government securities 4,399 4,264
------------------- -------------------
Other securities:
Maturing within one year 100 100
------------------- -------------------
Total other securities 100 100
------------------- -------------------
Total investment securities available-for-sale $ 4,499 $ 4,364
=================== ===================
Proceeds from sales of investment securities, including securities held for
sale, during fiscal 1993 were $181.8 million. Gross gains of $8.9 million and
gross losses of $0 were realized on sales for fiscal 1993. There were no sales
of investment securities during the years ended September 30, 1994 and 1992.
At September 30, 1994, certain investment securities were pledged as collateral
for certain letters of credit. See Note 28.
F-31
10. MORTGAGE-BACKED SECURITIES - THE BANK
At September 30, 1994, all mortgage-backed securities are classified as
available-for-sale in accordance with SFAS 115. Gross unrealized holding gains
and losses on the Bank's mortgage-backed securities at September 30, 1994 are as
follows:
Gross Gross
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
(In thousands) Cost Gains Losses Value
- ------------------------------------------------- ------------------- ------------------- ------------------- -------------------
SEPTEMBER 30, 1994
FNMA $ 34,896 $ 39 $ (454) $ 34,481
FHLMC 834,516 545 (24,143) 810,918
Private label, AA-rated 179,349 798 (21) 180,126
------------------- ------------------- ------------------- -------------------
Total $ 1,048,761 $ 1,382 $ (24,618) $ 1,025,525
=================== =================== =================== ===================
As discussed in Summary of Significant Accounting Policies -- The Bank, at
September 30, 1993, mortgage-backed securities were carried at amortized cost.
The amortized cost and estimated market values for the Bank's mortgage-backed
securities at September 30, 1993 were as follows:
Estimated
Principal Unamortized Unearned Carrying Market
(In thousands) 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
=================== =================== =================== =================== ===================
Gross unrealized gains were $27.1 million and gross unrealized losses were
$0.2 million at September 30, 1993.
Proceeds from sales of mortgage-backed securities, including mortgage-backed
securities held for sale, were $810.8 and $834.2 million during the years ended
September 30, 1993 and 1992, respectively. Gross gains of $10.2 and
$23.0 million and gross losses of $4.4 and $3.0 million were realized on the
sale of mortgage-backed securities, including mortgage-backed securities held
for sale, during the years ended September 30, 1993 and 1992, respectively.
There were no sales of mortgage-backed securities during the year ended
September 30, 1994.
Accrued interest receivable on mortgage-backed securities totaled $6.3 and
$8.9 million at September 30, 1994 and 1993, respectively, and is included in
other assets in the Consolidated Statements of Financial Condition.
At September 30, 1994, 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 $23.8 million were pledged as
collateral primarily for credit card settlement obligations.
F-32
11. LOANS RECEIVABLE - THE BANK
Loans receivable is composed of the following:
September 30,
(In thousands) 1994 1993
---------------------------------------------------------------------------------------- ------------------- -------------------
Single-family residential $ 1,335,645 $ 1,111,306
Home equity 34,708 60,549
Commercial and multifamily 84,639 95,611
Real estate construction 66,909 69,940
Ground 18,935 19,340
Credit card 535,199 454,520
Automobile 289,346 106,725
Overdraft lines of credit 8,365 7,166
Other 60,098 31,295
------------------- -------------------
2,433,844 1,956,452
------------------- -------------------
Less:
Undisbursed portion of loans 35,535 28,588
Unearned discounts 1,438 1,543
Net deferred loan origination costs (10,932) (2,995)
Reserve for losses on loans 50,205 68,040
------------------- -------------------
76,246 95,176
------------------- -------------------
Total $ 2,357,598 $ 1,861,276
=================== ===================
The Bank serviced loans owned by others amounting to $3,943.8, $3,423.6 and
$2,379.1 million at September 30, 1994, 1993 and 1992, respectively.
Accrued interest receivable on loans totaled $17.1 and $16.0 million at
September 30, 1994 and 1993, respectively, and is included in other assets in
the Consolidated Balance Sheets.
F-33
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) 1994 1993
---------------------------------------------------------------------------------------- ------------------- -------------------
Land, development, construction
and rental properties $ 69,767 $ 69,313
Investments in limited partnerships (2,478) (1,580)
Investments in real estate ventures 8,915 8,898
------------------- -------------------
Total real estate held for investment 76,204 76,631
------------------- -------------------
Real estate held for sale 387,024 434,616
------------------- -------------------
Less:
Reserve for losses on real estate held
for investment 9,899 10,182
Reserve for losses on real estate held for sale 109,074 101,462
Accumulated depreciation and amortization 13,600 11,144
------------------- -------------------
Total real estate held for investment or sale $ 330,655 $ 388,459
=================== ===================
Earnings (loss) on real estate held for investment or sale is composed of the
following:
Year Ended September 30,
(In thousands) 1994 1993 1992
-------------------------------------------------------------------- ------------------- ------------------- -------------------
Provision for losses $ (14,052) $ (30,415) $ (60,596)
Net income from operating properties 3,521 6,496 9,800
Equity earnings from investments in
limited partnerships 391 1,694 391
Net gain (loss) on sales 10,975 9,503 (244)
------------------- ------------------- -------------------
Total $ 835 $ (12,722) $ (50,649)
=================== =================== ===================
At September 30, 1994, the Corporations have an ADC arrangement with, and hold a
partnership interest in, a limited partnership. The partnership 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. At
September 30, 1994, there were no outstanding commitments, lines of credit or
other arrangements between the Corporations and the partnership relating to
these investments other than reflected below. Combined, condensed financial
information for the partnerships and ADC arrangement is presented below:
F-34
BALANCE SHEETS
September 30,
---------------------------------------
(In thousands) 1994 1993
- ------------------------------------------------------------------------------------------ ------------------- -------------------
ASSETS
Land, buildings, construction in progress
and other assets $ 49,567 $ 77,803
=================== ===================
LIABILITIES AND PARTNERSHIP EQUITY
Notes payable to the Corporations $ 8,915 $ 9,168
Other liabilities 46,546 69,241
Partnership (deficit) equity:
- Corporations (2,920) (2,344)
- Others (2,974) 1,738
------------------- -------------------
$ 49,567 $ 77,803
=================== ===================
STATEMENTS OF OPERATIONS
Year Ended September 30,
-----------------------------------------------------------
(In thousands) 1994 1993 1992
- ---------------------------------------------------------------------- ------------------- ------------------- -------------------
Income $ 7,280 $ 12,492 $ 12,041
Expenses (7,360) (13,669) (12,155)
Gain on sales of property - 4,892 -
------------------- ------------------- -------------------
Net income (loss) $ (80) $ 3,715 $ (114)
=================== =================== ===================
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.
During fiscal 1994, the Bank sold its interests in three limited partnerships to
other partners at an aggregate amount that exceeded the net carrying values of
these assets.
F-35
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, 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
Provision for losses 33,237 14,052
Charge-offs (65,159) (6,723)
Recoveries 14,087 -
------------------- -------------------
Balance, September 30, 1994 $ 50,205 $ 118,973
=================== ===================
The reserves for losses at September 30, 1994 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-36
14. NON-PERFORMING ASSETS - THE BANK
Non-performing assets are composed of the following at September 30, 1994:
Non-accrual
(Dollars in thousands) Loans Real Estate (1) Total
---------------------------------------------------------------- ------------------- ------------------- -------------------
Single-family residential $ 8,306 $ 1,322 $ 9,628
Residential land, development and construction - 248,037 248,037
Retail centers - 13,978 13,978
Commercial land (2) - 23,528 23,528
------------------- ------------------- -------------------
Total real estate assets 8,306 286,865 295,171
Credit card 16,229 - 16,229
Other 498 - 498
------------------- ------------------- -------------------
Total non-performing assets $ 25,033 $ 286,865 $ 311,898
=================== =================== ===================
RESERVES FOR LOSSES
Real estate $ 14,085 $ 118,973 $ 133,058
Credit card 34,530 - 34,530
Other 1,590 - 1,590
------------------- ------------------- -------------------
Total $ 50,205 $ 118,973 $ 169,178
=================== =================== ===================
RESERVES FOR LOSSES AS A PERCENTAGE OF
NON-PERFORMING ASSETS (3)
Real estate 169.58% 30.05% 32.92%
Credit card 212.77% - 212.77%
Other 319.28% - 319.28%
------------------- ------------------- -------------------
Total 200.56% 30.05% 40.19%
=================== =================== ===================
<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 18.9% 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 57.3% 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.
At September 30, 1994 and 1993, the Bank had $29.1 and $36.7 million,
respectively, of loans accounted for as troubled debt restructurings, all of
which were included as performing loans. At September 30, 1994, the Bank had
commitments to lend $2.5 million of additional funds on loans which have been
restructured.
F-37
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 $9.1, $10.5 and $16.3 million for the years ended September 30, 1994,
1993 and 1992, respectively. The amount of interest income that was recorded on
these loans was $2.7, $3.0 and $5.0 million for the years ended September 30,
1994, 1993 and 1992, respectively.
15. SIGNIFICANT SALES 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 $1,350.0, $350.0 and
$280.0 million for these asset-backed certificates for the years ended September
30, 1994, 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. Outstanding trust certificate balances related to
these and previous securitizations were $1,953.8 and $841.8 million at September
30, 1994 and 1993, respectively. The related receivable balances contained in
the trusts were $2,330.9 and $1,232.8 million at September 30, 1994 and 1993,
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 1994 and 1992, the Bank sold credit card relationships with
related outstanding receivable balances of $96.5 and $14.9 million,
respectively. Gains of $16.9 and $1.5 million were recorded in connection with
these sales for the years ended September 30, 1994 and 1992, respectively, and
the Bank will no longer service these relationships. No such sales occurred
during the year ended September 30, 1993.
In fiscal 1994, 1993 and 1992, 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 $181.9, $340.4 and $253.6
million, respectively. Gains recognized on these transactions were $9.5, $16.8
and $15.1 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 $485.4 and $530.1 million at
September 30, 1994 and 1993, 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 Bank continues to service the underlying
loans. The outstanding trust certificate balances and the related receivable
balances contained in the trust were $9.5 and $29.6 million at September 30,
1994 and 1993, respectively. The Bank is contingently liable under a surety
bond issued in connection with this transaction. See Note 28.
F-38
16. PROPERTY AND EQUIPMENT - THE BANK
Property and equipment is composed of the following:
Estimated September 30,
Useful ---------------------------------------
(Dollars in thousands) Lives 1994 1993
--------------------------------------------------------------- ------------------ ------------------- -------------------
Land - $ 24,035 $ 23,033
Construction in progress - 1,532 2,366
Buildings and improvements 10-45 years 48,411 47,001
Leasehold improvements 5-20 years 52,987 44,164
Furniture and equipment 5-10 years 121,947 106,603
Automobiles 3-5 years 1,366 791
------------------- -------------------
250,278 223,958
Less:
Accumulated depreciation and amortization 105,870 88,158
------------------- -------------------
Total $ 144,408 $ 135,800
=================== ===================
Depreciation expense amounted to $18.5, $14.8 and $14.5 million for the years
ended September 30, 1994, 1993 and 1992, 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 1995 to 2019 and
ground leases which have terms expiring from 2029 to 2080. 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, 1994:
Year Ending
September 30, (In thousands)
------------------ -------------------
1995 $ 10,564
1996 10,165
1997 7,910
1998 6,705
1999 5,381
Thereafter 47,016
-------------------
Total $ 87,741
===================
Rent expense totaled $9.7, $9.2 and $9.0 million for the years ended September
30, 1994, 1993 and 1992, respectively.
F-39
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,
-------------------------------------------------------------------------------
1994 1993
--------------------------------------- ---------------------------------------
Weighted Weighted
Average Average
(Dollars in thousands) Amount Rate Amount Rate
---------------------------------------------- ------------------- ------------------ ------------------- ------------------
Demand accounts $ 94,600 - $ 72,518 -
NOW accounts 823,627 2.95% 762,566 2.89%
Money market deposit accounts 1,104,730 3.84% 1,196,690 3.28%
Statement savings accounts 1,201,141 3.49% 941,289 3.48%
Other deposit accounts 57,696 2.99% 50,277 2.99%
Certificate accounts, less than $100 657,134 4.13% 790,806 4.33%
Certificate accounts, $100 or more 69,833 4.52% 55,877 4.18%
------------------- -------------------
Total $ 4,008,761 3.51% $ 3,870,023 3.42%
=================== ===================
Interest expense on deposit accounts is composed of the following:
Year Ended September 30,
-----------------------------------------------------------
(In thousands) 1994 1993 1992
---------------------------------------------------------- ------------------- ------------------- -------------------
NOW accounts $ 23,147 $ 18,523 $ 22,442
Money market deposit accounts 37,305 39,430 55,384
Statement savings accounts 39,147 26,598 26,081
Other deposit accounts 1,573 1,381 1,719
Certificate accounts 29,723 41,813 75,914
------------------- ------------------- -------------------
130,895 127,745 181,540
Custodial accounts 29 47 81
------------------- ------------------- -------------------
Total $ 130,924 $ 127,792 $ 181,621
=================== =================== ===================
Outstanding certificate accounts at September 30, 1994 mature in the years
indicated as follows:
Year Ending
September 30, (In thousands)
------------------ -------------------
1995 $ 482,344
1996 119,421
1997 41,023
1998 34,116
1999 50,063
-------------------
Total $ 726,967
===================
F-40
At September 30, 1994, certificate accounts of $100 or more have contractual
maturities as indicated below:
(In thousands)
-------------------
Three months or less $ 25,690
Over three months through six months 15,343
Over six months through 12 months 10,761
Over 12 months 18,039
-------------------
Total $ 69,833
===================
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) 1994 1993 1992
- ------------------------------------------------------------------ ------------------- ------------------- -------------------
Securities sold under repurchase agreements:
Balance at year-end $ - $ 83,151 $ 446,367
Average amount outstanding during the year 103,299 265,176 123,480
Maximum amount outstanding at any month-end 202,256 478,534 485,067
Amount maturing within 30 days - 83,151 446,367
Weighted average interest rate during the year 3.78% 3.28% 3.64%
Weighted average interest rate on year-end
balances - 3.23% 3.36%
Other short-term borrowings:
Balance at year-end $ 8,907 $ 5,115 $ 3,954
Average amount outstanding during the year 13,336 2,212 2,918
Maximum amount outstanding at any month-end 51,992 5,115 6,112
Amount maturing within 30 days 8,907 5,115 3,954
Weighted average interest rate during the year 3.42% 2.77% 4.03%
Weighted average interest rate on year-end
balances 4.87% 3.71% 4.00%
The investment and mortgage-backed securities underlying the repurchase
agreements were delivered to the dealers who arranged the transactions. The
dealers may have loaned such securities to other parties in the normal course of
their operations and agreed to resell to the Bank the identical securities at
the maturities of the agreements.
At September 30, 1994, the Bank had pledged mortgage-backed securities with a
book value of $11.6 million to secure certain other borrowings.
F-41
20. BONDS PAYABLE - THE BANK
Bonds payable represent bonds (term and serial) issued through a local housing
finance agency secured by land and two residential apartment buildings having an
aggregate net book value of $25.7 and $26.4 million at September 30, 1994 and
1993, 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 $0.3 million mature on November 1, 1994. Interest
rates on these bonds are 9.3%.
The aggregate principal payments on the bonds payable outstanding at September
30, 1994 for the next five years are summarized as follows:
Year Ending
September 30, (In thousands)
------------------ -------------------
1995 $ 630
1996 685
1997 760
1998 830
1999 915
Thereafter 20,210
-------------------
Total $ 24,030
===================
Deferred debt issuance costs, net of accumulated amortization, amounted to $0.5
and $0.8 million at September 30, 1994 and 1993, respectively, and are included
in other assets in the Consolidated Balance Sheets. These amounts are being
amortized using the level-yield method over the life of the related debt.
At September 30, 1994, $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-42
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, 1994 are as follows:
Year Ending
September 30, (In thousands)
------------------ -------------------
1995 $ 215
1996 236
1997 260
1998 286
1999 314
Thereafter 6,418
-------------------
Total $ 7,729
===================
22. FEDERAL HOME LOAN BANK ADVANCES - THE BANK
At September 30, 1994, the Bank had a $100.0 million advance from the Federal
Home Loan Bank of Atlanta ("FHLB") with an interest rate of 4.77% which adjusts
quarterly based on the three-month London Interbank Offered Rate ("LIBOR") and
maturing in August 1996.
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 total principal
balance of $433.6 million and mortgage-backed securities with a book value of
$131.7 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, 1994 advances is
available to secure additional advances from the FHLB, subject to its
collateralization guidelines.
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) 1994 1993 Rate
- -------------------------------------------------------------- ------------------- ------------------- ------------------
Private placement:
BACOB Bank, s.c.,
due 1996 $ 10,000 $ 10,000 LIBOR + 3.0%
Public placements:
Subordinated debentures due 2002 - 78,500 13 1/2%
Subordinated debentures due 2003 - 50,000 15%
Subordinated debentures due 2005 150,000 - 9 1/4%
------------------- -------------------
Total $ 160,000 $ 138,500
=================== ===================
F-43
On November 23, 1993, the Bank sold $150.0 million 9 1/4% Subordinated
Debentures due 2005 (the "1993 Debentures"). The Bank received net
proceeds of $143.6 million from the sale of the 1993 Debentures, of which
approximately $134.2 million was used to redeem $78.5 million of debentures
due in 2002 and $50.0 million of debentures due in 2003 on December 23, 1993
and December 24, 1993, respectively. The remaining net proceeds were used for
general corporate purposes. The Bank incurred a loss of $6.3 million, after
related income taxes, in connection with the redemption of these 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 default shall have occurred and be
continuing and the Bank is in compliance with its regulatory capital
requirements. In addition, the amount of the proposed dividend may not exceed
the sum of (i) $15.0 million, (ii) 66 2/3% of the Bank's consolidated net income
(as defined in the Indenture) accrued on a cumulative basis commencing on
October 1, 1993 and (iii) the aggregate net cash proceeds received by the Bank
after October 1, 1993 from the sale of qualified capital stock or certain debt
securities, minus the aggregate amount of any restricted payments made by the
Bank. Notwithstanding the above restrictions on dividends, provided no event of
default has occurred or is continuing, the Indenture does not restrict the
payment of dividends on the 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.
Deferred debt issuance costs, net of accumulated amortization, amounted to $6.2
and $4.9 million at September 30, 1994 and 1993, respectively, and are included
in other assets in the Consolidated Balance Sheets.
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%. If the Board of Directors does not declare the full amount of the
noncumulative cash dividend accrued in respect of any quarterly dividend period,
in lieu thereof the Board of Directors will be required to declare (subject to
regulatory and other restrictions) a stock dividend in the form of a new series
of payment-in-kind preferred stock of the Bank.
The OTS has approved the inclusion of the Preferred Stock as tier 1 or core
capital and has approved the payment of 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. 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 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.
F-44
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
equal to the employee contribution from October 1, 1991 to June 30, 1992 and
three times the employee contribution subsequent to June 30, 1992. Corporate
contributions were $3.5, $3.1 and $1.5 million for the years ended September 30,
1994, 1993 and 1992, 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 MATTERS - THE BANK
Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA"), the Bank's regulatory capital requirements at September 30, 1994
were a 1.5% tangible capital requirement, a 3.0% core capital requirement and an
8.0% total risk-based capital requirement. Under the OTS "prompt corrective
action" regulations, the Bank must maintain minimum leverage, tier 1 risk-based
and total risk-based capital ratios of 4.0%, 4.0% and 8.0%, respectively, to
meet the ratios established for "adequately-capitalized" institutions. At
September 30, 1994, the Bank was in compliance with its tangible, core and
risk-based regulatory capital requirements. In addition, on the basis of its
balance sheet at September 30, 1994, the Bank met the FIRREA-mandated fully
phased-in capital requirements. The information below is based upon the Bank's
understanding of the applicable FIRREA and "prompt corrective action"
regulations and related interpretations.
MINIMUM EXCESS
ACTUAL CAPITAL REQUIREMENT CAPITAL
--------------------------------------- --------------------------------------- ------------------
As a % of As a % of
(Dollars in thousands) Amount Assets (3) Amount Assets Amount
- ---------------------------- ------------------- ------------------ ------------------- ------------------ -------------------
Capital per financial $ 289,956
statements
Adjustments for tangible and
core capital:
Intangible assets (50,484)
Non-includable
subsidiaries (1) (9,990)
-------------------
Total tangible capital 229,482 4.96% $ 69,369 1.50% $ 160,113
Supervisory goodwill 17,342 ================== =================== ================== ===================
-------------------
Total core capital (2) 246,824 5.34% $ 184,984 4.00% $ 61,840
------------------- ================== =================== ================== ===================
Tier 1 risk-based capital (2) 246,824 6.95% $ 142,077 4.00% $ 104,747
------------------- ================== =================== ================== ===================
Adjustments for total risk-
based capital:
Subordinated capital
debentures 152,900
Reserve for general loan
losses 42,973
-------------------
Total supplementary capital 195,873
-------------------
Total available capital 442,697
Equity investments (1) (34,009)
-------------------
Total risk-based capital (2) $ 408,688 12.19% $ 284,154 8.00% $ 124,534
=================== ================== =================== ================== ===================
<FN>
- ----------------------------------------------------------------------------------------------------------------------------------
(1) Reflects an aggregate offset of $5.5 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%.
(3) If the OTS policy to exclude net unrealized holding gains (losses) from
regulatory capital (see below) had been in effect on September 30, 1994,
the Bank's tangible, core, tier 1 risk-based and total risk-based
regulatory capital ratios would have increased to 5.27%, 5.64%, 7.35% and
12.66%, respectively.
F-45
In November 1994, the OTS announced its policy to exclude net unrealized holding
gains (losses) on debt securities classified as available-for-sale from
regulatory capital for purposes of computing regulatory capital ratios. Savings
associations are required to adopt the revised policy by June 1995, but may
elect to adopt the revised policy beginning December 1994. This decision
reversed the interim OTS policy issued in August 1993, which required net
unrealized holding gains (losses) to be fully includable in tier 1 capital for
regulatory capital purposes.
At September 30, 1994, the Bank had $27.2 million in loans to and 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): 40% beginning July 1, 1994; 60% beginning
July 1, 1995 and 100% beginning July 1, 1996. At September 30, 1994, the Bank
also had $38.6 million in equity investments which were fully phased-out from
total risk-based capital.
As of September 30, 1994, the Bank had $48.3 million in supervisory goodwill, of
which $17.3 million was included in core capital subject to a limitation of
0.375% of tangible assets. The percentage includable in core capital declines
to 0% of tangible assets effective January 1, 1995.
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. Although there can be no
assurances, management believes that it will be able to receive the necessary
extensions. The following table sets forth the Bank's REO at September 30, 1994,
after valuation allowances of $109.1 million, by the fiscal year in which the
property was acquired through foreclosure.
Fiscal Year (In thousands)
------------------ -------------------
1990 $ 129,152 (1)
1991 106,318
1992 15,860
1993 7,450
1994 19,170
-------------------
Total REO $ 277,950
===================
<FN>
- ----------------------------------------------------------------------
(1) Includes REO with an aggregate net book value of $34.0 million, which the
Bank has agreed to treat as equity investments for regulatory capital
purposes.
Under the OTS "prompt corrective action" regulations, 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, 1994. On a
fully phased-in basis at September 30, 1994, the Bank's regulatory capital
ratios would meet the ratios established for "adequately-capitalized"
institutions.
F-46
The Bank is subject to a written agreement with the OTS dated September 30,
1991. The agreement, which was 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.
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, 1994 is
as follows:
(In thousands)
-------------------
Balance, September 30, 1993 $ 4,302
Additions 1,139
Collections (889)
-------------------
Balance, September 30, 1994 $ 4,552
===================
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 $0.5, $0.6 and $0.6 million for the years ended
September 30, 1994, 1993 and 1992, respectively.
The law firm in which one director of the Bank is a partner received $2.4,
$2.7 and $3.0 million for legal services rendered to the Corporations during
the years ended September 30, 1994, 1993 and 1992, respectively.
For the years ended September 30, 1994, 1993 and 1992, one of the directors
of the Bank was paid $30,000 $28,000 and $25,000, respectively, for consulting
services rendered to the Bank. Another director of the Bank was paid total
fees of $50,000 for the year ended September 30, 1994 for consulting services.
A director of the Bank and his wife are entitled to $125,000 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. The director also receives compensation under an agreement for
ongoing services provided to the Bank. Amounts paid to the director under
these agreements totaled $167,000 and $165,000 in fiscal 1994 and 1993.
F-47
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 Real Estate 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 $9.6
and $5.0 million to the Real Estate Trust during fiscal 1994 and 1993,
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 tax sharing payments during fiscal
1994 and 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. After receipt of OTS approval, the Bank made an additional tax
sharing payment of $5.0 million to the Real Estate Trust subsequent to
September 30, 1994. Under the terms of the Bank's written agreement with the
OTS dated September 30, 1991, as amended, 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, 1994 and
1993, the estimated tax sharing payment payable to the Real Estate Trust by
the Bank was $12.0 and $21.9 million, respectively.
OTHER:
The Corporations paid $3.9, $3.5 and $3.4 million for office space leased from
or managed by companies affiliated with the Bank or its directors during the
years ended September 30, 1994, 1993 and 1992, respectively.
The Corporations owned approximately 45% of Avenel Associates Limited
Partnership ("Avenel"), which owned a commercial property. The general partner
in the partnership was 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, a newly formed partnership in which the Trust owns a
21.5% interest, other affiliated entities of the Trust own a 5.5% interest and
public shareholders own a 73% interest. These assets were sold at amounts
that exceeded their net carrying values. During fiscal 1994, upon payment of
a final distribution to its partners, Avenel was dissolved.
The Trust, the B. F. Saul Company and Chevy Chase Lake Corporation, an
affiliate of the Bank, from time to time maintain interest-bearing deposit
accounts with the Bank. Those accounts totaled $46.8 million at September 30,
1994. The Bank paid interest on the accounts amounting to $1.1 million in
fiscal 1994.
During fiscal 1994, the Bank sold 12.70 acres of retail land to Saul Holdings
at an amount equal to its net carrying value.
F-48
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 $7,451.4 million of outstanding commitments to extend credit at
September 30, 1994. 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. Because many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
These commitments are subject to the Bank's normal underwriting and credit
evaluation policies and procedures.
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 its pipeline by entering
into whole loan and mortgage-backed security forward sale commitments. At
September 30, 1994, the Bank had whole loan and mortgage-backed security
forward sale commitments of $5.2 and $41.9 million, respectively. In
addition, at September 30, 1994, the Bank had $1.8 million in mortgage-backed
security forward 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, 1994, the
Bank had written letters of credit in the amount of $62.6 million, of which
$55.7 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, $31.3 million will expire in fiscal 1995 and the remainder will
expire over time through fiscal 1999. 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 $9.5 million were pledged as collateral for certain of these
letters of credit at September 30, 1994.
F-49
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, 1994, the primary
recourse to the Bank was $65.9 million. As a result of these recourse
provisions, the Bank maintained restricted cash accounts amounting to $73.1
and $125.8 million, at September 30, 1994 and 1993, 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, 1994, recourse to the Bank under these arrangements was $5.9 million. As
security for the payment of funds due under certain of the FHLMC recourse
obligations, the Bank is required to post collateral. At September 30, 1994,
mortgage-backed securities pledged as collateral under these obligations had a
book value of $6.2 million.
CONCENTRATIONS OF CREDIT:
The Bank's principal real estate lending market is the metropolitan
Washington, D.C. area. In addition, approximately 17.8% of the Bank's
outstanding credit card loans at September 30, 1994 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.
F-50
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, 1994 and 1993 are as follows:
September 30, 1994 September 30, 1993
--------------------------------------- ---------------------------------------
Carrying Fair Carrying Fair
(In thousands) Amount Value Amount Value
- --------------------------------------------- ------------------- ------------------- ------------------- -------------------
Financial assets:
Cash, due from banks,
interest-bearing deposits, federal
funds sold and securities purchased
under agreements to resell $ 372,097 $ 372,097 $ 183,199 $ 183,199
Loans held for sale 33,598 33,771 176,504 179,615
Loans held for securitization and sale 115,000 115,000 300,000 300,000
Investment securities 4,364 4,364 4,789 4,822
Mortgage-backed securities 1,025,525 1,025,525 1,501,192 1,528,060
Loans receivable, net of reserve 2,357,598 2,334,515 1,861,276 1,938,886
Other financial assets 236,934 238,417 276,026 277,509
Financial liabilities:
Deposit accounts with
no stated maturities 3,281,794 3,281,794 3,023,340 3,023,340
Deposit accounts with
stated maturities 726,967 734,547 846,683 854,398
Securities sold under
repurchase agreements and other
short-term borrowings, bonds payable,
notes payable and Federal Home Loan
Bank advances 140,162 (1) 142,027 531,973 (1) 536,831
Capital notes-subordinated 153,777 (1) 146,500 133,596 (1) 144,153
Other financial liabilities 72,111 72,111 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, 1994 and 1993:
CASH, DUE FROM BANKS, INTEREST-BEARING DEPOSITS AND FEDERAL FUNDS SOLD:
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.
F-51
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.
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. The fair value of an investment is based
on quoted market prices.
DEPOSIT ACCOUNTS WITH NO STATED MATURITIES: Deposit liabilities payable on
demand, consisting of NOW accounts, money market deposits, statement savings and
other deposit accounts, are assumed to have an estimated fair value equal to
carrying value. The indicated fair value does not consider the value of the
Bank's established deposit customer relationships.
DEPOSIT ACCOUNTS WITH STATED MATURITIES: Fair value of fixed-rate certificates
of deposit is estimated based on discounted cash flow analyses using the
remaining maturity of the underlying accounts and interest rates currently
offered on certificates of deposit with similar maturities.
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 1993 Debentures is based on
quoted market prices. The carrying amount of the $10.0 million private
placement capital note approximates fair value.
OTHER FINANCIAL LIABILITIES: The carrying amount of custodial accounts, amounts
due to banks, accrued interest payable and other short-term payables
approximates fair value.
F-52
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
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. COMMITMENTS AND CONTINGENCIES - THE TRUST
The Trust is involved in a number of lawsuits arising from the normal course of
its business. On the basis of consultations with counsel, management does not
believe that any material loss will result.
F-53
32. INCOME TAXES - THE TRUST
The Trust voluntarily terminated its qualification as a real estate investment
trust under the Internal Revenue Code during fiscal 1978.
As discussed in Organization and Summary of Significant Accounting Policies,
the Trust adopted SFAS 109 effective October 1, 1993, which had the effect of
increasing the Trust's net deferred tax asset by approximately $36.3 million.
For fiscal years 1993 and 1992, the Trust accounted for income taxes in
accordance with APB 11. The provision for income taxes for the years ended
September 30, 1994, 1993 and 1992, consists of the following:
Year Ended September 30,
-----------------------------------------------------------
(In thousands) 1994 1993 1992
- ------------------------------------------------------------- ------------------- ------------------- -------------------
Current provision (benefit):
Federal $ 13,480 $ (1,057) $ 6,754
State 4,421 3,971 5,364
------------------- ------------------- -------------------
17,901 2,914 12,118
------------------- ------------------- -------------------
Deferred provision (benefit):
Federal (10,390) 8,795 (2,937)
State (486) (6) (1,796)
------------------- ------------------- -------------------
(10,876) 8,789 (4,733)
------------------- ------------------- -------------------
Subtotal 7,025 11,703 7,385
Tax effect of other items:
Cumulative effect of adoption of SFAS 109 (36,260) - -
Extraordinary item (6,160) (7,738) (3,885)
Tax effect of net unrealized holding gains (losses)
reported in stockholders' equity (1) (9,243) - -
------------------- ------------------- -------------------
Total $ (44,638) $ 3,965 $ 3,500
=================== =================== ===================
<FN>
(1) Net unrealized holding gains (losses) on securities available-for-sale
recorded in conjunction with SFAS 115 are reflected net of related taxes in
the shareholders' deficit section in the accompanying Consolidated Balance
Sheets.
The tax effect of each timing difference resulting in a deferred income tax
benefit is as follows:
Year Ended September 30,
---------------------------------------
(In thousands) 1993 1992
---------------------------------------------------------------------------------- ------------------- -------------------
Provision for losses in excess of deductions $ 14,437 $ (8,147)
Depreciation (2,864) 1,610
Deferred loan fees (938) 2,121
Valuation allowances 19 77
Real estate mortgage investment conduit (1,454) (624)
State taxes (211) -
State net operating losses (1,577) -
Other 1,377 230
------------------- -------------------
Total $ 8,789 $ (4,733)
=================== ===================
F-54
On August 10, 1993, Congress passed the Tax Revenue Reconciliation Act of 1993,
retroactively increasing the Federal corporate income tax rate from 34% to 35%
effective January 1, 1993. As a result, the Trust's income tax rate for fiscal
years 1994, 1993 and 1992 was 35.00%, 34.75% and 34.00%, respectively.
The Trust's effective income tax rate varies from the statutory Federal income
tax rate as a result of the following factors:
Year Ended September 30,
-----------------------------------------------------------
(In thousands) 1994 1993 1992
- ------------------------------------------------------------ ------------------- ------------------- -------------------
Computed tax at statutory Federal income tax rate $ 6,609 $ 6,726 $ 5,065
Increase (reduction) in taxes resulting from:
Goodwill and other purchase accounting adjustments 1,311 1,965 32
State income taxes 2,570 2,705 2,203
Other (3,465) 307 85
------------------- ------------------- -------------------
$ 7,025 $ 11,703 $ 7,385
=================== =================== ===================
Under SFAS 109, the components of the net deferred tax asset were as follows:
September 30,
(In thousands) 1994
- ------------------------------------------------------------------------------------- -------------------
Deferred tax assets:
Provision for losses in excess of deductions $ 54,903
Property 8,496
Deferred loan fees 3,309
Real estate mortgage investment conduit 3,655
State net operating losses 1,333
Partnership investments 1,471
Alternative minimum tax 1,979
Forgiveness of debt 5,267
Depreciation 1,410
Net operating losses 15,790
Other 1,855
-------------------
Gross deferred tax assets 99,468
-------------------
Deferred tax liabilities:
Net unrealized holding gains on securities available for sale (10,324)
Saul Holdings (8,685)
Real estate taxes (346)
Depreciation (7,639)
FHLB stock dividends (5,658)
Other (4,668)
-------------------
Gross deferred tax liabilities (37,320)
-------------------
Valuation allowance (7,000)
-------------------
Net deferred tax asset $ 55,148
===================
F-55
Under SFAS 109, a valuation allowance is provided when it is more likely than
not that some portion of the deferred tax asset will not be realized. Management
has established a valuation allowance in part to reduce the net deferred tax
asset for net operating loss carryforwards related to state taxes.
Historically, the Bank has generated taxable income while the Real Estate Trust
has generated taxable losses. Net operating loss carryforwards are realizable
through future taxable income of the Bank since the Trust files a consolidated
tax return for federal purposes. The net operating loss carryforwards are not
expected to be realizable for state tax purposes since a consolidated return is
not filed with state tax authorities.
In the opinion of management, the net deferred tax asset of $55.2 million will
be realized through future taxable income primarily attributable to the Bank.
In order to realize the portion of the net deferred tax asset related to net
operating loss carryforwards, the Bank will need to generate future taxable
income of approximately $40.0 million in excess of annual taxable losses of the
Real Estate Trust. The Real Estate Trust generated a net taxable loss of
approximately $22 million in fiscal 1994.
Based on the Trust's historical consolidated net income of $23.1, $4.5 and $5.9
million in fiscal years 1994, 1993 and 1992, respectively, in the opinion of
management, it is more likely than not that the Trust will realize the benefit
of the federal net operating loss carryforward before expiration. Furthermore
management believes the existing net deductible temporary differences will
reverse during periods in which the Bank generates taxable income in excess of
Real Estate Trust taxable losses. Management believes that the positive
consolidated earnings trend will continue as a result of continued improvement
in Bank earnings. In addition, management believes that the losses from the
Real Estate Trust will stabilize as a result of recent transactions that either
eliminated or reduced debt service requirements. See further discussion in
Notes 2 and 3.
TAX SHARING AGREEMENT
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 overalll 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 $9.6 and $5.0
million, respectively, to the Trust during fiscal 1994 and 1993. Subsequent to
September 30, 1994, the OTS approved and the Bank made a tax sharing payment of
$5.0 million. The Bank 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 permission of the OTS.
In recent years, the operations of the Trust have generated net operating losses
while the Bank has reported net income. It is anticipated that the Trust's
consolidation of the Bank's operations into the Trust's federal income tax
return will result in the use of the Trust's net operating losses to reduce the
federal income taxes the Bank would otherwise owe. If in any future year, the
Bank has taxable losses or unused credits, the Trust would be obligated to
reimburse the Bank for the greater of (i) the tax benefit to the group using
such tax losses or unused tax credits in the group's consolidated Federal income
tax returns or (ii) the amount of 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.
As of September 30, 1994, the federal tax net operating loss carryforwards and
alternative minimum tax carryforwards were $39.9 and $2.0 million, respectively.
The net operating losses will begin to expire in the year 2004.
F-56
33. SHAREHOLDERS' EQUITY - THE TRUST
In June 1990, the Trust acquired from affiliated companies an additional equity
interest in the Bank, which raised the Trust's ownership share of the Bank to
80%. In exchange for the interest acquired, the Trust issued 450,000 shares of
a new class of $10.50 cumulative preferred shares of beneficial interest with a
par value of $1 ("preferred shares"). The transaction has been accounted for at
historical cost in a manner similar to the pooling of interests method because
the entities are considered to be under common control. In addition, the Trust
acquired two real estate properties from an affiliate in exchange for 66,000
preferred shares.
At September 30, 1994, 1993, and 1992, the amount of dividends in arrears on the
preferred shares was $21,226,500 ($41.14 per share), $15,808,500 ($30.64 per
share) and $10,390,500 ($20.14 per share), respectively.
F-57
34. QUARTERLY FINANCIAL DATA (UNAUDITED) - THE TRUST
Year Ended September 30, 1994
-------------------------------------------------------------------------------
(In thousands, except per share amounts) December March June September
- ----------------------------------------------- ------------------- ------------------- ------------------- -------------------
Real Estate Trust
Total income $ 14,854 $ 14,183 $ 19,010 $ 17,997
Operating loss (10,092) (9,261) (5,468) (9,484)
The Bank
Interest income 81,656 86,794 83,191 82,823
Interest expense 42,220 42,136 40,204 40,984
Provision for loan losses (12,095) (3,804) (11,701) (5,637)
Gain (loss) on real estate held for investment or
sale, net (284) (2,357) 2,566 910
Gain (loss) on sales of credit card relationships,
loans and mortgage-backed securities, net 2,490 18,968 (684) 9,748
Operating income 5,995 24,617 2,645 19,930
Total Company
Operating income (loss) before income taxes,
extraordinary items, cumulative effect of
change in accounting principle, and minority
interest (4,097) 15,356 (2,823) 10,446
Income (loss) before extraordinary items,
cumulative effect of change in accounting
principle and minority interest (3,389) 8,453 (2,823) 9,616
Extraordinary items (6,333) (4,982) - -
Income (loss) before cumulative effect of change
in accounting principle and minority interest (9,722) 3,471 (2,823) 9,616
Cumulative effect of change in accounting 36,260 - - -
principle
Net income (loss) 23,595 (1,342) (5,052) 5,888
Net income (loss) per common share 4.61 (0.56) (1.33) 0.94
- ----------------------------------------------------------------------------------------------------------------------------------
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 or
sale, net (19,601) 978 38 5,863
Gain on sales of credit card relationships, loans
and mortgage-backed securities, net 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)
- -----------------------------------------------------------------------------------------------------------------------------------
F-58
35. INDUSTRY SEGMENT INFORMATION - THE TRUST
Industry segment information with regard to the Real Estate Trust is presented
below. For information regarding the Bank please refer to the "Banking" sections
of the accompanying financial statements.
- ----------------------------------------------------------------------------------------------------------------------------------
Year Ended September 30
-----------------------------------------------------------
(In thousands) 1994 1993 1992
- ---------------------------------------------------------------- ------------------- ------------------- -------------------
INCOME
Commercial properties $ 16,815 $ 45,736 $ 51,489
Hotels 46,046 45,385 46,628
Other 3,183 2,124 2,062
------------------- ------------------- -------------------
$ 66,044 $ 93,245 $ 100,179
=================== =================== ===================
OPERATING PROFIT (LOSS)
Commercial properties $ 5,473 $ 24,316 $ 28,531
Hotels 7,488 7,228 7,937
Other 3,510 (252) (90)
------------------- ------------------- -------------------
16,471 31,292 36,378
Gain (loss) on sales of property - 184 (546)
Interest and debt expense (net of interest capitalized) (40,576) (53,499) (53,024)
Advisory fee, management and leasing fees - related parties (6,793) (7,249) (7,093)
General and administrative (2,027) (2,119) (4,226)
Abandoned development costs - (13,104) -
Write-down of assets to net realizable value (1,380) - -
------------------- ------------------- -------------------
Operating loss $ (34,305) $ (44,495) $ (28,511)
=================== =================== ===================
IDENTIFIABLE ASSETS (AT YEAR END)
Commercial properties:
Operating properties $ 83,937 $ 87,142 $ 183,731
Properties under development - - 640
Hotels - operating properties 79,183 82,472 83,897
Other 164,619 50,942 66,110
------------------- ------------------- -------------------
$ 327,739 $ 220,556 $ 334,378
=================== =================== ===================
DEPRECIATION
Commercial properties $ 4,370 $ 7,712 $ 8,542
Hotels 4,684 4,660 4,728
Other 28 85 130
------------------- ------------------- -------------------
$ 9,082 $ 12,457 $ 13,400
=================== =================== ===================
CAPITAL EXPENDITURES
Commercial properties:
Operating properties $ 2,486 $ 5,996 $ 3,814
Properties under development - - 32
Hotels - operating properties 3,586 1,458 2,279
Other 645 11 68
------------------- ------------------- -------------------
$ 6,717 $ 7,465 $ 6,193
=================== =================== ===================
- ----------------------------------------------------------------------------------------------------------------------------------
F-59
36. 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) 1994 1993
- ------------------------------------------------------------------------------------- ------------------- -------------------
ASSETS
Income-producing properties $ 227,640 $ 224,982
Accumulated depreciation (68,111) (62,626)
------------------- -------------------
159,529 162,356
Land parcels 38,455 38,411
Equity investment in bank 142,527 129,968
Cash and cash equivalents 30,445 2,710
Other assets 99,310 17,079
------------------- -------------------
Total assets $ 470,266 $ 350,524
=================== ===================
LIABILITIES
Mortgage notes payable $ 185,730 $ 264,776
Notes payable - secured 175,000 -
Notes payable - unsecured 40,288 38,661
Deferred gains - real estate 112,883 109,027
Other liabilities and accrued expenses 44,208 37,689
------------------- -------------------
Total liabilities 558,109 450,153
TOTAL SHAREHOLDERS' DEFICIT* (87,843) (99,629)
------------------- -------------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 470,266 $ 350,524
=================== ===================
<FN>
* See Consolidated Statements of Shareholders' Deficit
- ----------------------------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF OPERATIONS
Year Ended September 30
-----------------------------------------------------------
(In thousands) 1994 1993 1992
- ---------------------------------------------------------------- ------------------- ------------------- -------------------
Total income $ 66,044 $ 93,245 $ 100,179
Total expenses (102,087) (137,256) (127,936)
Equity in earnings (losses) of partnership investments 1,738 (668) (208)
Gain (loss) on sales of property - 184 (546)
------------------- ------------------- -------------------
Real estate operating loss (34,305) (44,495) (28,511)
Equity in earnings of bank 15,850 49,314 34,612
------------------- ------------------- -------------------
Total company operating income (loss) (18,455) 4,819 6,101
Provision for income taxes (income tax benefit) (15,369) 346 32
------------------- ------------------- -------------------
Income (loss) before extraordinary item and cumulative
effect of change in accounting principle (3,086) 4,473 6,069
Extraordinary item: loss on early extinguishment of debt (4,982) - (132)
------------------- ------------------- -------------------
Income (loss) before cumulative effect of change in accounting principle (8,068) 4,473 5,937
Cumulative effect of change in accounting principle 31,157 - -
------------------- ------------------- -------------------
TOTAL COMPANY NET INCOME (LOSS) $ 23,089 $ 4,473 $ 5,937
=================== =================== ===================
F-60
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended September 30
-----------------------------------------------------------
(In thousands) 1994 1993 1992
- ---------------------------------------------------------------- ------------------- ------------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 23,089 $ 4,473 $ 5,937
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation 9,082 12,457 13,400
Abandoned development costs - 13,104 -
Write-down of real estate to net realizable value 1,380 - -
Loss (gain) on sales of property - (184) 546
Equity in earnings of bank (15,850) (49,314) (34,612)
Increase in deferred tax asset (19,028) - -
Loss on early extinguishment of debt 4,982 - 132
Decrease (increase) in accounts receivable and accrued income (516) 98 2,906
Increase (decrease) in accounts payable and accrued expenses (5,473) 7,047 11,594
Other (8,525) 9,170 (787)
------------------- ------------------- -------------------
Net cash used in operating activities (10,859) (3,149) (884)
------------------- ------------------- -------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures - properties (6,717) (7,465) (6,193)
Property sales - 3,780 4,908
Equity investment in unconsolidated entities (17,780) 4,850 (58)
Notes receivable - affiliates (12,675) - -
Other investing activities 43 836 10
------------------- ------------------- -------------------
Net cash provided by (used in) investing activities (37,129) 2,001 (1,333)
------------------- ------------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 185,080 8,787 40,590
Repayments of long-term debt (74,161) (24,519) (35,747)
Financing proceeds placed in liquidity maintenance escrow (25,792) - -
Costs of obtaining financings (9,404) (1,170) (4,674)
Proceeds from the issuance of redeemable preferred stock - 21,507 -
Dividends paid - (1,375) -
------------------- ------------------- -------------------
Net cash provided by financing activities 75,723 3,230 169
------------------- ------------------- -------------------
Net increase (decrease) in cash and cash equivalents 27,735 2,082 (2,048)
Cash and cash equivalents at beginning of year 2,710 628 2,676
------------------- ------------------- -------------------
Cash and cash equivalents at end of year $ 30,445 $ 2,710 $ 628
=================== =================== ===================
F-61
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, 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 of Trustees. They provide an objective assessment of the
fairness and accuracy of the financial statements, consider the adequacy of the
system of internal accounting controls and perform such tests and other
procedures as they deem necessary to express an opinion on the fairness of the
financial statements. Management believes that the policies and procedures it
has established provide reasonable assurance that its operations are conducted
in conformity with law and a high standard of business conduct.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
In accordance with the requirements of rules promulgated under the
Securities Exchange Act of 1934, the Trust filed a Current Report on Form 8-K
with the Securities and Exchange Commission on May 23, 1994 with respect to the
appointment of Arthur Andersen LLP as the Trust's independent public
accountants.
-134-
FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Real Estate Trust are
included herein:
Schedule III - Condensed Financial
Information - Years ended
September 30, 1994, 1993, and 1992.
Schedule X - Consolidated Schedule
of Supplementary Income Statement
Information - Years ended
September 30, 1994, 1993, 1992
Schedule XI - Consolidated Schedule
of Investment Properties -
September 30, 1994
-135-
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL
STATEMENT SCHEDULES
To the Trustees and Shareholders of
B.F. Saul Real Estate Investment Trust:
We have audited in accordance with generally accepted auditing standards, the
consolidated financial statements of B.F. Saul Real Estate Investment Trust
(the "Trust") as of September 30, 1994 and for the year then ended and have
issued our report thereon dated December 19, 1994. Our audit was made for the
purpose of forming an opinion on those statements taken as a whole. The
schedules listed in Item 14 are the responsibility of the Trust's management
and are presented for purposes of complying with the Securities and Exchange
Commission's rules and are not part of the basic financial statements. These
schedules have been subjected to the auditing procedures applied in the audit
of the basic financial statements, and, in our opinion, fairly state in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
Washington, D.C. Arthur Andersen LLP
December 19, 1994
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL
STATEMENT SCHEDULES
To the Trustees and Shareholders of
B.F. Saul Real Estate Investment Trust:
We have audited the consolidated financial statements of B.F. Saul Real
Estate Investment Trust as of September 30, 1993, and for the years ended
September 30, 1993 and 1992, and have issued our report thereon dated
November 4, 1993; such consolidated financial statements and report are
included elsewhere in this Form 10-K. Our audits also included the consolidated
financial statement schedules of B.F. Saul Real Estate Investment Trust for the
years ended September 30, 1993 and 1992, listed in Item 14. These financial
statement schedules are the responsibility of the Trust's management. Our
responsibility is to express an opinion based on our audits. In our opinion,
such consolidated financial statement schedules for the years ended
September 30, 1993 and 1992, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
STOY, MALONE & COMPANY, P.C.
Bethesda, Maryland
November 4, 1993
B.F. SAUL REAL ESTATE INVESTMENT TRUST
CONDENSED FINANCIAL INFORMATION (RULE 12-04) SCHEDULE III
(a) Required condensed financial information on the Trust is disclosed in the
audited consolidated financial statements included herewith.
(b) Amounts of cash dividends paid to the Trust by consolidated subsidiaries
were as follows:
Year Ended September 30
-------------------------------------
1994 1993 1992
-------------------------------------
None None None
Schedule X
CONSOLIDATED SCHEDULE OF SUPPLEMENTARY INCOME STATEMENT INFORMATION
FOR THE YEARS ENDED SEPTEMBER 30
(In thousands)
1994 1993 1992
--------- --------- ---------
Repairs and maintenance
Real Estate Trust $4,219 $5,257 $5,190
The Bank 6,971 6,064 5,170
Depreciation
Real Estate Trust 9,104 12,457 13,400
The Bank 18,292 16,191 15,773
Amortization of intangible assets
The Bank 22,556 36,640 24,901
Taxes, other than payroll and income taxes
Real Estate Trust 3,216 5,616 5,839
The Bank 2,437 2,608 2,834
Advertising
Real Estate Trust 2,331 2,501 2,563
The Bank 49,242 13,157 4,632
Schedule XI
Consolidated Schedule of Investment Properties - Real Estate Trust
September 30, 1994
(Dollars in Thousands)
Costs Basis at Close of Period
Capitalized ----------------------------------------------------------
Initial Subsequent Buildings
Basis to to and Leasehold
Commercial Trust Acquisition Land Improvements Interests Total
- ------------------------------------ ------------ ------------- --------- -------------- ----------- -----------
900 Circle 75 Pkway, Atlanta, GA $ 34,458 $ 50 $ 563 $ 33,945 -- $ 34,508
1000 Circle 75 Pkway, Atlanta, GA 2,820 1,085 248 3,657 -- 3,905
1100 Circle 75 Pkway, Atlanta, GA 22,746 1,199 419 23,526 -- 23,945
8201 Greensboro, Tysons Corner, VA 28,890 2,370 1,633 29,627 -- 31,260
Commerce Ctr. - Ph II, Ft. Laud., FL 4,266 400 782 3,884 -- 4,666
Dulles North., Loudoun Co., VA -- 5,438 421 5,017 -- 5,438
Metairie Tower, Metairie, LA 2,729 539 403 2,865 -- 3,268
Perimeter Way, Atlanta, GA 6,950 (3,045) 1,201 2,704 -- 3,905
------------ ------------- --------- -------------- ----------- -----------
Subtotal - Commercial $102,859 $8,036 $5,670 $105,225 -- $110,895
------------ ------------- --------- -------------- ----------- -----------
Hotels
- ------------------------------------
Hampton Inn-Dulles, Sterling, VA $ -- 5,743 $ 290 $ 5,453 -- $ 5,743
Holiday Inn, Cincinnati, OH 6,859 1,019 245 7,633 -- 7,878
Holiday Inn, Dulles, VA 6,950 18,187 862 24,275 -- 25,137
Holiday Inn, Gaithersburg, MD 3,849 13,680 1,781 15,748 -- 17,529
Holiday Inn, Pueblo, CO 3,458 1,479 561 4,376 -- 4,937
Holiday Inn, Rochester, NY 3,340 9,052 605 11,787 -- 12,392
Holiday Inn, Tysons Corner, VA 6,976 11,024 3,107 14,893 -- 18,000
Howard Johnsons, Arl., VA 10,187 1,658 1,183 10,662 -- 11,845
Howard Johnsons, Norfolk, VA 5,275 1,383 228 6,430 -- 6,658
The Chase Rest., Tysons Corner, VA -- 956 -- 956 -- 956
The Chase Rest., Atlanta, GA -- 1,085 -- 1,085 -- 1,085
------------ ------------- --------- -------------- ----------- -----------
Subtotal - Hotels $46,894 $65,266 $8,862 $103,298 -- $112,160
------------ ------------- --------- -------------- ----------- -----------
Buildings
and
Improvements
Accumulated Related Date of Date Depreciable
Commercial Depreciation Debt Construction Acquired Lives (Years)
- ------------------------------------- -------------- ---------- --------------- ---------- ---------------
900 Circle 75 Pkway, Atlanta, GA $9,651 $22,580 1985 12/85 35
1000 Circle 75 Pkway, Atlanta, GA 1,690 2,230 1974 4/76 40
1100 Circle 75 Pkway, Atlanta, GA 7,671 16,241 1982 9/82 40
8201 Greensboro, Tysons Corner, VA 8,913 37,425 1985 4/86 35
Commerce Ctr. - Ph II, Ft. Laud., FL 874 1,340 1986 1/87 35
Dulles North., Loudoun Co., VA 613 3,617 1990 10/90 31.5
Metairie Tower, Metairie, LA 1,371 -- 1974 11/76 40
Perimeter Way, Atlanta, GA 798 2,000 1973 & 1974 6/84 35
------------- ----------
Subtotal - Commercial $31,581 $85,433
------------- ----------
Hotels
- -------------------------------------
Hampton Inn-Dulles, Sterling, VA $1,692 $2,386 1987 4/87 31.5
Holiday Inn, Cincinnati, OH 3,414 3,485 1975 2/76 40
Holiday Inn, Dulles, VA 7,740 13,070 1971 11/84 28
Holiday Inn, Gaithersburg, MD 4,887 7,639 1972 6/75 45
Holiday Inn, Pueblo, CO 1,743 4,854 1973 3/76 40
Holiday Inn, Rochester, NY 4,327 14,674 1975 3/76 40
Holiday Inn, Tysons Corner, VA 5,009 17,103 1971 6/75 47
Howard Johnsons, Arl., VA 3,766 10,070 1973 11/83 30
Howard Johnsons, Norfolk, VA 3,285 1,630 1960 2/79 33
The Chase Rest., Tysons Corner, VA 203 -- 1987 5/87 35
The Chase Rest., Atlanta, GA 269 -- 1985 2/86 35
------------- ----------
Subtotal - Hotels $36,335 $74,911
------------- ----------
Schedule XI-Continued
Consolidated Schedule of Investment Properties - Real Estate Trust (Continued)
September 30, 1994
(Dollars in Thousands)
Costs Basis at Close of Period
Capitalized -----------------------------------------------------
Initial Subsequent Buildings
Basis to to and Leasehold
Purchase-Leasebacks Trust Acquisition Land Improvements Interests Total
- ----------------------------------------- ----------- -------------- ---------- ----------------- ------------ -----------
Beverly Plaza, Casper, WY $500 -- $500 -- -- $500
Chateau di Jon, Metairie, LA 1,125 -- 1,125 -- -- 1,125
Country Club, Knoxville, TN 500 -- 500 -- -- 500
Houston Mall, Warner Robbins, GA 650 -- 650 -- -- 650
Old National, Atlanta, GA 550 -- 550 -- -- 550
----------- -------------- ---------- ----------------- ------------ -----------
Subtotal - Purchase-Leasebacks $3,325 -- $3,325 -- -- $3,325
----------- -------------- ---------- ----------------- ------------ -----------
Miscellaneous investments $633 $627 $250 $861 $149 $1,260
----------- -------------- ---------- ----------------- ------------ -----------
Total Income-Producing Properties $153,711 $73,929 $18,107 $209,384 $149 $227,640
----------- -------------- ---------- ----------------- ------------ -----------
Land Parcels
- -----------------------------------------
Arvida Park of Commerce,
Boca Raton, FL 7,378 126 7,504 -- -- 7,504
Avenel, Gaithersburg, MD 361 3 364 -- -- 364
Church Road, Loudoun Co., VA 2,586 2,230 4,816 -- -- 4,816
Circle 75, Atlanta, GA 10,006 1,145 11,151 -- -- 11,151
Flagship Centre, Rockville, MD 1,729 43 1,772 -- -- 1,772
Holiday Inn - Rochester, Roch., NY 68 1 69 -- -- 69
Overland Park, Overland Park, KA 3,771 397 4,168 -- -- 4,168
Perimeter Way Land, Atlanta, GA 2,921 -- 2,921 -- -- 2,921
Prospect Indust. Pk, Ft. Laud., FL 2,203 9 2,212 -- -- 2,212
Sterling Blvd., Loudoun Co., VA -- 3,478 3,478 -- -- 3,478
----------- -------------- ---------- ----------------- ------------ -----------
Subtotal $31,023 $7,432 $38,455 -- -- $38,455
----------- -------------- ---------- ----------------- ------------ -----------
Total Investment Properties $184,734 $81,361 $56,562 $209,384 $149 $266,095
=========== ============== ========== ================= ============ ===========
Buildings
and
Improvements
Accumulated Related Date of Date Depreciable
Purchase-Leasebacks Depreciation Debt Construction Acquired Lives (Years)
- ----------------------------------------- --------------- ----------- --------------- -------------- -----------------
Beverly Plaza, Casper, WY -- -- 4/74
Chateau di Jon, Metairie, LA -- -- 11/73
Country Club, Knoxville, TN -- -- 5/76
Houston Mall, Warner Robbins, GA -- -- 2/72
Old National, Atlanta, GA -- -- 8/71
--------------- -----------
Subtotal - Purchase-Leasebacks -- --
--------------- -----------
Miscellaneous investments $195 $395
--------------- -----------
Total Income-Producing Properties $68,111 $160,739
--------------- -----------
Land Parcels
- -----------------------------------------
Arvida Park of Commerce,
Boca Raton, FL -- 19,000 12/84 & 5/85
Avenel, Gaithersburg, MD -- -- 12/76
Church Road, Loudoun Co., VA -- -- 9/84 & 4/85
Circle 75, Atlanta, GA -- 8,312 2/77 & 1/84
Flagship Centre, Rockville, MD -- -- 8/85
Holiday Inn - Rochester, Roch., NY -- -- 9/86
Overland Park, Overland Park, KA -- -- 1/77 & 2/85
Perimeter Way Land, Atlanta, GA -- -- 10/86
Prospect Indust. Pk, Ft. Laud., FL -- 1,260 10/83 & 8/84
Sterling Blvd., Loudoun Co., VA -- -- 4/84
--------------- -----------
Subtotal -- $28,572
--------------- -----------
Total Investment Properties $68,111 $189,311
=============== ===========
Schedule XI (cont'd)
CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIES - REAL ESTATE TRUST
NOTES:
(1) See Summary of Significant Accounting Policies for basis of recording
investment properties and computing depreciation. Investment properties are
discussed in Note 3 of Notes to Consolidated Financial Statements.
(2) A reconciliation of the basis of investment properties and accumulated
depreciation follows.
BASIS OF INVESTMENT PROPERTIES (In thousands)
For the Year Ended September 30
--------------------------------
1994 1993 1992
---------- ---------- ----------
Balance at beginning of period $263,393 $401,147 $408,739
Additions (reductions) during the period:
Capital expenditures 6,717 7,465 6,161
Construction & development -- -- 32
Sales - nonaffiliates -- (4,414) (5,453)
Abandoned development costs -- (13,104) --
Properties exchanged for partnership investment -- (127,995) --
Write-down of assets to net realizable value (1,380) -- --
Other (2,635) 294 (8,332)
---------- ---------- ----------
Balance at end of period $266,095 $263,393 $401,147
========== ========== ==========
ACCUMULATED DEPRECIATION (In thousands)
For the Year Ended September 30
--------------------------------
1994 1993 1992
---------- ---------- ----------
Balance at beginning of period $62,626 $95,466 $90,564
Additions (reductions) during the period:
Depreciation expense 9,082 12,457 13,400
Sales - nonaffiliates -- (820) (10)
Properties exchanged for partnership investment -- (40,870) --
Other (3,597) (3,607) (8,488)
---------- ---------- ----------
Balance at end of period $68,111 $62,626 $95,466
========== ========== ==========
EXECUTIVE OFFICES OF TRUST TRUSTEES PRINCIPAL OFFICERS
- -------------------------- -------- ------------------
B.F. Saul Real Estate GARLAND J. BLOOM, JR (A) B. FRANCIS SAUL II
Investment Trust Real Estate Consultant CHAIRMAN OF THE BOARD
8401 Connecticut Avenue Chairman of the Board
Chevy Chase, Maryland 20815 GILBERT M. GROSVENOR (A) and President, Chevy Chase
(301)986-6000 President and Chairman Bank, F.S.B.,
National Geographic B. F. Saul Company and
NOTE SALES OFFICE Society B. F. Saul Advisory Company
7200 Wisconsin Avenue, Suite 903 Chairman and Chief Executive
Bethesda, Maryland 20815 GEORGE M. ROGERS, JR. (E,N) Officer, Saul Centers, Inc.
(301)986-6207 Partner, Shaw, Pittman,
Potts & Trowbridge PHILIP D. CARACI
ADVISOR (Attorneys at Law) SENIOR VICE PRESIDENT AND
B. F. Saul Advisory Company SECRETARY
8401 Connecticut Avenue B. FRANCIS SAUL II (E) Executive, Vice President, B. F. Saul
Chevy Chase, Maryland 20815 Chairman of the Board and Company, Senior Vice President B. F. Saul
(301)986-6000 President, Chevy Chase Advisory Company, President, Franklin
Bank, F.S.B., Property Company, President, Saul
REAL ESTATE MANAGER B. F. Saul Company and Centers, Inc.
Franklin Property Company B. F. Saul Advisory Company,
8401 Connecticut Avenue Chairman & Chief Executive STEPHEN R. HALPIN, JR.
Chevy Chase, Maryland 20815 Officer, Saul Centers, Inc. VICE PRESIDENT AND
(301)986-6000 CHIEF FINANCIAL OFFICER
JOHN R. WHITMORE (E,N) Senior Vice President and
GENERAL COUNSEL President and Chief Chief Financial Officer,
Shaw, Pittman, Potts & Executive Officer Chevy Chase Bank, F.S.B.
Trowbridge The Bessemer Group and B. F. Saul Company
Washington, DC 20037 Incorporated
INDEPENDENT ACCOUNTANTS ROSS E. HEASLEY
Arthur Andersen LLP VICE PRESIDENT
Washington, D.C. 20006 Vice President, B. F. Saul
Company, B. F. Saul Advisory Company,
INDENTURE TRUSTEE -- Franklin Property Company and
SENIOR NOTES Saul Centers, Inc.
The Riggs National Bank of
Washington, DC
Washington, DC 20013 HENRY RAVENEL, JR.
VICE PRESIDENT
Vice President, B. F. Saul Company,
B. F. Saul Advisory Company and Saul
Centers, Inc.
WILLIAM K. ALBRIGHT
VICE PRESIDENT AND TREASURER
Vice President and Treasurer,
B. F. Saul Company, B. F. Saul
Advisory Company and Franklin
Property Company, Vice President &
Assistant Treasurer, Saul Centers, Inc.
<FN>
(A) Audit Committee Member
(E) Executive Committee Member
(N) Nominating Committee Member
10-K REPORT TO SEC
The Trust's Annual Report to the
Securities and Exchange Commission
(Form 10-K), which includes
a consolidated schedule of investment
properties, is available without
charge from the Secretary of the Trust.