<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER , 1996
REGISTRATION NO. 333-10495
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
AMENDMENT NO. 2
TO
FORM S-11
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES
----------------
CHEVY CHASE PREFERRED CAPITAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS GOVERNING INSTRUMENTS)
----------------
STEPHEN R. HALPIN, JR.
CHEVY CHASE PREFERRED CAPITAL CORPORATION
8401 CONNECTICUT AVENUE
CHEVY CHASE, MARYLAND 20815
(301) 986-7000
(NAME, ADDRESS AND TELEPHONE NUMBER OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES AND AGENT FOR SERVICE)
----------------
WITH COPIES TO:
THOMAS H. MCCORMICK, ESQ. VINCENT J. PISANO, ESQ.
SHAW, PITTMAN, POTTS & TROWBRIDGE
2300 N STREET, N.W. SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP
WASHINGTON, D.C. 20037 919 THIRD AVENUE
TEL: (202) 663-8175 NEW YORK, NEW YORK 10022
FAX: (202) 663-8007 TEL: (212) 735-3000
FAX: (212) 735-2000
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION
8(A), MAY DETERMINE.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF SECURITIES +
+IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL +
+PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH +
+STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED NOVEMBER 13, 1996
PROSPECTUS
3,000,000 SHARES
CHEVY CHASE PREFERRED CAPITAL CORPORATION
% NONCUMULATIVE EXCHANGEABLE PREFERRED STOCK, SERIES A
(LIQUIDATION PREFERENCE $50.00 PER SHARE)
EXCHANGEABLE INTO PREFERRED STOCK
OF
CHEVY CHASE BANK, F.S.B.
----------
Chevy Chase Preferred Capital Corporation (the "Company") is hereby offering
(the "Offering") 3,000,000 shares of its % Noncumulative Exchangeable
Preferred Stock, Series A, par value $5.00 per share (the "Series A Preferred
Shares"). Dividends on the Series A Preferred Shares are payable at the rate of
% per annum of the liquidation preference (an amount equal to $ per annum per
share), if, when and as declared by the Board of Directors of the Company.
Dividends are not cumulative and, if declared, are payable quarterly in arrears
on the fifteenth day of January, April, July and October in each year,
commencing January 15, 1997. If no dividend is declared on the Series A
Preferred Shares by the Company for a quarterly dividend period, holders of the
Series A Preferred Shares will have no right to receive a dividend for that
period, and the Company will have no obligation to pay a dividend for that
period, whether or not dividends are declared and paid for any future period.
Dividends in each dividend period shall accrue from the first day of such
period, whether or not declared or paid in the prior period.
SEE "RISK FACTORS" COMMENCING ON PAGE 9 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS IN THE SERIES A PREFERRED
SHARES OFFERED HEREBY. AMONG THE RISKS THAT PROSPECTIVE INVESTORS SHOULD
CAREFULLY CONSIDER ARE THE FOLLOWING:
. Possibility that a significant decline in interest rates could have an
adverse effect on the Company's cash flow;
. Possibility that there could be an exchange of the Series A Preferred
Shares for Bank Preferred Shares at a time when the Bank is experiencing
financial difficulties;
. Possibility that federal regulators of the Bank will impose restrictions
on the operations of the Company or the Company's ability to pay
dividends;
. Dividends are not cumulative;
. Geographic concentration in Washington, D.C., Maryland and Virginia of
properties securing the Company's initial mortgage asset portfolio;
. Possibility that the Company will not qualify as a real estate investment
trust ("REIT") for federal income tax purposes and will therefore be
subject to regular corporate income tax; and
. Lack of prior operating history of the Company.
(continued on next page)
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC(1) DISCOUNT(2) COMPANY(1)(3)
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<S> <C> <C> <C>
Per Share.............................. $50.00 $ $
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Total(4)(5)............................ $150,000,000 $ $
</TABLE>
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(1) Plus accrued dividends, if any, from , 1996.
(2) The Company and the Bank have agreed to indemnify the several Underwriters
against certain liabilities, including liabilities under the Securities Act
of 1933, as amended. See "Underwriting."
(3) Before deducting expenses payable by the Company estimated at $ .
(4) The Company has granted the several Underwriters an option exercisable
within 30 days after the date hereof to purchase up to an additional
300,000 Series A Preferred Shares at the Price to Public, less the
Underwriting Discount, solely to cover over-allotments. If such option is
exercised in full, the total Price to Public, Underwriting Discount and
Proceeds to Company will be $ , $ and $ , respectively. See
"Underwriting."
(5) In addition, the Bank will make capital contributions to the Company in
amounts equal to the sum of the total Price to Public, the Underwriting
Discount and the expenses of the Offering.
----------
The Series A Preferred Shares are offered by the several Underwriters,
subject to prior sale, when, as and if issued to and accepted by them, subject
to approval of certain legal matters by counsel for the Underwriters. The
Underwriters reserve the right to withdraw, cancel or modify such offer and to
reject orders in whole or in part. It is expected that delivery of the Series A
Preferred Shares offered hereby will be made in New York, New York on or about
, 1996.
----------
MERRILL LYNCH & CO.
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
SMITH BARNEY INC.
----------
The date of this Prospectus is , 1996.
<PAGE>
(continued from previous page)
The Series A Preferred Shares are not redeemable prior to , 2001 (except
upon the occurrence of a Tax Event, as described herein). On and after ,
2001, the Series A Preferred Shares may be redeemed for cash at the option of
the Company, in whole or in part, at a redemption price of $50.00 per share,
plus the quarterly accrued and unpaid dividend, if any, thereon, subject to
the receipt of prior approval from the Office of Thrift Supervision (the
"OTS"). The Series A Preferred Shares are not subject to any sinking fund or
mandatory redemption and are not convertible into any other securities of the
Company.
Each Series A Preferred Share will be exchanged automatically (the
"Automatic Exchange") for one newly issued Series B preferred share (the "Bank
Preferred Shares") of Chevy Chase Bank, F.S.B., a federally chartered and
federally insured stock savings bank (the "Bank"), if the appropriate federal
regulatory agency directs in writing (a "Directive") an exchange of the Series
A Preferred Shares for Bank Preferred Shares because (i) the Bank becomes
"undercapitalized" under prompt corrective action regulations, (ii) the Bank
is placed into conservatorship or receivership or (iii) the appropriate
federal regulatory agency, in its sole discretion, anticipates the Bank
becoming "undercapitalized" in the near term (the "Exchange Event").
CONSEQUENTLY, AN INVESTMENT IN SERIES A PREFERRED SHARES COULD BE REPLACED BY
AN INVESTMENT IN BANK PREFERRED SHARES AT A TIME WHEN THE BANK'S FINANCIAL
CONDITION IS DETERIORATING OR WHEN THE BANK HAS BEEN PLACED INTO
CONSERVATORSHIP OR RECEIVERSHIP. POTENTIAL INVESTORS IN THE SERIES A PREFERRED
SHARES, THEREFORE, SHOULD CAREFULLY CONSIDER THE DESCRIPTION OF THE BANK SET
FORTH ELSEWHERE IN THIS PROSPECTUS. In the event of the Automatic Exchange,
the Bank Preferred Shares would constitute a new series of preferred shares of
the Bank, would have the same dividend rights, liquidation preference,
redemption options and other attributes as the Series A Preferred Shares,
except that the Bank Preferred Shares would not be listed on the New York
Stock Exchange (the "NYSE"), and would rank pari passu in terms of cash
dividend payments and liquidation preference with any outstanding shares of
preferred stock of the Bank. Holders of Series A Preferred Shares cannot
exchange their Series A Preferred Shares for Bank Preferred Shares
voluntarily, and, absent the occurrence of the Automatic Exchange, holders of
Series A Preferred Shares will have no dividend, voting, liquidation
preference or other rights with respect to the Bank or any security of the
Bank. See "Description of Series A Preferred Shares--Automatic Exchange."
Prior to this Offering, there has been no market for the Series A Preferred
Shares. The Series A Preferred Shares have been approved for listing on the
NYSE, subject to official notice of issuance, under the trading symbol "CCP."
While the Bank intends to register the Bank Preferred Shares with the OTS, it
does not intend to apply for listing of the Bank Preferred Shares on any
national securities exchange or for quotation of the Bank Preferred Shares
through the National Association of Securities Dealers Automated Quotation
System. Consequently, there can be no assurance as to the liquidity of the
trading markets for the Bank Preferred Shares, if issued, or that an active
public market for the Bank Preferred Shares would develop or be maintained.
The Company has been formed for the purpose of acquiring, holding and
managing real estate mortgage assets. The Company expects that all or
substantially all of its mortgage assets will be purchased from the Bank and
affiliates of the Bank. All of the shares of the Company's common stock, par
value $1.00 per share (the "Common Stock"), are owned by the Bank.
The Company expects to qualify as a REIT for federal income tax purposes,
commencing with the taxable year ending December 31, 1996. Individuals are not
permitted to beneficially own more than 1% of any series of preferred stock of
the Company, including the Series A Preferred Shares.
IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE SERIES A
PREFERRED SHARES OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE
PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
PROSPECTUS SUMMARY......................................................... 1
The Company............................................................... 1
The Bank.................................................................. 2
Risk Factors.............................................................. 2
The Offering.............................................................. 4
The Formation............................................................. 6
Business and Strategy..................................................... 6
Tax Status of the Company................................................. 8
RISK FACTORS............................................................... 9
Interest Rate Risk........................................................ 9
Certain Risks Associated with the Bank.................................... 9
Dividend and Other Regulatory Restrictions on Operations of the Company... 9
Dividends Not Cumulative.................................................. 11
Risks Associated With Mortgage Loans Generally............................ 11
Tax Risks................................................................. 13
No Operating History...................................................... 14
Bank Preferred Shares Will Not be Listed on the NYSE...................... 14
Dependence Upon the Bank as Advisor and Servicer.......................... 14
Relationship With the Bank and its Affiliates; Conflicts of Interest...... 15
Risk of Future Revisions in Policies and Strategies By Board of
Directors................................................................ 15
Risks Related to Balancing Distributions.................................. 15
Risk Associated With Leverage............................................. 16
No Third Party Valuation of the Mortgage Assets; No Arm's-Length
Negotiations With Affiliates............................................. 16
No Prior Market for Series A Preferred Shares............................. 16
THE COMPANY................................................................ 16
USE OF PROCEEDS............................................................ 17
CAPITALIZATION............................................................. 18
BUSINESS AND STRATEGY...................................................... 19
General................................................................... 19
Dividend Policy........................................................... 19
Liquidity and Capital Resources........................................... 20
General Description of Mortgage Assets; Investment Policy................. 21
Acquisition of Initial Portfolio.......................................... 22
Management Policies and Programs.......................................... 22
Description of Initial Portfolio.......................................... 25
Servicing................................................................. 30
Employees................................................................. 32
Competition............................................................... 32
Legal Proceedings......................................................... 32
MANAGEMENT................................................................. 33
Directors and Executive Officers.......................................... 33
Independent Directors..................................................... 34
Audit Committee........................................................... 34
Compensation of Directors and Officers.................................... 34
Limitations on Liability of Directors and Officers........................ 34
The Advisor............................................................... 35
</TABLE>
<TABLE>
<S> <C>
CERTAIN TRANSACTIONS CONSTITUTING THE FORMATION............................ 36
The Formation............................................................. 36
Benefits to the Bank...................................................... 36
DESCRIPTION OF SERIES A PREFERRED SHARES................................... 39
General................................................................... 39
Dividends................................................................. 39
Automatic Exchange........................................................ 40
Voting Rights............................................................. 41
Redemption................................................................ 42
Rights Upon Liquidation................................................... 42
Independent Director Approval............................................. 43
Restrictions on Ownership................................................. 43
DESCRIPTION OF CAPITAL STOCK............................................... 44
Common Stock.............................................................. 44
Preferred Stock........................................................... 44
Restrictions on Ownership and Transfer.................................... 45
Super-majority Director Approval.......................................... 46
Business Combinations..................................................... 46
Control Share Acquisitions................................................ 46
FEDERAL INCOME TAX CONSIDERATIONS.......................................... 47
Taxation of the Company................................................... 47
Failure to Qualify........................................................ 51
Tax Treatment of Automatic Exchange....................................... 52
Taxation of United States Stockholders.................................... 52
Taxation of Foreign Stockholders.......................................... 53
Information Reporting Requirements and Backup Withholding Tax............. 55
Other Tax Consequences.................................................... 55
ERISA CONSIDERATIONS....................................................... 56
General................................................................... 56
Plan Asset Regulation..................................................... 56
Effect of Plan Asset Status............................................... 57
Prohibited Transactions................................................... 57
Unrelated Business Taxable Income......................................... 58
CERTAIN INFORMATION REGARDING THE BANK..................................... 58
Operations of the Bank.................................................... 58
Selected Consolidated Financial and Other Data............................ 62
Risk Factors and Other Considerations..................................... 63
Recent Developments....................................................... 68
Restrictions on Bank Dividends............................................ 70
Capitalization............................................................ 71
UNDERWRITING............................................................... 72
EXPERTS.................................................................... 73
RATINGS.................................................................... 73
LEGAL MATTERS.............................................................. 73
AVAILABLE INFORMATION...................................................... 73
GLOSSARY................................................................... 74
INDEX TO FINANCIAL STATEMENT............................................... F-1
ANNEX I--OFFERING CIRCULAR FOR BANK PREFERRED SHARES....................... OC-1
Bank Form 10-K for Fiscal Year Ended September 30, 1995
Bank Form 10-Q for Third Quarter Ended June 30, 1996
</TABLE>
i
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK.]
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the detailed
information appearing elsewhere in this Prospectus. The offering by Chevy Chase
Preferred Capital Corporation (the "Company") of 3,000,000 shares of its %
Noncumulative Exchangeable Preferred Stock, Series A, par value $5.00 per share
(the "Series A Preferred Shares"), is referred to herein as the "Offering."
Unless otherwise indicated, all information in this Prospectus assumes that the
over-allotment option described in "Underwriting" is not exercised. Capitalized
terms used herein and not otherwise defined are as defined in the Glossary
appearing elsewhere in this Prospectus.
THE COMPANY
Chevy Chase Preferred Capital Corporation is a newly formed Maryland
corporation incorporated on August 20, 1996 and created for the purpose of
acquiring, holding and managing real estate mortgage assets ("Mortgage
Assets"). The Company will elect to be subject to tax as a real estate
investment trust (a "REIT") under the Internal Revenue Code of 1986, as amended
(the "Code"), and will generally not be subject to federal income tax to the
extent that it distributes its earnings to its stockholders and maintains its
qualification as a REIT. All of the shares of the Company's common stock, par
value $1.00 per share (the "Common Stock"), are owned by Chevy Chase Bank,
F.S.B., a federally chartered and federally insured stock savings bank (the
"Bank"). The Bank has indicated to the Company that, for as long as any Series
A Preferred Shares are outstanding, the Bank intends to maintain direct or
indirect ownership of 80% of the outstanding Common Stock of the Company. The
Company has been formed by the Bank to provide the Bank with a cost-effective
means of raising capital for federal regulatory purposes.
The Company and the Bank are undertaking the Offering for two principal
reasons: (i) the qualification of the Series A Preferred Shares as core capital
of the Bank under relevant regulatory capital guidelines, as a result of the
treatment of the Series A Preferred Shares as a minority interest in a
consolidated subsidiary of the Bank, and (ii) the tax deductibility of the
dividends payable on the Series A Preferred Shares as a result of the Company's
qualification as a REIT. See "Certain Transactions Constituting the Formation--
Benefits to the Bank."
Each Series A Preferred Share will be exchanged automatically for one newly
issued Series B preferred share of the Bank (a "Bank Preferred Share") if the
appropriate federal regulatory agency directs in writing (a "Directive") an
exchange of the Series A Preferred Shares for Bank Preferred Shares because (i)
the Bank becomes "undercapitalized" under prompt corrective action regulations,
(ii) the Bank is placed into conservatorship or receivership or (iii) the
appropriate federal regulatory agency, in its sole discretion, anticipates the
Bank becoming "undercapitalized" in the near term (the "Exchange Event").
CONSEQUENTLY, AN INVESTMENT IN SERIES A PREFERRED SHARES COULD BE REPLACED BY
AN INVESTMENT IN BANK PREFERRED SHARES AT A TIME WHEN THE BANK'S FINANCIAL
CONDITION IS DETERIORATING OR THE BANK HAS BEEN PLACED INTO CONSERVATORSHIP OR
RECEIVERSHIP. POTENTIAL INVESTORS IN THE SERIES A PREFERRED SHARES, THEREFORE,
SHOULD CAREFULLY CONSIDER THE DESCRIPTION OF THE BANK SET FORTH UNDER "CERTAIN
INFORMATION REGARDING THE BANK." See also "Description of Series A Preferred
Shares--Automatic Exchange." The Bank will be considered to be
"undercapitalized" under the prompt corrective action regulations if it has (i)
a core capital (or leverage) ratio of less than 4.0%, (ii) a Tier 1 risk-based
capital ratio of less than 4.0%, or (iii) a total risk-based capital ratio of
less than 8.0%. For its fiscal years ended September 30, 1995, 1994 and 1993,
the Bank's core capital (or leverage) ratio was 5.77%, 5.34% and 5.35%, its
Tier 1 risk-based capital ratio was 6.65%, 6.95% and 7.29%, and its total risk-
based capital ratio was 11.63%, 12.19% and 11.70%, respectively. Based on
unaudited results, at September 30, 1996, the Bank's
<PAGE>
core capital (or leverage) ratio was 5.21%, its Tier 1 risk-based capital ratio
was 5.80%, and its total risk-based capital ratio was 10.14%. After giving
effect to the Offering, those ratios would have been 6.78%, 7.68% and 12.63%,
respectively. After the Offering, the Bank's capital ratios are expected to
decrease as the Bank expands its business and, thus, its total assets. However,
the Bank currently intends to maintain its core capital ratio at least 1% in
excess of the 5% level, and its Tier 1 risk-based and total risk-based capital
ratios in excess of the 6.0% and 10.0% levels, respectively, required of "well
capitalized" institutions under the prompt corrective action regulations. For a
discussion of the capital requirements applicable to the Bank, see "Certain
Information Regarding the Bank--Risk Factors and Other Considerations--
Regulatory Capital Levels."
The principal executive offices of the Company are located at 8401
Connecticut Avenue, Chevy Chase, Maryland 20815, and its telephone number is
(301) 986-7000.
THE BANK
The Bank is a federally chartered and federally insured stock savings bank,
which at June 30, 1996 was conducting business from 101 full-service offices
and 497 automated teller machines ("ATMs") in Maryland, Virginia and the
District of Columbia. At June 30, 1996, the Bank had total assets of $5.0
billion, total deposits of $4.2 billion and total stockholders' equity of
$357.0 million. Based on total consolidated assets at June 30, 1996, the Bank
is the largest bank headquartered in the Washington, D.C. metropolitan area.
The Bank Preferred Shares will only be issued upon the occurrence of the
Exchange Event. The Bank Preferred Shares will not be registered with the
Securities and Exchange Commission (the "Commission") but are being registered
with the Office of Thrift Supervision (the "OTS"). A copy of the offering
circular filed with the OTS relating to the Bank Preferred Shares is affixed to
this Prospectus (the "Offering Circular") as Annex I, together with the
documents incorporated by reference therein. The Offering Circular incorporates
by reference the Bank's Annual Report on Form 10-K for the fiscal year ended
September 30, 1995 and its Quarterly Report on Form 10-Q for the nine months
ended June 30, 1996. Immediately prior to or concurrently with the Offering,
the Bank plans to issue $100 million principal amount of its subordinated
capital debentures in an underwritten public offering. The Offering is not
conditioned upon the consummation of the proposed offering of the Bank's
debentures. See "Certain Information Regarding the Bank--Operations of the
Bank--Debenture Offering." The principal executive offices of the Bank are
located at 8401 Connecticut Avenue, Chevy Chase, Maryland 20815, and its
telephone number at such address is (301) 986-7000, and the home office of the
Bank is located at 7926 Jones Branch Drive, McLean, Virginia 22102, and its
telephone number at such address is 703-893-1504.
RISK FACTORS
The purchase of Series A Preferred Shares offered hereby is subject to
certain risks. See "Risk Factors" commencing on page 9. Among such risks are
the following:
. Because the rate at which dividends are to be paid is fixed, a
significant decline in interest rates might adversely affect the Company's
ability to pay dividends on the Series A Preferred Shares.
. A decline in the performance and capital levels of the Bank or the
placement of the Bank into conservatorship or receivership could lead to
the exchange of the Series A Preferred Shares for Bank Preferred Shares,
which would represent an investment in the Bank and not in the Company. An
investment in the Bank is subject to certain risks that are distinct from
the risks associated with an investment in the Company. For example, an
investment in the Bank would involve risks relating to the capital levels
of and other federal regulatory requirements applicable to the Bank, the
size of the Bank's credit card portfolio and the Bank's reliance on non-
interest income. In the event of a liquidation of the Bank, the claims of
the
2
<PAGE>
Bank's depositors and of its secured, senior, general and subordinated
creditors will be entitled to a priority of payment over the claims of
holders of equity securities such as the Bank Preferred Shares. As a
result, if the Bank were to be placed into receivership after the Automatic
Exchange or if the Automatic Exchange were to occur after receivership of
the Bank, the holders of the Bank Preferred Shares likely would receive, if
anything, substantially less than holders of the Series A Preferred Shares
would have received had the Series A Preferred Shares not been exchanged
for Bank Preferred Shares. Potential investors in the Series A Preferred
Shares should carefully consider the risks with respect to an investment in
the Bank set forth under "Certain Information Regarding the Bank--Risk
Factors and Other Considerations."
. As a subsidiary of the Bank, the Company is subject to the risk that
federal regulators of the Bank will restrict the ability of the Company to
transfer assets, to make distributions to stockholders, including dividends
to the holders of Series A Preferred Shares, or to redeem shares of
preferred stock of the Company (the "Preferred Stock"). Under certain
circumstances, certain of these restrictions could result in the Company's
failure to qualify as a REIT.
. Dividends are not cumulative. Consequently, if the Board of Directors
of the Company (the "Board of Directors") does not declare a dividend on
the Series A Preferred Shares for any quarterly period, the holders thereof
would not be entitled to recover such dividend whether or not funds are or
subsequently become available. The Board of Directors may determine, in its
business judgment, that it would be in the best interests of the Company to
pay less than the full amount of the stated dividends on the Series A
Preferred Shares or no dividends for any quarter notwithstanding that funds
are available. To remain qualified as a REIT, however, the Company must
distribute annually at least 95% of its "REIT taxable income" to
stockholders, and the Company expects that the Board of Directors will
declare dividends on the Series A Preferred Shares quarterly.
. Risks associated with mortgage loans generally, and particularly the
geographic concentration of the Company's mortgage loan portfolio in
Washington, D.C., Maryland and Virginia, could adversely affect the value
of the Series A Preferred Shares and the Mortgage Assets held by the
Company.
. If the Company fails to maintain its status as a REIT for federal
income tax purposes, it will be subject to corporate income tax.
. The Company is a newly organized corporation with no operating history.
. Although the Series A Preferred Shares will be listed on the New York
Stock Exchange (the "NYSE"), the Bank does not intend to apply for listing
of the Bank Preferred Shares, for which the Series A Preferred Shares will
be exchanged automatically on a one-for-one basis upon the occurrence of
the Exchange Event, on any national securities exchange or for quotation of
the Bank Preferred Shares through the National Association of Securities
Dealers Automated Quotation System. Consequently, there can be no assurance
as to the liquidity of the trading markets for the Bank Preferred Shares,
if issued, or that an active public market for the Bank Preferred Shares
would develop or be maintained.
. The Company will be dependent in virtually every phase of its
operations on the diligence and skill of the officers and employees of the
Bank and its affiliates.
. Because of the relationship between the Company and the Bank and its
affiliates, conflicts of interests may arise between the Company and the
Bank and its affiliates.
3
<PAGE>
THE OFFERING
For a more complete description of the terms of the Series A Preferred Shares
specified in the following summary, see "Description of Series A Preferred
Shares."
Issuer........................ Chevy Chase Preferred Capital Corporation, a
newly formed Maryland corporation created for
the purpose of acquiring, holding and managing
Mortgage Assets.
Securities Offered............
3,000,000 Series A Preferred Shares. The
Company has granted the Underwriters an option
for 30 days to purchase up to an additional
300,000 Series A Preferred Shares at the public
offering price solely to cover over-allotments,
if any.
Ranking....................... The Series A Preferred Shares rank senior to
the Company's Common Stock with respect to
dividend rights and rights upon liquidation.
Additional shares of Preferred Stock ranking
senior to the Series A Preferred Shares may not
be issued without the approval of holders of at
least 67% of the Series A Preferred Shares.
Additional shares of Preferred Stock ranking on
a parity with the Series A Preferred Shares may
not be issued without the approval of a
majority of the Independent Directors.
Dividends.....................
Dividends on the Series A Preferred Shares are
payable at the rate of % per annum of the
liquidation preference (an amount equal to $
per annum per share), if, when and as declared
by the Board of Directors of the Company. If
declared, dividends are payable quarterly in
arrears on the 15th day of January, April, July
and October in each year, commencing January
15, 1997. Dividends accrue in each quarterly
period from the first day of such period,
whether or not dividends are paid with respect
to the preceding period. Dividends on the
Series A Preferred Shares are not cumulative
and, accordingly, if no dividend is declared on
the Series A Preferred Shares by the Company
for a quarterly dividend period, holders of the
Series A Preferred Shares will have no right to
receive a dividend for that period, and the
Company will have no obligation to pay a
dividend for that period, whether or not
dividends are declared and paid for any future
period with respect to either the Series A
Preferred Shares or the Common Stock. If no
dividend is paid on the Series A Preferred
Shares for a quarterly dividend period, the
payment of dividends on the Common Stock will
be prohibited for that period and at least the
following three quarterly dividend periods. See
"Description of Series A Preferred Shares--
Dividends."
Liquidation Preference........
The liquidation preference for each Series A
Preferred Share is $50.00, plus an amount equal
to the quarterly accrued and unpaid dividend,
if any, thereon. See "Description of Series A
Preferred Shares--Rights Upon Liquidation."
Redemption.................... The Series A Preferred Shares are not
redeemable prior to , 2001 (except upon
the occurrence of a Tax Event, as defined in
"Description of Series A Preferred Shares--
Redemption"). On and after , 2001, the
Series A
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Preferred Shares may be redeemed for cash at
the option of the Company, in whole or in part,
at any time and from time to time, at a
redemption price of $50.00 per share, plus the
quarterly accrued and unpaid dividend, if any,
thereon. Upon the occurrence of a Tax Event,
the Company will have the right to redeem the
Series A Preferred Shares in whole (but not in
part) at a redemption price of $50.00 per
share, plus the quarterly accrued and unpaid
dividend, if any, thereon. Any redemption is
subject to the prior written approval of the
OTS. See "Description of Series A Preferred
Shares--Redemption." The Series A Preferred
Shares are not subject to any sinking fund or
mandatory redemption and are not convertible
into any other securities of the Company.
Automatic Exchange............ Each Series A Preferred Share will be exchanged
automatically for one Bank Preferred Share upon
the occurrence of the Exchange Event. See
"Description of Series A Preferred Shares--
Automatic Exchange."
Voting Rights................. Holders of Series A Preferred Shares will not
have any voting rights, except as expressly
provided herein. On any matter on which holders
of the Series A Preferred Shares may vote, each
Series A Preferred Share will be entitled to
one vote. See "Description of Series A
Preferred Shares--Voting Rights."
Ownership Limits.............. Beneficial ownership of more than 1% by any
individual of any outstanding series of
Preferred Stock, including the Series A
Preferred Shares offered hereby, is restricted
in order to preserve the Company's status as a
REIT for federal income tax purposes. See
"Description of Capital Stock--Restrictions on
Ownership and Transfer."
Listing.................. The Series A Preferred Shares have been
approved for listing on the NYSE, subject to
official notice of issuance, under the trading
symbol "CCP."
Ratings....................... It is expected that the Series A Preferred
Shares will be rated by Moody's Investors
Service, Inc. and by Standard and Poor's
Ratings Service. A security rating is not a
recommendation to buy, sell or hold securities
and may be subject to revision or withdrawal at
any time by the assigning rating organization.
Use of Proceeds.......... The net proceeds to the Company from the
Offering, together with proceeds received as
capital contributions from the Bank, will be
used to purchase the Company's initial
portfolio of Mortgage Assets and to pay the
expenses of the Offering and the formation of
the Company. See "Use of Proceeds."
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THE FORMATION
Prior to or simultaneously with the completion of the Offering, the Company
and the Bank will engage in the transactions described under "Certain
Transactions Constituting the Formation--The Formation." These transactions are
designed (i) to facilitate the Offering, (ii) to transfer the ownership of the
Initial Portfolio (defined below) to the Company, and (iii) to enable the
Company to qualify as a REIT for federal income tax purposes commencing with
its taxable year ending December 31, 1996.
The following diagram outlines the relationship between the Company and the
Bank relevant to the Offering following consummation of the Offering:
[GRAPHIC APPEARS HERE]
BUSINESS AND STRATEGY
General. The Company's principal business objective is to acquire, hold and
manage Mortgage Assets that will generate net income for distribution to
stockholders. The Company expects that its Mortgage Assets primarily will
consist of whole loans ("Mortgage Loans") secured by first mortgages or deeds
of trust on single-family (one- to four-unit) residential real estate
properties ("Residential Mortgage Loans") and of investment grade mortgage
securities representing interests in pools of Mortgage Loans ("Mortgage-Backed
Securities"). Mortgage Loans underlying the Mortgage-Backed Securities will be
secured by single-family residential real estate properties located in the
United States. The Company intends to acquire substantially all of its Mortgage
Assets from the Bank and/or affiliates of the Bank on terms that are comparable
to those that could be obtained by the Company if such Mortgage Assets were
purchased from unrelated third parties. The Company may also from time to time
acquire Mortgage Assets from unrelated third parties. As of the date of this
Prospectus, the Company has not adopted any arrangements or procedures by which
it would purchase Mortgage Assets from unrelated third parties, and the Company
has not entered into any agreements with any third parties with respect to the
purchase of Mortgage Assets. The Company anticipates that it would purchase
Mortgage Assets from unrelated third parties only if neither the Bank nor any
affiliate of the Bank had an amount or type of Mortgage Asset sufficient to
meet the requirements of the Company.
The Company expects that the Residential Mortgage Loans that it purchases
will represent first lien positions and will have been originated and
underwritten in conformity with standards generally applied by the originator
at the time the Residential Mortgage Loans were originated. The Company
currently intends to maintain at least 95% of its portfolio in Mortgage Assets
consisting of either Residential Mortgage Loans or Mortgage-Backed Securities
and may invest up to 5% in Mortgage Loans secured by commercial real estate
properties or multi-family properties ("Commercial Loans") or in other assets
eligible to be held by a REIT.
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The Company's current policy prohibits the acquisition of any Mortgage Loan or
any interest in a Mortgage Loan (other than an interest resulting from the
acquisition of Mortgage-Backed Securities), which Mortgage Loan (i) is
delinquent in the payment of principal or interest; (ii) is or was at any time
during the preceding 12 months (a) classified, (b) in nonaccrual status or (c)
renegotiated due to the financial deterioration of the borrower; or (iii) has
been, more than once during the preceding 12 months, more than 30 days past due
in the payment of principal or interest. Loans that are in a "nonaccrual
status" are generally loans that are past due 90 days or more in principal or
interest, and "classified" loans are generally troubled loans which are deemed
substandard or doubtful with respect to collectibility.
Initial Portfolio. Simultaneously with the consummation of the Offering, the
Bank, as owner of the Company's Common Stock, will make a capital contribution
to the Company equal to approximately $150 million. The Company will use the
aggregate net proceeds of approximately $300 million received in connection
with both the Offering and such capital contribution by the Bank to purchase a
portfolio exclusively of Residential Mortgage Loans (the "Initial Portfolio")
from the Bank. If the Underwriters exercise their option to purchase additional
Series A Preferred Shares to cover over-allotments, the Bank will make
additional capital contributions equal to the aggregate public offering price
of the additional Series A Preferred Shares purchased pursuant to the
Underwriters' over-allotment option, and the Company will use the additional
proceeds from any such additional capital contributions and sales of Series A
Preferred Shares to purchase additional Mortgage Assets of the types described
in "Business and Strategy--Description of the Initial Portfolio."
Simultaneously with the consummation of the Offering (or upon the exercise by
the Underwriters of their over-allotment option), the Bank will also make
additional capital contributions equal to the aggregate amount of underwriting
discounts and expenses incurred by the Company in connection with the Offering
(including without limitation any underwriting discounts associated with the
exercise by the Underwriters of their over-allotment option) and all expenses
incurred by the Company in connection with its formation in order to provide
the Company with funds sufficient to pay such expenses. See "Use of Proceeds."
On October 31, 1996, the Residential Mortgage Loans expected to be included
in the Initial Portfolio had an aggregate outstanding principal balance of
approximately $321.9 million. See "Business and Strategy--Description of
Initial Portfolio." The Bank will service the Mortgage Loans included in the
Initial Portfolio and will be entitled to receive fees in connection with the
servicing of such Mortgage Loans pursuant to a servicing agreement with the
Company (the "Servicing Agreement"). The Bank in its role as servicer under the
terms of the Servicing Agreement is hereinafter referred to as the "Servicer."
See "Business and Strategy--Servicing."
The Company and the Bank believe that the fair value of the Initial Portfolio
will equal the amount (approximately $300 million) that the Company will pay
for the Initial Portfolio. However, no third party valuations of the Mortgage
Assets constituting the Initial Portfolio have been or will be obtained for
purposes of the Offering. See "Risk Factors--No Third Party Valuation of the
Mortgage Assets; No Arm's-Length Negotiations with Affiliates."
Advisory Agreement. The Company will enter into an advisory agreement with
the Bank (the "Advisory Agreement") pursuant to which the Bank will administer
the day-to-day operations of the Company. The Bank in its role as advisor under
the terms of the Advisory Agreement is hereinafter referred to as the
"Advisor." The Advisor will be responsible for (i) monitoring the credit
quality of Mortgage Assets held by the Company, (ii) advising the Company with
respect to the acquisition, management, financing and disposition of the
Company's Mortgage Assets, and (iii) holding documents relating to the Mortgage
Assets as custodian on behalf of the Company. The Advisor may from time to time
subcontract all or a portion of its obligations under the Advisory Agreement to
one or more of its affiliates. The Advisor may, with the approval of a majority
of the Board of Directors, as well as a majority of the "Independent
Directors," subcontract all or a portion of its obligations under the Advisory
Agreement to unrelated third parties. An "Independent Director" is a director
who is not a current officer or employee of the Company or a current director,
officer or employee of the Bank or any affiliate of the Bank. The Advisor will
not, in connection with the subcontracting of any of its obligations under the
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<PAGE>
Advisory Agreement, be discharged or relieved in any respect from its
obligations under the Advisory Agreement. The Advisor and its personnel have
substantial experience in mortgage finance and in the administration of
Mortgage Loans.
The Advisory Agreement has an initial term of three years, and will be
renewed automatically for additional one-year periods unless notice of
nonrenewal is delivered to the Advisor by the Company. The Advisory Agreement
may be terminated by the Company at any time upon 60 days' prior written
notice. As long as any Series A Preferred Shares remain outstanding, any
decision by the Company either not to renew the Advisory Agreement or to
terminate the Advisory Agreement must be approved by a majority of the Board of
Directors, as well as by a majority of the Independent Directors. The Advisor
will be entitled to receive an advisory fee equal to $200,000 per year, payable
in equal quarterly installments. See "Management--The Advisor."
Additional Investments. The Company may from time to time purchase additional
Mortgage Assets out of proceeds received in connection with the repayment or
disposition of Mortgage Assets, the issuance of additional shares of Preferred
Stock or additional capital contributions with respect to the Common Stock.
Additional shares of Preferred Stock ranking on a parity with the Series A
Preferred Shares may not be issued by the Company without the approval of a
majority of the Independent Directors. See "Description of Series A Preferred
Shares" and "--Independent Director Approval." The Company does not currently
intend to issue any additional shares of Preferred Stock unless it
simultaneously receives additional capital contributions from the Bank equal to
the aggregate offering price of such additional Preferred Stock and the
Company's expenses (including any underwriting discounts or placement fees)
incurred in connection with the issuance of such additional shares of Preferred
Stock. The Company anticipates that, prior to its issuance of additional shares
of Preferred Stock, it will take into consideration the Bank's regulatory
capital requirements and an assessment of other available options for raising
any necessary capital. See "Certain Transactions Constituting the Formation--
Benefits to the Bank."
Management. The Board of Directors will be composed of six members, two of
whom will be Independent Directors. Pursuant to the Articles Supplementary
establishing the Series A Preferred Shares, the Independent Directors are
required to take into account the interests of the holders of both the Series A
Preferred Shares and the Common Stock in assessing the benefit to the Company
of any proposed action requiring their approval. The Company currently has six
officers. The Company has no other employees and does not anticipate that it
will require additional employees. See "Management."
Newly Formed Entity. As a newly formed entity, the Company has no prior
operating history. As of the date hereof, it has $1,000 of assets and
stockholder's equity and no indebtedness. Immediately after the issuance by the
Company of the Series A Preferred Shares to the public and the contribution of
capital by the Bank to the Company and the purchase by the Company of the
Initial Portfolio, the Company (assuming that the Underwriters' over-allotment
option is not exercised) will have approximately $300 million in Mortgage
Assets, $15 million of stated capital attributable to the Series A Preferred
Shares, $100 of stated capital attributable to the Common Stock and
approximately $285 million of additional paid-in capital. See "Capitalization."
TAX STATUS OF THE COMPANY
The Company will elect to be taxed as a REIT under Sections 856 through 860
of the Code, commencing with its taxable year ending December 31, 1996. As a
REIT, the Company generally will not be subject to federal income tax on net
income and capital gains that it distributes to the holders of its Common Stock
and Preferred Stock, including the Series A Preferred Shares.
A REIT is subject to a number of organizational and operational requirements,
including a requirement that it currently distribute to stockholders at least
95% of its "REIT taxable income" (not including capital gains). Notwithstanding
qualification for taxation as a REIT, the Company may be subject to federal,
state and/or local tax. See "Risk Factors--Tax Risks" and "Federal Income Tax
Considerations."
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<PAGE>
RISK FACTORS
Prospective investors should carefully consider the following information in
conjunction with the other information contained in this Prospectus before
purchasing Series A Preferred Shares in the Offering. This Prospectus contains
forward-looking statements that involve risks and uncertainties. THE COMPANY'S
ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE
FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH DIFFERENCES INCLUDE
THOSE DISCUSSED BELOW. IN ADDITION, PROSPECTIVE INVESTORS SHOULD ALSO
CAREFULLY CONSIDER THE INFORMATION CONTAINED IN THE OFFERING CIRCULAR ATTACHED
HERETO FOR INFORMATION CONCERNING THE BANK.
INTEREST RATE RISK
The Company's income will consist primarily of interest payments on the
Mortgage Assets held by it. The Company anticipates that most of its Mortgage
Assets will bear interest at adjustable rates. If there is a decline in
interest rates (as measured by the indices upon which the interest rates of
the Mortgage Assets are based), then the Company will experience a decrease in
income available to be distributed to its stockholders. In such an interest
rate environment, the Company may experience an increase in prepayments on its
Mortgage Assets and may find it difficult to purchase additional Mortgage
Assets bearing rates sufficient to support payment of dividends on the Series
A Preferred Shares. In addition, certain Mortgage Asset products which the
Company will purchase may permit the borrower to convert an adjustable rate
mortgage to a fixed rate mortgage. Borrowers are likely to exercise this right
in a low interest rate environment in order to "lock in" a low fixed interest
rate. Because the rate at which dividends, if, when and as declared, are
payable on the Series A Preferred Shares is fixed, there can be no assurance
that an interest rate environment in which there is a significant decline in
interest rates would not adversely affect the Company's ability to pay
dividends on the Series A Preferred Shares.
CERTAIN RISKS ASSOCIATED WITH THE BANK
The purchase of Series A Preferred Shares involves a high degree of risk
with respect to the performance and capital levels of the Bank. A decline in
the performance and capital levels of the Bank or the placement of the Bank
into conservatorship or receivership could result in the exchange of the
Series A Preferred Shares for Bank Preferred Shares, which would be an
investment in the Bank and not in the Company. As a result, holders of Series
A Preferred Shares would become preferred stockholders of the Bank at a time
when the Bank's financial condition was deteriorating or when the Bank had
been placed into conservatorship or receivership. An investment in the Bank is
also subject to certain risks that are distinct from the risks associated with
an investment in the Company. For example, an investment in the Bank would
involve risks relating to the capital levels of, and other federal regulatory
requirements applicable to, the Bank, the performance of the Bank's loan
portfolio, including its credit card portfolio, and the Bank's reliance on
non-interest income. An investment in the Bank is also subject to the general
risks inherent in equity investments in depository institutions. In the event
of a liquidation of the Bank, the claims of depositors and secured, senior,
general and subordinated creditors of the Bank would be entitled to a priority
of payment over the claims of holders of equity interests such as the Bank
Preferred Shares. As a result, if the Bank were to be placed into receivership
after the Automatic Exchange or if the Automatic Exchange were to occur after
receivership of the Bank, the holders of the Bank Preferred Shares likely
would receive, if anything, substantially less than the holders of the Series
A Preferred Shares would have received had the Series A Preferred Shares not
been exchanged for Bank Preferred Shares. Potential investors in the Series A
Preferred Shares should carefully consider the risks with respect to an
investment in the Bank set forth under "Certain Information Regarding the
Bank--Risk Factors and Other Considerations." See also "Description of Series
A Preferred Shares--Automatic Exchange."
DIVIDEND AND OTHER REGULATORY RESTRICTIONS ON OPERATIONS OF THE COMPANY
Because the Company is a subsidiary of the Bank, federal regulatory
authorities will have the right to examine the Company and its activities.
Under certain circumstances, including any determination that the
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<PAGE>
Bank's relationship to the Company results in an unsafe and unsound banking
practice, such regulatory authorities will have the authority to restrict the
ability of the Company to transfer assets, to make distributions to its
stockholders (including dividends to the holders of Series A Preferred Shares,
as described below), or to redeem shares of Preferred Stock, or even to
require the Bank to sever its relationship with or divest its ownership of the
Company. Such actions could potentially result in the Company's failure to
qualify as a REIT.
Payment of dividends on the Series A Preferred Shares could also be subject
to regulatory limitations if the Bank became "undercapitalized" for purposes
of the OTS prompt corrective action regulations, which is currently defined as
having a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based
capital ratio of less than 4.0% and a core capital (or leverage) ratio of less
than 4.0%. Based on unaudited results, at September 30, 1996, the Bank's total
risk-based capital ratio was 10.14%, its Tier 1 risk-based capital ratio was
5.80% and its core capital (or leverage) ratio was 5.21%. Such ratios,
adjusted to give effect to the sale of Series A Preferred Shares in the
Offering, would be 12.63%, 7.68% and 6.78%, respectively.
If the Automatic Exchange occurs, the Bank would likely be prohibited from
paying dividends on the Bank Preferred Shares. In all circumstances following
the Automatic Exchange, the Bank's ability to pay dividends would be subject
to various restrictions under OTS regulations, a resolution of the Bank's
board of directors and certain contractual provisions.
Furthermore, in the event the Bank is placed into conservatorship or
receivership (whether before or after the Automatic Exchange), the Bank would
be unable to pay dividends on the Bank Preferred Shares. In addition, in the
event of a liquidation of the Bank, the claims of the Bank's depositors and of
its secured, senior, general and subordinated creditors would be entitled to a
priority of payment over the dividend and other claims of holders of equity
interests such as the Bank Preferred Shares issued pursuant to the Automatic
Exchange.
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 earnings and regulatory capital levels. While the Company
believes that dividends on the Series A Preferred Shares should not be
considered "capital distributions" for this purpose, there can be no
assurances that the OTS would agree with this position. However, without
addressing the issue of whether dividends on the Series A Preferred Shares are
"capital distributions" subject to the regulations, the OTS has indicated that
it would not object to the Company's payment of quarterly dividends on the
Series A Preferred Shares in an amount up to the amount of the Company's net
income for that quarter. The Company currently expects that its net income
will be in excess of amounts needed to pay dividends on the Series A Preferred
Shares. See "Business and Strategy--Dividend Policy."
Dividends on the Series A Preferred Shares in excess of the Company's net
income could be treated as "capital distributions" by the OTS, in which case
the Company's payment of such dividends would be subject to restrictions under
the OTS capital distribution regulations. Under these regulations,
institutions are divided into tiers. Tier 1 institutions are those in
compliance with their "fully phased-in" capital requirements and which have
not been notified by the OTS that they are "in need of more than normal
supervision." Tier 1 institutions may make capital distributions without
regulatory approval of 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 1 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 institutions may seek OTS approval to pay dividends
beyond these amounts.
The category of Tier 2 institutions, which are defined as institutions that
are in compliance with their current, but not their "fully phased-in" capital
requirements, is no longer relevant because all deductions from capital
requirements have been fully phased-in as of July 1, 1996.
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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.
As of September 30, 1996, the Bank had sufficient levels of capital to be a
Tier 1 institution. However, the OTS retains discretion under its capital
distribution regulations to treat an institution that is in need of more than
normal supervision (after written notice) as a Tier 3 institution.
The OTS retains general discretion to prohibit any otherwise permitted
capital distribution on general safety and soundness grounds and must be given
30 days advance notice of all capital distributions.
DIVIDENDS NOT CUMULATIVE
Dividends on the Series A Preferred Shares are not cumulative. Consequently,
if the Board of Directors does not declare a dividend on the Series A
Preferred Shares for any quarterly period, the holders of the Series A
Preferred Shares would not be entitled to recover such dividend whether or not
funds are or subsequently become available. The Board of Directors may
determine, in its business judgment, that it would be in the best interests of
the Company to pay less than the full amount of the stated dividends on the
Series A Preferred Shares or no dividends for any quarter notwithstanding that
funds are available. Factors that would be considered by the Board of
Directors in making this determination are the Company's financial condition
and capital needs, the impact of legislation and regulations as then in effect
or as may be proposed, economic conditions, and such other factors as the
Board may deem relevant. Notwithstanding the foregoing, to remain qualified as
a REIT, the Company must distribute annually at least 95% of its "REIT taxable
income" (not including capital gains) to stockholders. See "--Tax Risks,"
below and "Federal Income Tax Considerations--Taxation of the Company--
Organizational Requirements."
RISKS ASSOCIATED WITH MORTGAGE LOANS GENERALLY
An investment in the Series A Preferred Shares may be affected by, among
other things, a decline in real estate values. In the event the Mortgage
Assets held by the Company become nonperforming, the Company may not have
funds sufficient to pay dividends on the Series A Preferred Shares. Factors
that could affect the value of the Mortgage Assets held by the Company include
the following:
Geographic Concentration. Certain geographic regions of the United States
may from time to time experience natural disasters or weaker regional economic
conditions and housing markets, and, consequently, may experience higher rates
of loss and delinquency on Mortgage Loans generally. Any concentration of the
Mortgage Loans in such a region may present risks in addition to those
generally present with respect to Mortgage Loans generally. The Company
currently anticipates that substantially all of the residential properties
underlying the Mortgage Assets included in the Initial Portfolio will be
located in Washington, D.C., Maryland and Virginia. These Mortgage Assets may
be subject to a greater risk of default than other comparable Mortgage Assets
in the event of adverse economic, political or business developments or
natural hazards that may affect such region and the ability of property owners
in such region to make payments of principal and interest on the underlying
mortgages.
No Credit Enhancement or Special Hazard Insurance. The Company generally
does not intend to obtain credit enhancements such as mortgagor bankruptcy
insurance or to obtain special hazard insurance for its Mortgage Loans, other
than standard hazard insurance, which will in each case only relate to
individual Mortgage Loans. Accordingly, during the time it holds Mortgage
Loans for which third party insurance is not obtained, the Company will be
subject to risks of borrower defaults and bankruptcies and special hazard
losses that are not covered by standard hazard insurance (such as those
occurring from earthquakes or floods). In addition, in the event of a default
on any Mortgage Loan held by the Company resulting from declining property
values or worsening economic conditions, among other factors, the Company
would bear the risk of loss of principal to the extent of any deficiency
between (i) the value of the related mortgaged property, plus any payments
from an insurer (or guarantor in the case of Commercial Mortgage Loans) and
(ii) the amount owing on the Mortgage Loan.
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Real Estate Market Conditions. The results of the Company's operations will
be affected by various factors, many of which are beyond the control of the
Company, such as: (i) local and other economic conditions affecting real
estate values, (ii) the ability of tenants to make lease payments, (iii) the
ability of a property to attract and retain tenants, which may in turn be
affected by local conditions such as an oversupply of space or a reduction in
demand for rental space in the area, the attractiveness of properties to
tenants, competition from other available space, the ability of the owner to
pay leasing commissions, provide adequate maintenance and insurance, pay
tenant improvement costs and make other tenant concessions, (iv) interest rate
levels and the availability of credit to refinance such loans at or prior to
maturity, and (v) increased operating costs, including energy costs, real
estate taxes and costs of compliance with environmental controls and
regulations. The results of the Company's operations depend on, among other
things, the level of interest income generated by the Company's Mortgage
Assets, the market value of such Mortgage Assets and the supply of and demand
for such Mortgage Assets. Further, there can be no assurance that the values
of the Mortgage Assets included in the Company's Initial Portfolio, or the
values of properties securing such Mortgage Assets, have remained or will
remain at the levels existing on the dates of origination of such Mortgage
Assets.
Delays in Liquidating Defaulted Mortgage Loans. Even assuming that the
mortgaged properties underlying the Mortgage Loans held by the Company provide
adequate security for such Mortgage Loans, substantial delays could be
encountered in connection with the liquidation of defaulted Mortgage Loans,
with corresponding delays in the receipt of related proceeds by the Company.
An action to foreclose on a mortgaged property securing a Mortgage Loan is
regulated by state statutes and rules and is subject to many of the delays and
expenses of other lawsuits if defenses or counterclaims are interposed,
sometimes requiring several years to complete. Furthermore, in some states
(not including Washington, D.C., Maryland or Virginia) an action to obtain a
deficiency judgment is not permitted following a nonjudicial sale of a
mortgaged property. In the event of a default by a mortgagor, these
restrictions, among other things, may impede the ability of the Company to
foreclose on or sell the mortgaged property or to obtain proceeds sufficient
to repay all amounts due on the related Mortgage Loan. In addition, the
Servicers of the Company's Mortgage Loans will be entitled to deduct from
collections received all expenses reasonably incurred in attempting to recover
amounts due and not yet repaid on liquidated Mortgage Loans, including legal
fees and costs of legal action, real estate taxes and maintenance and
preservation expenses, thereby reducing amounts available to the Company.
Legal Considerations. Applicable state laws generally regulate interest
rates and other charges and require certain disclosures to borrowers. In
addition, most states have other laws, public policy and general principles of
equity relating to the protection of consumers, unfair and deceptive practices
and practices which may apply to the servicing and collection of the Mortgage
Loans. Depending on the provisions of the applicable law and the specific
facts and circumstances involved, violations of these laws, policies and
principles may limit the ability of the Company to collect all or part of the
principal of or interest on the Mortgage Loans, may entitle the borrower to a
refund of amounts previously paid and, in addition, could subject the Company
to damages and administrative sanctions.
Special Risks Relating to Commercial Mortgage Loans. The Initial Portfolio
will not include any Commercial Mortgage Loans. In the future, however, the
Company may from time to time acquire Commercial Mortgage Loans. Commercial
Mortgage Loans have certain distinct risks. The Company's current policy is
not to acquire any Commercial Mortgage Loan if such Commercial Mortgage Loan
would constitute more than 5% of the total book value of the Mortgage Assets
of the Company at the time of its acquisition. Commercial Mortgage Loans
generally lack standardized terms, which may complicate their structure.
Commercial real estate properties themselves tend to be unique and are more
difficult to value than residential real estate properties. Commercial
Mortgage Loans also tend to have shorter maturities than Residential Mortgage
Loans and may not be fully amortizing, meaning that they may have a
significant principal balance or "balloon" payment due on maturity. In
addition, commercial real estate properties, particularly industrial and
warehouse properties, are generally subject to relatively greater
environmental risks than non-commercial properties and to the corresponding
burdens and costs of compliance with environmental laws and regulations. See
"--Environmental
12
<PAGE>
Considerations," below. Also, there may be costs and delays involved in
enforcing rights of a property owner against tenants in default under the
terms of leases with respect to commercial properties. For example, tenants
may seek the protection of the bankruptcy laws, which could result in
termination of lease contracts.
Environmental Considerations. In the event that the Company is forced to
foreclose on a defaulted Mortgage Loan to recover its investment in such
Mortgage Loan, the Company may be subject to environmental liabilities in
connection with the underlying real property which could exceed the value of
the real property. Although the Company intends to exercise due diligence to
discover potential environmental liabilities prior to the acquisition of any
property through foreclosure, hazardous substances or wastes, contaminants,
pollutants or sources thereof (as defined by state and federal laws and
regulations) may be discovered on properties during the Company's ownership or
after a sale thereof to a third party. If such hazardous substances are
discovered on a property which the Company has acquired through foreclosure or
otherwise, the Company may be required to remove those substances and clean up
the property. There can be no assurance that in such a case the Company would
not incur full recourse liability for the entire costs of any removal and
clean-up, that the cost of such removal and clean-up would not exceed the
value of the property or that the Company could recoup any of such costs from
any third party. The Company may also be liable to tenants and other users of
neighboring properties. In addition, the Company may find it difficult or
impossible to sell the property prior to or following any such clean-up.
TAX RISKS
Adverse Consequences of Failure to Qualify as a REIT. The Company intends to
operate so as to qualify as a REIT under the Code. Although the Company
believes that it will be owned and organized and will operate in such a
manner, and Shaw, Pittman, Potts & Trowbridge will render certain opinions,
described under "Federal Income Tax Considerations" below, regarding the
Company's qualification as a REIT, no assurance can be given that the Company
will be able to operate in such a manner so as to qualify as a REIT or to
remain so qualified. Qualification as a REIT involves the application of
highly technical and complex Code provisions for which there are only limited
judicial or administrative interpretations. The determination of various
factual matters and circumstances, not entirely within the Company's control
and not addressed by the opinion of Shaw, Pittman, Potts & Trowbridge, may
affect the Company's ability to qualify as a REIT. Although the Company is not
aware of any proposal in Congress to amend the tax laws in a manner that would
materially and adversely affect the Company's ability to operate as a REIT, no
assurance can be given that new legislation or new regulations, administrative
interpretations or court decisions will not significantly change the tax laws
in the future with respect to qualification as a REIT or the federal income
tax consequences of such qualification.
The Company is relying on the opinion of Shaw, Pittman, Potts & Trowbridge,
counsel to the Company, regarding various issues affecting the Company's
ability to qualify, and retain qualification, as a REIT. Such legal opinions
are not binding on the Internal Revenue Service (the "IRS") or the courts.
If in any taxable year the Company fails to qualify as a REIT, the Company
would not be allowed a deduction for distributions to stockholders in
computing its taxable income and would be subject to federal income tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. As a result, the amount available for distribution to
the Company's stockholders, including the holders of the Series A Preferred
Shares, would be reduced for the year or years involved. In addition, unless
entitled to relief under certain statutory provisions, the Company would also
be disqualified from treatment as a REIT for the four taxable years following
the year during which qualification was lost. A failure of the Company to
qualify as a REIT would not by itself give the Company the right to redeem the
Series A Preferred Shares, nor would it give the holders of the Series A
Preferred Shares the right to have their shares redeemed. See "Description of
Series A Preferred Shares--Redemption."
Notwithstanding that the Company currently intends to operate in a manner
designed to qualify as a REIT, future economic, market, legal, tax or other
considerations may cause the Company to determine that it is in the best
interest of the Company and the holders of its Common Stock and Preferred
Stock to revoke the REIT
13
<PAGE>
election. As long as any Series A Preferred Shares are outstanding, any such
determination by the Company may not be made without the approval of a
majority of the Independent Directors. The tax law prohibits the Company from
electing treatment as a REIT for the four taxable years following the year of
such revocation. See "Federal Income Tax Considerations."
REIT Requirements with Respect to Stockholder Distributions. To obtain
favorable tax treatment as a REIT qualifying under the Code, the Company
generally will be required each year to distribute as dividends to its
stockholders at least 95% of its "REIT taxable income" (excluding capital
gains). Failure to comply with this requirement would result in the Company's
income being subject to tax at regular corporate rates. In addition, the
Company will be subject to a 4% nondeductible excise tax on the amount, if
any, by which certain distributions considered as paid by it with respect to
any calendar year are less than the sum of 85% of its ordinary income for the
calendar year, 95% of its capital gains net income for the calendar year and
any undistributed taxable income from prior periods. Under certain
circumstances, federal regulatory authorities may restrict the ability of the
Company, as a subsidiary of the Bank, to make distributions to its
stockholders. Such a restriction could result in the Company's failure to meet
REIT requirements with respect to stockholder distributions. See "--Dividend
and Other Regulatory Restrictions on Operations of the Company."
Redemption upon Occurrence of a Tax Event. At any time following the
occurrence of a Tax Event (as defined under "Description of Series A Preferred
Shares--Redemption"), even if such Tax Event occurs prior to , 2001, the
Company will have the right to redeem the Series A Preferred Shares in whole
but not in part, subject to the prior written approval of the OTS. The
occurrence of a Tax Event will not, however, give the holders of the Series A
Preferred Shares any right to have such shares redeemed. See "Description of
Series A Preferred Shares--Redemption."
Automatic Exchange upon Occurrence of the Exchange Event. Upon the
occurrence of the Exchange Event, the outstanding Series A Preferred Shares
will be automatically exchanged on a one-for-one basis into Bank Preferred
Shares. See "Description of Series A Preferred Shares--Automatic Exchange."
Assuming, as is anticipated to be the case, that the Bank Preferred Shares are
nonvoting, the Automatic Exchange will be taxable, and each holder of Series A
Preferred Shares will have a gain or loss, as the case may be, measured by the
difference between the basis of such holder in the Series A Preferred Shares
and the fair market value of the Bank Preferred Shares received in the
Automatic Exchange. Assuming that such holder's Series A Preferred Shares were
held for more than one year prior to the Automatic Exchange and held as
capital assets, any gain or loss will be long-term capital gain or loss. See
"Federal Income Tax Considerations--Tax Treatment of Automatic Exchange."
NO OPERATING HISTORY
The Company is a newly organized corporation with no operating history and
no revenues to date.
BANK PREFERRED SHARES WILL NOT BE LISTED ON THE NYSE
Although the Series A Preferred Shares will be listed on the NYSE, the Bank
does not intend to apply for listing of the Bank Preferred Shares, for which
the Series A Preferred Shares will be exchanged automatically on a one-for-one
basis upon the occurrence of the Exchange Event, on any national securities
exchange or for quotation of the Bank Preferred Shares through the National
Association of Securities Dealers Automated Quotation System. Consequently,
there can be no assurance as to the liquidity of the trading markets for the
Bank Preferred Shares, if issued, or that an active public market for the Bank
Preferred Shares would develop or be maintained.
DEPENDENCE UPON THE BANK AS ADVISOR AND SERVICER
The Company will be dependent for the selection, structuring and monitoring
of its Mortgage Assets on the diligence and skill of its officers and the
officers and employees of the Advisor. See "Management." In addition,
14
<PAGE>
the Company will be dependent upon the expertise of the Servicer for the
servicing of the Mortgage Loans. The Advisor may subcontract all or a portion
of its obligations under the Advisory Agreement, and the Servicer of the
Mortgage Loans may subcontract all or a portion of its obligations under the
Servicing Agreement, to one or more affiliates, and under certain conditions
to non-affiliates, involved in the business of managing Mortgage Assets. In
the event the Advisor or the Servicer subcontracts its obligations in such a
manner, the Company will be dependent upon the subcontractor to provide
services. See "Management--The Advisor" and "Business and Strategy--
Servicing."
RELATIONSHIP WITH THE BANK AND ITS AFFILIATES; CONFLICTS OF INTEREST
The Bank and its affiliates are involved in virtually every aspect of the
Company's existence. The Bank is the sole holder of the Common Stock of the
Company and administers the day-to-day activities of the Company in its role
as Advisor under the Advisory Agreement. The Bank acts as Servicer of the
Company's Mortgage Loans under the Servicing Agreement. In addition, other
than the Independent Directors, all of the officers and directors of the
Company are also officers and/or directors of the Bank and/or affiliates of
the Bank. As the holder of all of the outstanding voting stock of the Company,
the Bank will have the right to elect all directors of the Company, including
the Independent Directors.
The Bank and its affiliates may have interests which are not identical to
those of the Company. Consequently, conflicts of interest may arise with
respect to transactions, including without limitation, the Company's
acquisition of the Initial Portfolio; future acquisitions of Mortgage Assets
from the Bank and/or affiliates of the Bank; servicing of Mortgage Loans;
future dispositions of Mortgage Loans to the Bank or affiliates of the Bank;
and the modification of the Advisory Agreement or the Servicing Agreement. It
is the intention of the Company and the Bank that any agreements and
transactions between the Company, on the one hand, and the Bank and/or its
affiliates, on the other hand, are fair to all parties and consistent with
market terms, including the prices paid and received for Mortgage Assets,
including those in the Initial Portfolio, on their acquisition or disposition
by the Company or in connection with the servicing of Mortgage Loans. The
requirement in the Articles Supplementary establishing the Series A Preferred
Shares that certain actions of the Company be approved by a majority of the
Independent Directors is also intended to ensure fair dealings between the
Company and the Bank and its affiliates. However, there can be no assurance
that such agreements or transactions will be on terms as favorable to the
Company as those that could have been obtained from unaffiliated third
parties. See "Business and Strategy--Management Policies and Programs--
Conflict of Interest Policies."
RISK OF FUTURE REVISIONS IN POLICIES AND STRATEGIES BY BOARD OF DIRECTORS
The Board of Directors has established the investment policies and operating
policies and strategies of the Company, certain of which are described in this
Prospectus. These policies may be amended or revised from time to time at the
discretion of the Board of Directors (in certain circumstances subject to the
approval of a majority of the Independent Directors) without a vote of the
Company's stockholders, including holders of the Series A Preferred Shares.
The ultimate effect of any change in the policies and strategies of the
Company on a holder of Series A Preferred Shares may be positive or negative.
See "Business and Strategy--Management Policies and Programs."
RISKS RELATED TO BALANCING DISTRIBUTIONS
In order to limit increases in the value of the Common Stock and enable the
Company to attempt to maintain its status as a REIT, the Company will be
permitted, subject to certain limitations, to make special distributions of
cash or property to the holders of the Common Stock ("Balancing
Distributions") at any time the value of the Common Stock exceeds 52% of the
total value of the Company's outstanding Common Stock and Preferred Stock.
Such Balancing Distributions will reduce the assets of the Company available
to make payments to the holders of the Preferred Stock.
15
<PAGE>
RISK ASSOCIATED WITH LEVERAGE
Although the Company does not currently intend to incur any indebtedness in
connection with the acquisition and holding of Mortgage Assets, the Company
may do so at any time (although indebtedness in excess of 25% of the Company's
total stockholders' equity may not be incurred without the approval of a
majority of the Independent Directors of the Company). To the extent the
Company were to change its policy with respect to the incurrence of
indebtedness, the Company would be subject to risks associated with leverage,
including, without limitation, changes in interest rates and prepayment risk.
NO THIRD PARTY VALUATION OF THE MORTGAGE ASSETS; NO ARM'S-LENGTH NEGOTIATIONS
WITH AFFILIATES
The Company and the Bank intend that the fair value of the Initial Portfolio
will approximately equal the amount (approximately $300 million) that the
Company will pay for the Initial Portfolio. However, no third party valuations
of the Mortgage Assets constituting the Initial Portfolio were obtained for
purposes of the Offering, and there can be no assurance that the fair value of
the Initial Portfolio does not differ from the purchase price payable by the
Company.
In addition, it is not anticipated that third party valuations will be
obtained in connection with future acquisitions and dispositions of Mortgage
Assets even in circumstances where an affiliate of the Company is selling the
Mortgage Assets to, or purchasing the Mortgage Assets from, the Company.
Accordingly, although the Company and the Bank intend that future acquisitions
or dispositions of Mortgage Assets be on a fair value basis, there can be no
assurance that the consideration to be paid (or received) by the Company to
(or from) the Bank or any of its affiliates in connection with future
acquisitions or dispositions of Mortgage Assets will not differ from the fair
value of such Mortgage Assets.
NO PRIOR MARKET FOR SERIES A PREFERRED SHARES
Prior to the Offering, there has been no public market for the Series A
Preferred Shares, and there can be no assurance that an active trading market
will develop or be sustained or that the Series A Preferred Shares may be
resold at or above the initial public offering price.
THE COMPANY
The Company is a newly formed Maryland corporation created for the purpose
of acquiring, holding and managing Mortgage Assets that will generate net
income for distribution to stockholders. The Company anticipates that at least
95% of its portfolio of Mortgage Assets will represent interests in
Residential Mortgage Loans and Mortgage-Backed Securities, and up to 5% of its
portfolio will represent interests in Commercial Mortgage Loans.
Generally, the Company expects that it will acquire its Mortgage Assets from
the Bank and affiliates of the Bank. The Company may also from time to time,
however, acquire Mortgage Assets from unrelated third parties. The Bank will
administer the day-to-day operations of the Company in its role as Advisor
under the Advisory Agreement. All of the Common Stock of the Company is owned
by the Bank. The Company will elect to be subject to tax as a REIT under the
Code, and will generally not be subject to federal income tax to the extent
that it distributes its earnings to its stockholders and maintains its
qualification as a REIT. For a further description of the operations of the
Company, see "Business and Strategy," "Management," "Risk Factors" and
"Federal Income Tax Considerations."
The Series A Preferred Shares will be exchanged automatically on a one-for-
one basis for Bank Preferred Shares upon the occurrence of the Exchange Event.
CONSEQUENTLY, AN INVESTMENT IN SERIES A PREFERRED SHARES COULD BE REPLACED BY
AN INVESTMENT IN BANK PREFERRED SHARES AT A TIME WHEN THE BANK'S FINANCIAL
CONDITION IS DETERIORATING OR WHEN THE BANK HAS BEEN PLACED INTO
CONSERVATORSHIP OR RECEIVERSHIP. POTENTIAL INVESTORS IN THE SERIES A PREFERRED
SHARES, THEREFORE, SHOULD CAREFULLY CONSIDER THE DESCRIPTION OF THE BANK SET
FORTH UNDER "CERTAIN INFORMATION REGARDING THE BANK." See also "Description of
Series A Preferred Shares--Automatic Exchange."
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<PAGE>
USE OF PROCEEDS
The gross proceeds to the Company from the sale of the Series A Preferred
Shares offered hereby are expected to be $150 million ($165 million if the
Underwriters' over-allotment option is exercised in full). Simultaneously with
the consummation of the Offering, the Bank will make capital contributions to
the Company with respect to its Common Stock equal to approximately $150
million plus an amount equal to the underwriting discount and the expenses of
the Offering and the formation of the Company. The Company will use the
aggregate net proceeds of approximately $300 million received in connection
with both the Offering and such capital contributions by the Bank to purchase
the Initial Portfolio from the Bank upon the consummation of the Offering. See
"Business and Strategy."
If the Underwriters exercise their option to purchase additional Series A
Preferred Shares to cover over-allotments in the Offering, the Bank will make
additional capital contributions equal to the aggregate initial public
offering price of such additional Series A Preferred Shares and the expenses
incurred by the Company in connection with the exercise of such over-allotment
option. The Company will use the additional proceeds from any such additional
sales of Series A Preferred Shares and capital contributions to purchase
additional Mortgage Assets of the types described in "Business and Strategy--
Description of Initial Portfolio." The Company expects that it will purchase
any such additional Mortgage Assets within two months from the exercise by the
Underwriters of their over-allotment option. Pending such purchase, the
Company will invest such additional proceeds in short-term money market
investments.
The following table illustrates the use of proceeds by the Company from the
sale of the Series A Preferred Shares offered hereby (assuming the
Underwriters' over-allotment option is not exercised) and the capital
contributions by the Bank described above.
<TABLE>
<S> <C>
Gross proceeds from the Offering of Series A Preferred
Shares................................................... $150,000,000
Gross proceeds from the capital contributions by the
Bank..................................................... 156,000,000
Underwriting discount and expenses........................ (6,000,000)(1)
------------
Net proceeds to be applied to the purchase of Mortgage
Assets from the Bank..................................... $300,000,000
============
</TABLE>
- --------
(1) If actual expenses are in excess of the amounts set forth, the Bank will
make additional capital contributions to the Company equal to such excess.
The Bank will not receive any transaction fees upon consummation of the
Offering, including any advance payment in respect of advisory or servicing
fees.
17
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
November 5, 1996 (the date of the most recent audited financial statement of
the Company) and as adjusted to reflect (i) the consummation of the Offering
and (ii) the transactions described in "Certain Transactions Constituting the
Formation--The Formation" and the use of the proceeds therefrom as described
under "Use of Proceeds."
<TABLE>
<CAPTION>
NOVEMBER 5, 1996
------------------
ACTUAL AS ADJUSTED
------ -----------
(IN THOUSANDS,
EXCEPT SHARE DATA)
<S> <C> <C>
DEBT
Total long-term debt....................................... $ -- $ --
STOCKHOLDERS' EQUITY
Preferred Stock, $5.00 par value; none authorized, issued
and outstanding, actual; and 10,000,000 shares
authorized,
3,000,000 shares issued and outstanding, as adjusted..... -- 15,000
Common Stock, $1.00 par value; 100 shares authorized,
issued and outstanding, actual; and 1,000 shares
authorized,
100 shares issued and outstanding, as adjusted........... -- -- (1)
Capital contributed in excess of par...................... 1 285,000(1)
----- --------
Total stockholders' equity............................. 1 300,000
----- --------
TOTAL CAPITALIZATION....................................... $ 1 $300,000
===== ========
</TABLE>
- --------
(1) The Company was formed with an initial capitalization of $1,000.
Immediately prior to the consummation of the Offering, the Bank will make
capital contributions to the Company equal to $150 million plus an amount
sufficient to pay aggregate underwriting discount and Offering and
organization expenses, estimated by the Company to be approximately $6.0
million. Upon consummation of the Offering, the Common Stock capital
amount will equal $100. The additional paid-in capital of $285 million
represents (i) the total capital contributions made by the Bank to the
Company minus the aggregate underwriting discount and Offering and
organization expenses and (ii) the full $150 million raised in the
Offering minus the aggregate $15 million par value of the Series A
Preferred Shares.
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<PAGE>
BUSINESS AND STRATEGY
GENERAL
The Company's principal business objective is to acquire, hold and manage
Mortgage Assets that will generate net income for distribution to
stockholders. The Company will acquire the Initial Portfolio of Residential
Mortgage Loans from the Bank for an aggregate purchase price of approximately
$300 million. See "Certain Transactions Constituting the Formation--The
Formation."
In order to preserve its status as a REIT under the Code, substantially all
of the assets of the Company will consist of Mortgage Loans, Mortgage-Backed
Securities and other qualified REIT real estate assets of the type set forth
in Section 856(c)(6)(B) of the Code. See "Federal Income Tax Considerations."
DIVIDEND POLICY
The Company currently expects to pay an aggregate amount of dividends with
respect to its outstanding shares of capital stock equal to not less than 100%
of the Company's "REIT taxable income" (excluding capital gains). In order to
remain qualified as a REIT, the Company must distribute annually at least 95%
of its "REIT taxable income" (excluding capital gains) to stockholders. The
Company anticipates that none of the dividends on the Series A Preferred
Shares and none or no material portion of the dividends on the Common Stock
will constitute non-taxable returns of capital.
Dividends will be declared at the discretion of the Board of Directors after
considering the Company's distributable funds, financial requirements, tax
considerations and other factors. Because (i) the Mortgage Assets are interest
bearing, (ii) the Series A Preferred Shares represent approximately 50% of the
Company's capitalization, and (iii) the Company does not anticipate incurring
any indebtedness, the Company currently expects that both its cash available
for distribution and its "REIT taxable income" will exceed the amount needed
to pay dividends on the Series A Preferred Shares, even in the event of a
significant decline in interest rate levels. Accordingly, the Company expects
that it will, after paying the quarterly dividend on the Series A Preferred
Shares, pay dividends to holders of its Common Stock. Assuming that (i) the
Mortgage Assets included in the Initial Portfolio are held for the 12-month
period following consummation of the Offering, (ii) principal repayments are
reinvested in additional Mortgage Assets with characteristics similar to those
of the Mortgage Assets included in the Initial Portfolio, and (iii) interest
rates remain constant during such 12-month period, the Company anticipates
that the Initial Portfolio will generate interest income of approximately
$22.1 million, after payment of servicing and advisory fees, during such 12-
month period. Because the aggregate annual dividend payment on the Series A
Preferred Shares is $ million, the Company anticipates, based on the
foregoing, that $ million would be available for payment of dividends on the
shares of Common Stock held by the Bank during such 12-month period.
Furthermore, in order to further the objective of avoiding disqualification as
a REIT for federal income tax purposes by reason of violating certain
ownership requirements, the Company will generally be permitted to make
Balancing Distributions of cash or property to holders of its Common Stock in
situations where the value of the Common Stock would otherwise exceed 52% of
the total value of the stock of the Company, reducing the value of the Common
Stock to not less than 50% of the total value of the Company. Such Balancing
Distributions will reduce the assets of the Company available to make payments
to the holders of the Preferred Stock, including the holders of the Series A
Preferred Shares. The Advisor will inform the Company of the need for any
Balancing Distributions based on the Advisor's regular monitoring of (i) the
fair market value of the Company's assets based on the Advisor's knowledge of
the market for such assets, and (ii) the trading price of the Series A
Preferred Shares. Under the applicable federal income tax rules, it may be
necessary to make these determinations on each day of the second half of each
taxable year. See "Federal Income Tax Considerations--Taxation of the
Company--Organizational Requirements."
However, there are several limitations on the Company's ability to pay
dividends on the Common Stock (none of which should adversely affect the legal
right of the Company to pay dividends in respect of the Series A Preferred
Shares). First, under the Company's current dividend policy, the Company may
not make any distribution in respect of the Common Stock with respect to any
year to the extent that, after taking into account such proposed distribution
(other than any Balancing Distributions), total cash or property distributions
on the
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<PAGE>
Company's outstanding shares of Preferred Stock and Common Stock with respect
to that year would exceed 105% of the Company's "REIT taxable income"
(excluding capital gains) for that year plus net capital gains of the Company
for that year. This policy regarding the limitations on payment of dividends
in respect of Common Stock may not be modified without the approval of a
majority of the Independent Directors. Second, if the Company fails to declare
and pay full dividends on the Series A Preferred Shares in any dividend
period, the Company may not make any dividends or other distributions with
respect to the Common Stock, including Balancing Distributions, until such
time as dividends on all outstanding Series A Preferred Shares have been (i)
declared and paid for three consecutive dividend periods and (ii) declared and
paid or declared and a sum sufficient for the payment thereof has been set
apart for payment for the fourth consecutive dividend period. See "Description
of Series A Preferred Shares--Dividends." Third, Maryland law provides that
dividends may be paid on the capital stock of the Company out of (i) the
Company's capital surplus (i.e., the excess of the Company's net assets over
the aggregate par value of all shares of capital stock issued by the Company),
and (ii) the Company's net profits for the year in which the dividend is
declared and for the preceding year. Because the aggregate par value of the
Series A Preferred Shares and the outstanding shares of Common Stock will,
upon the consummation of the Offering, equal $15 million (assuming the
Underwriters' over-allotment option is not exercised), the amount of dividends
which the Company could legally pay on its Common Stock cannot exceed an
amount which would cause the Company's net assets to be less than $15 million.
It is, however, possible that these limitations on the Company's ability to
pay dividends on the Common Stock could affect the ability of the Company to
qualify as a REIT for federal income tax purposes. See "Federal Income Tax
Considerations--Taxation of the Company--Organizational Requirements."
The OTS prompt corrective action regulations prohibit thrift institutions
such as the Bank from making "capital distributions" (defined to include a
transaction that the OTS or FDIC determines, by order or regulation, to be "in
substance a distribution of capital") unless the institution is at least
"adequately capitalized" after the distribution. There can be no assurances
that either the OTS or the FDIC would not seek to restrict the Company's
payment of dividends on the Series A Preferred Shares under this provision if
the Bank were to fail to maintain its status as "adequately capitalized."
Currently, an institution is considered "adequately capitalized" if it has a
total risk-based capital ratio of at least 8.0%, a Tier 1 risk-based capital
ratio of at least 4.0% and a leverage (or core capital) ratio of at least
4.0%. Based on unaudited results, at September 30, 1996, the Bank's total
risk-based capital ratio was 10.14%, Tier 1 risk-based capital ratio was 5.80%
and core capital (or leverage) ratio was 5.21%. Such ratios, adjusted to give
effect to the sale of Series A Preferred Shares in the Offering, would be
12.63%, 7.68% and 6.78%, respectively. In addition, the Exchange Event may
take place under circumstances in which the Bank will not be considered
"adequately capitalized" for purposes of the OTS' prompt corrective action
regulations. Thus, at the time of the Automatic Exchange, the Bank would
likely be prohibited from paying dividends on the Bank Preferred Shares.
Further, the Bank's ability to pay dividends on the Bank Preferred Shares
following the Automatic Exchange also would be subject to various restrictions
under OTS regulations, a resolution of the Bank's board of directors and
certain contractual provisions. See "Certain Information Regarding the Bank--
Restrictions on Bank Dividends." In the event that the Bank did pay dividends
on the Bank Preferred Shares, such dividends would be paid out of the Bank's
capital surplus.
Under certain circumstances, including any determination that the Bank's
relationship to the Company results in an unsafe and unsound banking practice,
federal regulatory authorities will have additional authority to restrict the
ability of the Company to make dividend payments to its stockholders.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal liquidity need will be to fund the acquisition of
additional Mortgage Assets as Mortgage Assets held by the Company are repaid.
The acquisition of such additional Mortgage Assets will be funded with the
proceeds of principal repayments on its current portfolio of Mortgage Assets.
The Company does not anticipate that it will have any other material capital
expenditures. The Company believes that cash generated from the payment of
interest and principal on its Mortgage Asset portfolio will provide sufficient
funds to meet its operating requirements and to pay dividends in accordance
with the requirements to be taxed as a REIT for the foreseeable future.
20
<PAGE>
GENERAL DESCRIPTION OF MORTGAGE ASSETS; INVESTMENT POLICY
Residential Mortgage Loans. The Company may from time to time acquire both
conforming and nonconforming Residential Mortgage Loans. Conventional
conforming Residential Mortgage Loans comply with the requirements for
inclusion in a loan guarantee program sponsored by either the Federal Home
Loan Mortgage Corporation ("FHLMC") or the Federal National Mortgage
Association ("FNMA"). Under current regulations, the maximum principal balance
allowed on conforming Residential Mortgage Loans ranges from $207,000
($310,500 for Residential Mortgage Loans secured by mortgaged properties
located in either Alaska or Hawaii) for one-unit residential loans to $397,800
($596,700 for Residential Mortgage Loans secured by mortgaged properties
located in either Alaska or Hawaii) for four-unit residential loans.
Nonconforming Residential Mortgage Loans are Residential Mortgage Loans that
do not qualify in one or more respects for purchase by FNMA or FHLMC under
their standard programs. The nonconforming Residential Mortgage Loans that the
Company purchases will be nonconforming generally because they have original
principal balances which exceed the limits for FHLMC or FNMA programs. The
Company's nonconforming Residential Mortgage Loans are expected to meet the
requirements for sale to national private mortgage conduit programs or other
investors in the secondary mortgage market.
Each Residential Mortgage Loan will be evidenced by a promissory note
secured by a mortgage or deed of trust or other similar security instrument
creating a first lien on single-family (one- to four-unit) residential
properties, including stock allocated to a dwelling unit in a residential
cooperative housing corporation. Residential real estate properties underlying
Residential Mortgage Loans consist of individual dwelling units, individual
cooperative apartment units, individual condominium units, two- to four-family
dwelling units, planned unit developments and townhouses. The Company
currently expects that most of the Residential Mortgage Loans to be acquired
by it will be adjustable rate Mortgage Loans; however, the Company may also
purchase fixed rate Residential Mortgage Loans.
Mortgage-Backed Securities. While no Mortgage-Backed Securities will be
included in the Initial Portfolio, the Company may from time to time acquire
fixed-rate or variable-rate Mortgage-Backed Securities representing interests
in pools of Mortgage Loans. A portion of any Mortgage-Backed Securities that
the Company purchases may have been originated by the Bank by exchanging pools
of Mortgage Loans for the Mortgage-Backed Securities. The Mortgage Loans
underlying the Mortgage-Backed Securities will be secured by single-family
residential properties located throughout the United States.
The Company intends to acquire only investment grade Mortgage-Backed
Securities issued by agencies of the federal government or government
sponsored agencies, such as FHLMC, FNMA and the Government National Mortgage
Association ("GNMA"). The Company does not intend to acquire any interest-
only, principal-only or high-risk Mortgage-Backed Securities.
Commercial Mortgage Loans. While no Commercial Mortgage Loans will be
included in the Initial Portfolio, the Company may from time to time in the
future acquire Commercial Mortgage Loans secured by industrial and warehouse
properties, recreational facilities, office buildings, retail space and
shopping malls, hotels and motels, hospitals, nursing homes or senior living
centers. Unlike Residential Mortgage Loans, Commercial Mortgage Loans
generally lack standardized terms. In addition, Commercial Mortgage Loans tend
to be fixed rate loans having shorter maturities than Residential Mortgage
Loans. Commercial Mortgage Loans may also not be fully amortizing, meaning
that they may have a significant principal balance or "balloon" payment due on
maturity. Moreover, commercial properties, particularly industrial and
warehouse properties, are generally subject to relatively greater
environmental risks than non-commercial properties, generally giving rise to
increased costs of compliance with environmental laws and regulations. See
"Risk Factors--Risks Associated with Mortgage Loans Generally--Special Risks
Relating to Commercial Mortgage Loans" and "--Environmental Considerations."
There is no requirement regarding the percentage of any commercial real estate
property that must be leased at the time the Company acquires a Commercial
Mortgage Loan secured by such commercial real restate property, and there is
no requirement that Commercial Mortgage Loans have third party guarantees.
21
<PAGE>
The credit quality of a Commercial Mortgage Loan may depend on, among other
factors, the existence and structure of underlying leases, the physical
condition of the property (including whether any maintenance has been
deferred), the creditworthiness of tenants, the historical and anticipated
level of vacancies and rents on the property and on other comparable
properties located in the same region, potential or existing environmental
risks, the availability of credit to refinance the Commercial Mortgage Loan at
or prior to maturity and the local and regional economic climate in general.
Foreclosures of defaulted Commercial Mortgage Loans are generally subject to a
number of complicating factors, including environmental considerations, which
are generally not present in foreclosures of Residential Mortgage Loans. See
"Risk Factors--Risks Associated with Mortgage Loans Generally" and "--
Environmental Considerations."
Other Real Estate Assets. The Company may invest up to 5% of the total value
of its portfolio in assets other than Residential Mortgage Loans and Mortgage-
Backed Securities eligible to be held by REITs. In addition to Commercial
Mortgage Loans, and Mortgage Loans secured by multi-family properties, such
assets could include cash, cash equivalents and securities, including shares
or interests in other REITs.
ACQUISITION OF INITIAL PORTFOLIO
Simultaneously with the consummation of the Offering, the Company will
acquire the Residential Mortgage Loans included in the Initial Portfolio
pursuant to the terms of a residential mortgage loan purchase agreement with
the Bank (collectively, the "Residential Mortgage Loan Purchase Agreements").
Each Residential Mortgage Loan in the Initial Portfolio will be assigned to
the Company pursuant to the Residential Mortgage Loan Purchase Agreement. Each
Residential Mortgage Loan will be identified in a schedule appearing as an
exhibit to the Residential Mortgage Loan Purchase Agreement (the "Residential
Mortgage Loan Schedule"). The Residential Mortgage Loan Schedule will specify,
among other things, with respect to each Residential Mortgage Loan: the loan
number, the interest rate or interest rate formula applicable to such
Residential Mortgage Loan, the interest rate as of the purchase date pursuant
to such formula, the original principal amount and the unpaid principal
balance as of the purchase date, the monthly payment, the maturity date and
the type of the mortgaged property.
In addition, the Bank will deliver or cause to be delivered to the Company
the mortgage note with respect to each Residential Mortgage Loan (together
with all amendments and modifications thereto) endorsed in blank, the original
or certified copy of the mortgage (together with all amendments and
modifications thereto) with evidence of recording indicated thereon, if
available, and an original or certified copy of an assignment of the mortgage
in recordable form. Such documents will initially be held by the Bank, as
Advisor, acting as custodian for the Company. None of the assignments of the
Residential Mortgage Loans in the Initial Portfolio will be recorded since the
Bank will hold record title to the Residential Mortgage Loans to facilitate
the servicing of such loans. See "--Servicing" and "--Description of Initial
Portfolio--General."
The Bank will make certain representations and warranties with respect to
the Residential Mortgage Loans in the Initial Portfolio for the benefit of the
Company and will be obligated to repurchase any Residential Mortgage Loan sold
by it to the Company as to which there is a material breach of any such
representation or warranty, unless the Bank elects to substitute a qualified
Residential Mortgage Loan for such Residential Mortgage Loan. The Bank will
also indemnify the Company for damages or costs resulting from any such
breach. The repurchase price for any such Residential Mortgage Loan will be
its outstanding principal amount plus accrued and unpaid interest on the date
of repurchase. In addition, under the terms of the Residential Mortgage Loan
Purchase Agreement, the Company will acquire, in addition to the Residential
Mortgage Loans included in the Initial Portfolio, (i) the amounts held in one
or more accounts currently maintained for the benefit of or in the name of the
Bank, which will be transferred to the Company pursuant to the Servicing
Agreement, and (ii) all insurance policies relating to the Residential
Mortgage Loans and the proceeds thereof.
MANAGEMENT POLICIES AND PROGRAMS
In administering the Company's Mortgage Assets, the Advisor has a high
degree of autonomy. The Board of Directors, however, has adopted certain
policies to guide administration of the Company and the Advisor with
22
<PAGE>
respect to the acquisition and disposition of assets, use of capital and
leverage, credit risk management and certain other activities. These policies,
which are discussed below, may be amended or revised from time to time at the
discretion of the Board of Directors (in certain circumstances subject to the
approval of a majority of the Independent Directors) without a vote of the
Company's stockholders, including holders of the Series A Preferred Shares.
See also "--Dividend Policy."
Asset Acquisition and Disposition Policies. Subsequent to the acquisition of
the Initial Portfolio, the Company anticipates that it will from time to time
purchase additional Mortgage Assets. The Company intends to acquire all or
substantially all of such Mortgage Assets from the Bank and/or affiliates of
the Bank, on terms that are comparable to those that could be obtained by the
Company if such Mortgage Assets were purchased from unrelated third parties,
out of proceeds received in connection with the repayment or disposition of
Mortgage Assets or the issuance of additional shares of Preferred Stock or the
contribution of additional capital by the Bank. The Company may also from time
to time, however, acquire Mortgage Assets from unrelated third parties. As of
the date of this Prospectus, the Company has not adopted any arrangements or
procedures by which it would purchase Mortgage Assets from unrelated third
parties, and the Company has not entered into any agreements with any third
parties with respect to the purchase of Mortgage Assets. The Company
anticipates that it would purchase Mortgage Assets from unrelated third
parties only if neither the Bank nor any affiliate of the Bank had an amount
or type of Mortgage Asset sufficient to meet the requirements of the Company.
The Company currently anticipates that the Mortgage Assets that it purchases
will include Residential Mortgage Loans, as described in "--Description of
Initial Portfolio," and Mortgage-Backed Securities, although if the Bank
and/or any of its affiliates develop additional Mortgage Asset products, the
Company may purchase such additional types of Mortgage Assets. In addition,
the Company may also from time to time acquire limited amounts of other assets
eligible to be held by REITs. The Company currently anticipates that it will
not acquire the right to service any Mortgage Loan it acquires in the future.
The Company anticipates that any servicing arrangement that it enters into in
the future will contain fees and other terms consistent with secondary market
standards.
The Company currently intends to maintain at least 95% of its portfolio in a
combination of Residential Mortgage Loans and Mortgage-Backed Securities. As
indicated above, the Company may invest up to 5% of its portfolio in other
assets eligible to be held by REITs. The Company's current policy prohibits
the acquisition of any Mortgage Loan or any interest in a Mortgage Loan (other
than an interest resulting from the acquisition of Mortgage-Backed
Securities), which Mortgage Loan (i) is delinquent in the payment of principal
or interest at the time of proposed acquisition; (ii) is or was at any time
during the preceding 12 months (a) classified, (b) in nonaccrual status or (c)
renegotiated due to financial deterioration of the borrower; or (iii) has
been, more than once during the preceding 12 months, more than 30 days past
due in the payment of principal or interest. Loans that are in a "nonaccrual
status" are generally loans that are past due 90 days or more in principal or
interest, and "classified" loans are generally troubled loans which are deemed
substandard or doubtful with respect to collectibility.
The Company currently intends to maintain a policy of disposing of any
Mortgage Loan which, subsequent to its acquisition by the Company, (i) becomes
classified, (ii) falls into nonaccrual status, (iii) has to be renegotiated
due to the financial deterioration of the borrower, or (iv) is more than 30
days past due in the payment of principal or interest more than once in any 12
month period. The Company may choose, at any time subsequent to its
acquisition of any Mortgage Loan, to require the Servicer of the Mortgage Loan
to dispose of any Mortgage Loan for any of these reasons or for any other
reason. The Bank has indicated to the Company that the Bank will not purchase
any Mortgage Loan of the Company that the Company chooses to dispose of for
any of the foregoing reasons; accordingly, the Company currently anticipates
that any such Mortgage Loan would be sold at its then current fair value by
the Company to an unrelated third party.
The Company will develop forms of assignment and a policy regarding
recording of mortgage assignments for the Residential Mortgage Loans that it
acquires.
Capital and Leverage Policies. To the extent that the Board of Directors
determines that additional funding is required, the Company may raise such
funds through additional equity offerings, debt financing or
23
<PAGE>
retention of cash flow (after consideration of provisions of the Code
requiring the distribution by a REIT of a certain percentage of taxable income
and taking into account taxes that would be imposed on undistributed taxable
income), or a combination of these methods.
The Company will have no debt outstanding following consummation of the
Offering, and the Company does not currently intend to incur any indebtedness.
However, the organizational documents of the Company do not contain any
limitation on the amount or percentage of debt, funded or otherwise, the
Company might incur. Notwithstanding the foregoing, the Company may not,
without the approval of a majority of the Independent Directors, incur debt
for borrowed money other than debt not in excess of 25% of the Company's total
stockholders' equity. Any such debt incurred may include intercompany advances
made by the Bank to the Company.
The Company may also issue additional series of Preferred Stock. However,
the Company may not issue additional shares of Preferred Stock senior to the
Series A Preferred Shares without the consent of holders of at least 67% of
the outstanding shares of Preferred Stock at that time, including the Series A
Preferred Shares, and the Company may not issue additional shares of Preferred
Stock on a parity with the Series A Preferred Shares without the approval of a
majority of the Company's Independent Directors. The Company does not
currently intend to issue any additional series of Preferred Stock unless it
simultaneously receives additional capital contributions from the Bank equal
to the sum of the aggregate offering price of such additional Preferred Stock
and the Company's expenses in connection with the issuance of such additional
shares of Preferred Stock. Prior to its issuance of additional shares of
Preferred Stock, the Company will take into consideration the Bank's
regulatory capital requirements and the cost of raising and maintaining that
capital at the time. See "Certain Transactions Constituting the Formation--
Benefits to the Bank."
Credit Risk Management Policies. The Company intends that each Mortgage Loan
acquired from the Bank, an affiliate of the Bank or an unrelated third party
in the future will represent a first lien position and will be originated in
the ordinary course of the originator's real estate lending activities based
on the underwriting standards generally applied (at the time of origination)
for the originator's own account. See "--Description of Initial Portfolio--
Underwriting Standards." The Company also intends that all Mortgage Loans held
by the Company will be serviced pursuant to the Servicing Agreement, which
requires servicing in conformity with accepted secondary market standards,
with any servicing guidelines promulgated by the Company and, in the case of
the Residential Mortgage Loans, with FNMA and FHLMC guidelines and procedures.
The Company may also choose, at any time subsequent to its acquisition of
Mortgage Loans, to dispose of any Mortgage Loan for any reason, including as a
result of such Mortgage Loan becoming "classified" or being placed in a
"nonaccrual status" or renegotiated due to the financial deterioration of the
borrower or having been, more than once during the preceding 12 months, more
than 30 days past due in the payment of principal or interest, as described
above.
Conflict of Interest Policies. Because of the nature of the Company's
relationship with the Bank and its affiliates, it is likely that conflicts of
interest will arise with respect to certain transactions, including without
limitation, the Company's acquisition of Mortgage Assets from, or disposition
of Mortgage Assets to, the Bank or its affiliates and the modification of the
Advisory Agreement or the Servicing Agreement. It is the Company's policy that
the terms of any financial dealings with the Bank and its affiliates will be
consistent with those available from third parties in the mortgage lending
industry. In addition, neither the Advisory Agreement nor the Servicing
Agreement may be modified or terminated without the approval of a majority of
the Independent Directors.
Conflicts of interest between the Company and the Bank and its affiliates
may also arise in connection with making decisions that bear upon the credit
arrangements that the Bank or one of its affiliates may have with a borrower.
Conflicts could also arise in connection with actions taken by the Bank as a
controlling person in the Company. It is the intention of the Company and the
Bank that any agreements and transactions between the Company, on the one
hand, and the Bank or its affiliates, on the other hand, including, without
limitation, the Residential Mortgage Loan Purchase Agreements, are fair to all
parties and are consistent with market terms for
24
<PAGE>
such types of transactions. The Servicing Agreement provides that (i)
foreclosures and dispositions of the Mortgage Loans are to be performed with a
view toward maximizing the recovery by the Company as owner of the Mortgage
Loans, and the Servicer shall service the Mortgage Loans solely with a view
toward the interests of the Company, and without regard to the interests of
the Bank or any of its affiliates. The requirement in the Articles
Supplementary establishing the Series A Preferred Shares that certain actions
of the Company be approved by a majority of the Independent Directors is also
intended to ensure fair dealings between the Company and the Bank and its
affiliates. However, there can be no assurance that any such agreement or
transaction will be on terms as favorable to the Company as would have been
obtained from unaffiliated third parties.
There are no provisions in the Company's Articles of Incorporation limiting
any officer, director, security holder or affiliate of the Company from having
any direct or indirect pecuniary interest in any Mortgage Asset to be acquired
or disposed of by the Company or in any transaction in which the Company has
an interest or from engaging in acquiring, holding and managing Mortgage
Assets. As described herein, it is expected that the Bank and its affiliates
will have direct interests in transactions with the Company (including without
limitation the sale of Mortgage Assets to the Company); however, it is not
currently anticipated that any of the officers or directors of the Company
will have any interests in such Mortgage Assets.
Other Policies. The Company intends to operate in a manner that will not
subject it to regulation under the Investment Company Act of 1940, as amended.
The Company does not intend to (i) invest in the securities of other issuers
for the purpose of exercising control over such issuers, (ii) underwrite
securities of other issuers, (iii) actively trade in loans or other
investments, (iv) offer securities in exchange for property, or (v) make loans
to third parties, including without limitation officers, directors or other
affiliates of the Company. The Company may, under certain circumstances,
purchase the Series A Preferred Shares in the open market or otherwise. The
Company has no present intention of causing the Company to repurchase any
shares of its capital stock, and any such action would be taken only in
conformity with applicable federal and state laws and the requirements for
qualifying as a REIT.
The Company intends to publish and distribute to stockholders, in accordance
with the rules of the NYSE, annual reports containing financial statements
prepared in accordance with generally accepted accounting principles and
certified by the Company's independent public accountants. The Articles
Supplementary establishing the Series A Preferred Shares provide that the
Company shall maintain its status as a reporting company under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), for as long as any of
the Series A Preferred Shares are outstanding.
The Company currently intends to make investments and operate its business
at all times in such a manner as to be consistent with the requirements of the
Code to qualify as a REIT. However, future economic, market, legal, tax or
other considerations may cause the Board of Directors, subject to approval by
a majority of the Independent Directors, to determine that it is in the best
interests of the Company and its stockholders to revoke its REIT status.
DESCRIPTION OF INITIAL PORTFOLIO
Information with respect to the Initial Portfolio is presented as of October
31, 1996. Factual data with respect to the Mortgage Assets included in the
Initial Portfolio relates to Mortgage Assets which the Company currently
believes will be purchased simultaneously with the consummation of the
Offering. The composition of the Initial Portfolio as actually purchased
contemporaneously with the consummation of the Offering may differ in certain
respects from the Initial Portfolio as described in this Prospectus; provided,
however, that (i) at least 95% of the Mortgage Assets included in the actual
Initial Portfolio (measured by aggregate outstanding principal balance) shall
include Mortgage Assets described herein, and (ii) the Company must first
determine that any changes in the Initial Portfolio from the description
herein are not material.
References herein to percentages of Mortgage Assets included in the Initial
Portfolio refer in each case to the percentage of the aggregate outstanding
principal balance of the Mortgage Assets in the Initial Portfolio as of
October 31, 1996, based on the outstanding principal balances of such Mortgage
Assets as of such date, after giving effect to scheduled monthly payments due
on or prior to such date, whether or not received.
25
<PAGE>
The detailed information set forth in this Prospectus with respect to the
Mortgage Assets applies only to the Initial Portfolio. The Company's portfolio
of Mortgage Assets may or may not have the characteristics described below at
future dates, although the Company currently intends to maintain at least 95%
of its portfolio in a combination of Residential Mortgage Loans and Mortgage-
Backed Securities and the remainder of its portfolio in other assets eligible
to be held by REITs.
General. The Initial Portfolio contains 1,682 Residential Mortgage Loans. On
October 31, 1996, the Residential Mortgage Loans included in the Initial
Portfolio had an aggregate outstanding principal balance of approximately
$321.9 million.
Substantially all of the Residential Mortgage Loans included in the Initial
Portfolio were originated in the ordinary course of the real estate lending
activities of either the Bank or one of the Bank's affiliates. Certain of the
Residential Mortgage Loans included in the Initial Portfolio may have been
originated by mortgagees approved by the Secretary of Housing and Urban
Development or institutions (such as banks, credit unions and insurance
companies) subject to supervision and examination by federal and state
authorities and then sold to the Bank or one of the Bank's affiliates. All of
the Residential Mortgage Loans included in the Initial Portfolio were
originated generally in accordance with the underwriting standards customarily
employed by the originator during the period in which such Mortgage Loans were
originated.
All of the Residential Mortgage Loans included in the Initial Portfolio were
originated between 1988 and 1996, and have original terms to stated maturity
of either 30 or 40 years. The weighted average number of months since
origination of the Residential Mortgage Loans included in the Initial
Portfolio (calculated as of October 31, 1996) was approximately 30 months. The
weighted average "Loan-to-Value Ratio" of the Residential Mortgage Loans
included in the Initial Portfolio is 82.0%. "Loan-to-Value Ratio" means the
ratio (expressed as a percentage) of the original principal amount of a
mortgage loan to the lesser of (i) the appraised value at origination of the
underlying mortgage property, and (ii) if the mortgage loan was made to
finance the acquisition of property, the purchase price of the mortgaged
property.
Except as described below, upon transfer of the residential mortgaged
property underlying a Residential Mortgage Loan included in the Initial
Portfolio that is an adjustable rate Mortgage Loan, the mortgage note
generally will not preclude assumption of the related Residential Mortgage
Loan by the proposed transferee if the proposed transferee satisfies certain
criteria with respect to its ability to repay the Residential Mortgage Loan.
The mortgage notes with respect to certain of the Residential Mortgage Loans
included in the Initial Portfolio contain "due-on-sale" provisions, which
prevent the assumption of the Residential Mortgage Loan by a proposed
transferee and accelerate the payment of the outstanding principal balance of
the Residential Mortgage Loan. "Due-on-sale" provisions in mortgage notes with
respect to adjustable rate Residential Mortgage Loans may be applicable in the
period prior to the first Rate Adjustment Date (as defined herein) or
following the exercise of a conversion option fixing the interest rate.
None of the Residential Mortgage Loans included in the Initial Portfolio (i)
is currently delinquent in the payment of principal or interest; (ii) is or
was at any time during the preceding 12 months (a) classified, (b) in
nonaccrual status or (c) renegotiated due to the financial deterioration of
the borrower; or (iii) was, more than once during the preceding 12 months,
more than 30 days past due in the payment of principal or interest. If, prior
to the acquisition of the Initial Portfolio, any Residential Mortgage Loan
included in the description of the Initial Portfolio herein falls within any
of the foregoing categories, the Company will not purchase such Residential
Mortgage Loan but will instead purchase a Residential Mortgage Loan similar in
aggregate outstanding principal balance and product type which does not fall
into any of these categories.
Residential Mortgage Loans. The following types of Residential Mortgage Loan
products, each of which is more fully described below, will be included in the
Initial Portfolio: Three-Year ARM, 5/1 ARM and 10/1 ARM.
26
<PAGE>
The following table sets forth certain information with respect to each type
of Residential Mortgage Loan included in the Initial Portfolio as of October
31, 1996:
TYPE OF RESIDENTIAL MORTGAGE LOAN PRODUCT
<TABLE>
<CAPTION>
PERCENTAGE
AGGREGATE OF INITIAL WEIGHTED AVERAGE
PRINCIPAL PORTFOLIO BY WEIGHTED AVERAGE EXPECTED MONTHS
BALANCE AGGREGATE PRINCIPAL INITIAL LOAN TO REMAINING
TYPE (IN THOUSANDS) BALANCE VALUE RATIO TO MATURITY
---- -------------- ------------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Three-Year ARM.......... $113,783 35.35% 81.24% 327
5/1 ARM................. 196,817 61.15% 83.03% 333
10/1 ARM................ 11,252 3.50% 72.05% 311
-------- ------
Total............... $321,852 100.00% 82.01% 330
======== ======
</TABLE>
All of the Residential Mortgage Loans included in the Initial Portfolio bear
interest at adjustable rates. The interest rate on an "adjustable rate
mortgage" or an "ARM" is typically tied to an index (such as the interest rate
on United States Treasury Bills), and is adjustable periodically. ARMs are
typically subject to lifetime interest rate caps and periodic interest rate
caps. As of October 31, 1996, the interest rates of the Residential Mortgage
Loans included in the Initial Portfolio ranged from 5.125% per annum to 9.500%
per annum and the weighted average interest rate was approximately 7.79% per
annum. The following table contains certain additional data with respect to
the interest rates of the Residential Mortgage Loans included in the Initial
Portfolio as of October 31, 1996:
CURRENT INTEREST RATE OF ADJUSTABLE RATE RESIDENTIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
AGGREGATE INITIAL PORTFOLIO
CURRENT NUMBER OF PRINCIPAL BALANCE BY AGGREGATE
INTEREST RATE MORTGAGE LOANS (IN THOUSANDS) PRINCIPAL BALANCE
------------- -------------- ----------------- -----------------
<S> <C> <C> <C>
5.000%-5.249%................ 1 $ 153 0.05%
5.250%-5.499%................ 2 513 0.16%
5.500%-5.749%................ 4 697 0.22%
5.750%-5.999%................ 27 4,385 1.36%
6.000%-6.249%................ 24 3,595 1.12%
6.250%-6.499%................ 22 3,991 1.24%
6.500%-6.749%................ 15 2,331 0.72%
6.750%-6.999%................ 30 5,327 1.66%
7.000%-7.249%................ 37 7,482 2.32%
7.250%-7.499%................ 65 12,992 4.04%
7.500%-7.749%................ 375 73,366 22.79%
7.750%-7.999%................ 465 88,861 27.60%
8.000%-8.249%................ 269 53,747 16.70%
8.250%-8.499%................ 158 31,238 9.71%
8.500%-8.749%................ 117 21,203 6.59%
8.750%-8.999%................ 51 8,591 2.67%
9.000%-9.249%................ 13 2,139 0.66%
9.250%-9.499%................ 5 833 0.26%
9.500%-9.749%................ 2 408 0.13%
----- -------- ------
Total.................... 1,682 $321,852 100.00%
===== ======== ======
</TABLE>
"Gross Margin," with respect to a Residential Mortgage Loan that is an ARM,
means the applicable fixed percentage which is added to the applicable index
to calculate the current interest rate paid by the borrower of such
Residential Mortgage Loan (without taking into account any interest rate caps
or minimum interest rates).
27
<PAGE>
Gross Margin is inapplicable to fixed rate Residential Mortgage Loans. As of
October 31, 1996, the weighted average Gross Margin of the Residential
Mortgage Loans included in the Initial Portfolio was approximately 2.95%.
The following table sets forth certain additional data with respect to the
Gross Margins of the Residential Mortgage Loans included in the Initial
Portfolio as of October 31, 1996:
GROSS MARGIN
<TABLE>
<CAPTION>
PERCENTAGE OF
AGGREGATE INITIAL PORTFOLIO
NUMBER OF PRINCIPAL BALANCE BY AGGREGATE
GROSS MARGIN MORTGAGE LOANS (IN THOUSANDS) PRINCIPAL BALANCE
------------ -------------- ----------------- -----------------
<S> <C> <C> <C>
1.625%-2.124%................ 6 $ 519 0.2%
2.625%-3.124%................ 1,461 280,180 87.0%
Greater than 3.124%.......... 215 41,153 12.8%
----- -------- -----
Total.................... 1,682 $321,852 100.0%
===== ======== =====
</TABLE>
The interest rate of each type of ARM product included in the Initial
Portfolio adjusts at the times (each, a "Rate Adjustment Date") and in the
manner described below subject to lifetime interest rate caps, to minimum
interest rates and, in the case of most ARMs in the Initial Portfolio, to
maximum periodic adjustment increases or decreases, each as specified in the
mortgage note relating to the ARM. Information set forth below regarding
interest rate caps and minimum interest rates applies to the Initial Portfolio
only. Mortgage Loans purchased by the Company after consummation of the
Offering may be subject to different interest rate caps and minimum interest
rates.
Each ARM bears interest at its initial interest rate until its first Rate
Adjustment Date. Effective with each Rate Adjustment Date, the monthly
principal and interest payment on an adjustable rate Mortgage Loan will be
adjusted to an amount that will fully amortize the then-outstanding principal
balance of such Residential Mortgage Loan over its remaining term to stated
maturity and that will be sufficient to pay interest at the adjusted interest
rate. Certain of the types of Residential Mortgage Loan products that are ARMs
contain an option, which may be exercised by the mortgagor, to convert the ARM
into a fixed rate loan for the remainder of the mortgage term. If a
Residential Mortgage Loan that is an ARM is converted into a fixed rate loan,
the interest rate will be determined at the time of conversion as specified in
the mortgage note relating to such Mortgage Loan and will remain fixed at such
rate until the stated maturity of such Residential Mortgage Loan. All the
Mortgage Loans included in the Initial Portfolio allow the mortgagor to prepay
at any time some or all of the outstanding principal balance of the Mortgage
Loan without a fee or penalty.
One-Year ARM. The interest rate with respect to a one-year ARM ("One-Year
ARM") is fixed at an initial rate for the first twelve monthly payments and
adjusts annually thereafter on the date specified in the related mortgage note
to a rate equal to the then-current Treasury Index (defined below) plus the
Gross Margin set forth in such mortgage note, subject to a maximum annual
interest rate increase or decrease of 2.00%, a lifetime interest rate cap as
specified in the related mortgage note and a minimum interest rate no less
than the Gross Margin. The sum of the Treasury Index and the Gross Margin is
generally rounded to the nearest 0.125%; however, certain mortgage notes
provide for the sum to be rounded upwards to the nearest 0.125%. The "Treasury
Index" with respect to each One-Year ARM is the weekly average yield on United
States Treasury securities adjusted to a constant maturity of one year as
published by the Federal Reserve Board in Statistical Release H.15 (519) or
any similar publication or, if not so published, as reported by any Federal
Reserve Bank or by any United States government department or agency and made
available to the applicable servicer. Should the Treasury Index not be
published or become otherwise unavailable, the applicable servicer will select
a comparable alternative index over which it has no control and which is
readily available.
28
<PAGE>
Certain One-Year ARMs contain a conversion option which, if exercised, would
convert the One-Year ARM into a fixed rate loan for the remainder of the term
of the mortgage. Subject to conditions specified in the mortgage note related
to a One-Year ARM, a mortgagor may have the right to convert the One-Year ARM
to a fixed rate loan beginning with the first Rate Adjustment Date and on the
first day of each month thereafter until and including the fifth Rate
Adjustment Date. If the conversion option is exercised, the interest rate will
be fixed for the remainder of the term of the mortgage and will equal the sum
of a percentage equal to at least 0.625% and the FNMA Required Net Yield. The
mortgagor must pay a conversion fee at the time the option is exercised.
Three-Year ARM. The interest rate with respect to each three-year ARM
("Three-Year ARM") is fixed at an initial rate for the first 36 monthly
payments and adjusts every three years thereafter in the same manner described
for the One-Year ARM, except that the "Treasury Index" is the weekly average
yield on United States Treasury securities adjusted to a constant maturity of
three years. Certain Three-Year ARMs contain a conversion option that is
substantially the same as the conversion option for the One-Year ARM, except
that the option may only be exercised at the first and second Rate Adjustment
Dates.
Five-Year Fixed Rate Loan with Automatic Conversion to One-Year ARM. The
interest rate with respect to each five-year fixed rate loan with automatic
conversion to a One-Year ARM (a "5/1 ARM") is fixed at an initial rate for the
first 60 monthly payments and adjusts annually thereafter as if the
Residential Mortgage Loan were a One-Year ARM with a lifetime interest rate
cap equal to the initial interest rate with respect to such Residential
Mortgage Loan plus 6% to 8%. There is no ability to continue at a fixed rate
after the first Rate Adjustment Date.
Ten-Year Fixed Rate Loan with Automatic Conversion to One-Year ARM. The
interest rate with respect to each ten-year fixed rate loan with automatic
conversion to a One-Year ARM (a "10/1 ARM") is fixed at an initial rate for
the first 120 monthly payments and adjusts annually thereafter as if the
Residential Mortgage Loan were a One-Year ARM with a lifetime interest rate
cap equal to the initial interest rate with respect to such Residential
Mortgage Loan plus 6% to 7%. There is no ability to continue at a fixed rate
after the first Rate Adjustment Date.
Underwriting Standards. The Bank has represented to the Company that all of
the Mortgage Loans included in the Initial Portfolio were originated generally
in accordance with the underwriting policies customarily employed by the
originator during the period in which the Residential Mortgage Loans in the
Initial Portfolio were originated.
In the Mortgage Loan approval process, the Bank assesses both the borrower's
ability to repay the Mortgage Loan and, in appropriate cases, the adequacy of
the proposed security. Credit approval is vested with the board of directors
of the Bank and delegated to the executive loan committee of the Bank (the
"Executive Loan Committee") and certain senior officers in accordance with the
credit authorizations approved by the board of directors of the Bank. All
multi-family Residential Mortgage Loans and Commercial Loans are reviewed and
approved by the Executive Loan Committee. Any significant Mortgage Loan not
conforming to the Bank's approved policies must be approved by the Executive
Loan Committee or the chief executive officer of the Bank. All Mortgage Loans
of $15 million or more are presented to the board of directors of the Bank for
final approval.
The approval process for all types of Mortgage Loans includes on-site
appraisals of the properties securing such loans and a review of the
applicant's financial statements and credit, payment and banking history,
financial statements of any guarantors, and tax returns of guarantors of
multi-family Residential Mortgage Loans and Commercial Loans. The Bank
generally lends up to 95% of the appraised value of single-family residential
dwellings to be owner-occupied. The Loan-to-Value Ratio generally applied by
the Bank to multi-family Residential Mortgage Loans and Commercial Loans has
been 80% of the appraised value of the property.
The Bank requires title insurance policies protecting the priority of the
Bank's liens for all Mortgage Loans and also requires fire and casualty
insurance for permanent Mortgage Loans. The borrower selects the insurance
carrier, subject to the Bank's approval. Generally, for any Residential
Mortgage Loan in an amount exceeding 80% of the appraised value of the
security property, the Bank currently requires mortgage insurance from an
independent mortgage insurance company.
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Substantially all fixed-rate Mortgage Loans originated by the Bank contain a
"due-on-sale" clause providing that the Bank may declare a Mortgage 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.
Geographic Distribution. The Company currently anticipates that
approximately 98% of the residential real estate properties underlying the
Company's Residential Mortgage Loans included in the Initial Portfolio will be
located in Washington, D.C., Maryland and Virginia. Consequently, these
Residential Mortgage Loans may be subject to a greater risk of default than
other comparable Residential Mortgage Loans in the event of adverse economic,
political or business developments in Washington, D.C., Maryland and Virginia
that may affect the ability of residential property owners in any of these
areas to make payments of principal and interest on the underlying mortgages.
Loan-to-Value Ratios; Insurance. Approximately 99.2% of the Residential
Mortgage Loans having Loan-to-Value Ratios of greater than 80%, are insured
under primary mortgage guaranty insurance policies. Approximately 38.3% of the
insured Residential Mortgage Loans are insured by any one primary mortgage
insurance policy issuer. At the time of origination of the Residential
Mortgage Loans, each of the primary mortgage insurance policy insurers was
approved by FNMA or FHLMC. A standard hazard insurance policy is required to
be maintained by the mortgagor with respect to each Residential Mortgage Loan
in an amount equal to the maximum insurable value of the improvements securing
such Residential Mortgage Loan or the principal balance of such Residential
Mortgage Loan, whichever is less. If the residential real estate property
underlying a Residential Mortgage Loan is located in a flood zone, such
Residential Mortgage Loan may also be covered by a flood insurance policy as
required by law. No special hazard insurance policy or mortgagor bankruptcy
insurance will be maintained by the Company with respect to the Residential
Mortgage Loans in the Initial Portfolio, nor will any Residential Mortgage
Loan be insured by the Federal Housing Administration or guaranteed by the
Veterans Administration.
SERVICING
The Mortgage Loans included in the Initial Portfolio will be serviced by the
Bank pursuant to the terms of the Servicing Agreement. The Bank in its role as
servicer under the terms of the Servicing Agreement is herein referred to as
the "Servicer." The Servicer will receive a fee equal to .375% per annum on
the principal balances of the loans serviced.
The Servicing Agreement requires the Servicer to service the Company's
Mortgage Loans in a manner generally consistent with accepted secondary market
practices, with any servicing guidelines promulgated by the Company and, in
the case of Residential Mortgage Loans, with FNMA and FHLMC guidelines and
procedures. The Servicing Agreement requires the Servicer to service the
Mortgage Loan solely with a view toward the interests of the Company and
without regard to the interests of the Bank or any of its affiliates. The
Servicer will collect and remit principal and interest payments, administer
mortgage escrow accounts, submit and pursue insurance claims and initiate and
supervise foreclosure proceedings on the Mortgage Loans it services. The
Servicer will also provide accounting and reporting services required by the
Company for such Mortgage Loans. The Servicing Agreement requires the Servicer
to follow such collection procedures as are customary in the industry,
including contacting delinquent borrowers and supervising foreclosures and
property disposition in the event of unremedied defaults in accordance with
servicing guidelines promulgated by the Company. The Servicer may, in its
discretion, arrange with a defaulting borrower a schedule for the liquidation
of delinquencies, provided that, in the case of Residential Mortgage Loans, no
primary mortgage guaranty insurance coverage is adversely affected. The
Servicer may also be directed by the Company, at any time during the servicing
process, to dispose of any Mortgage Loan which becomes classified, placed in a
nonaccrual status, renegotiated due to the financial deterioration of the
borrower or which has been, more than once during the preceding 12 months,
more than 30 days past due in the payment of principal or interest. The
Servicer may from time to time subcontract all or a portion of its servicing
obligations under the Servicing Agreement to which it is a party to affiliates
of the Bank. If no affiliate of the Bank is engaged in the business of
servicing Mortgage Loans, the
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Servicer may subcontract all or a portion of its obligations under the
Servicing Agreement to an unrelated third party subject to approval of a
majority of the Independent Directors. The Servicer will not, in connection
with subcontracting any of its obligations under the Servicing Agreement, be
discharged or relieved in any respect from its obligation to the Company to
perform its obligations under the Servicing Agreement.
The Servicer will be required to pay all expenses related to the performance
of its duties under the Servicing Agreement. The Servicer will be required to
make advances of taxes and required insurance premiums that are not collected
from borrowers with respect to any Mortgage Loan serviced by it, unless it
determines that such advances are nonrecoverable from the mortgagor, insurance
proceeds or other sources with respect to such Mortgage Loan. If such advances
are made, the Servicer generally will be reimbursed prior to the Company being
reimbursed out of proceeds related to such Mortgage Loan. The Servicer also
will be entitled to reimbursement by the Company for expenses incurred by it
in connection with the liquidation of defaulted Mortgage Loans serviced by it
and in connection with the restoration of mortgaged property. If claims are
not made or paid under applicable insurance policies or if coverage thereunder
has ceased, the Company will suffer a loss to the extent that the proceeds
from liquidation of the mortgaged property, after reimbursement of the
Servicer's expenses in the sale, are less than the outstanding principal
balance of the related Mortgage Loan. The Servicer will be responsible to the
Company for any loss suffered as a result of the Servicer's failure to make
and pursue timely claims or as a result of actions taken or omissions made by
the Servicer which cause the policies to be cancelled by the insurer. The
Servicer will be required to represent and warrant that the Mortgage Loans it
services will comply with any loan servicing guidelines promulgated by the
Company and to agree to repurchase, at the request of the Company, any
Mortgage Loan it services in the event that it fails to make such
representations or warranties or any such representation or warranty is
untrue. The repurchase price for any such Mortgage Loan will be the
outstanding principal amount thereof plus accrued and unpaid interest thereon
at the date of repurchase. The Servicer may institute foreclosure proceedings,
exercise any power of sale contained in any mortgage or deed of trust, obtain
a deed in lieu of foreclosure or otherwise acquire title to a mortgaged
property underlying a Mortgage Loan by operation of law or otherwise in
accordance with the terms of the Servicing Agreement.
The Company may terminate the Servicing Agreement upon the occurrence of one
or more events specified in the Servicing Agreement. Such events relate
generally to the Servicer's proper and timely performance of its duties and
obligations under the Servicing Agreement. In addition, the Company may also
terminate the Servicing Agreement without cause upon 60 days' notice and
payment of a termination fee that is competitive with that which is generally
payable in the industry. The termination fee will be based on the aggregate
outstanding principal amount of the loans then serviced under the Servicing
Agreement. As long as any Series A Preferred Shares remain outstanding, the
Company may not terminate, or elect not to renew, the Servicing Agreement
without the approval of a majority of the Independent Directors.
As is customary in the mortgage loan servicing industry, the Servicer will
be entitled to retain any late payment charges, prepayment fees, penalties and
assumption fees collected in connection with the Mortgage Loans serviced by
it. The Servicer will receive any benefit derived from interest earned on
collected principal and interest payments between the date of collection and
the date of remittance to the Company and from interest earned on tax and
insurance impound funds with respect to Mortgage Loans serviced by it. The
Servicer will be required to remit to the Company no later than the 10th day
of each month (or the next business day if such 10th day is not a business
day) all principal and interest collected from borrowers of Mortgage Loans
serviced by it on or before the 9th day of such month.
When any mortgaged property underlying a Mortgage Loan is conveyed by a
mortgagor, the Servicer generally will enforce any "due-on-sale" clause
contained in the Mortgage Loan, to the extent permitted under applicable law
and governmental regulations. The terms of a particular Mortgage Loan or
applicable law, however, may provide that the Servicer is prohibited from
exercising the "due-on-sale" clause under certain circumstances related to the
security underlying the Mortgage Loan and the buyer's ability to fulfill the
obligations under the related mortgage note. Upon any assumption of a Mortgage
Loan by a transferee, a fee equal to a specified percentage of the outstanding
principal balance of the Mortgage Loan is typically required, which sum will
be retained by the Servicer as additional servicing compensation.
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EMPLOYEES
The Company has six officers. The executive officers of the Company are
described further below under "Management." The Company does not anticipate
that it will require any additional employees because it has retained the
Advisor to perform certain functions pursuant to the Advisory Agreement
described below under "Management--The Advisor." Each officer of the Company
currently is also an officer and/or director of the Bank and/or affiliates of
the Bank. The Company will maintain corporate records and audited financial
statements that are separate from those of the Bank or any of the Bank's
affiliates. None of the officers, directors or employees of the Company will
have any direct or indirect pecuniary interest in any Mortgage Asset to be
acquired or disposed of by the Company or in any transaction in which the
Company has an interest or will engage in acquiring, holding and managing
Mortgage Assets.
COMPETITION
The Company does not anticipate that it will engage in the business of
originating Mortgage Loans. It does anticipate that it will purchase Mortgage
Assets in addition to those in the Initial Portfolio and that all these
Mortgage Assets will be purchased from the Bank and affiliates of the Bank.
Accordingly, the Company does not expect to compete with mortgage conduit
programs, investment banking firms, savings and loan associations, banks,
thrift and loan associations, finance companies, mortgage bankers or insurance
companies in acquiring its Mortgage Assets.
LEGAL PROCEEDINGS
The Company is not the subject of any material litigation. None of the
Company, the Bank or any affiliate of the Bank is currently involved in nor,
to the Company's knowledge, currently threatened with any material litigation
with respect to the Mortgage Assets to be included in the Initial Portfolio,
other than routine litigation arising in the ordinary course of business, most
of which is expected to be covered by liability insurance.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The Company's Board of Directors currently consists of four members. Two
additional persons will be appointed to the Board, each of whom will be an
Independent Director. Pursuant to the Articles Supplementary establishing the
Series A Preferred Shares, the Independent Directors are required to take into
account the interests of the holders of both the Series A Preferred Shares and
the Common Stock in assessing the benefit to the Company of any proposed
action requiring their consent. In considering the interests of the holders of
the Series A Preferred Shares, the Independent Directors shall owe the same
duties which the Independent Directors owe to holders of Common Stock. The
Company currently has six officers. The Company has no other employees and
does not anticipate that it will require additional employees. See "Business
and Strategy--Employees."
The persons who are current and proposed directors and executive officers of
the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION AND OFFICES HELD
---- --- -------------------------
<C> <C> <S>
Alexander R. M. Boyle.......... 58 Director
Stephen R. Halpin, Jr. ........ 41 Executive Vice President, Chief Financial
Officer, Treasurer and Director
Leslie A. Nicholson............ 56 Executive Vice President, General Counsel
and Director
B. Francis Saul II............. 64 Chairman of the Board and President and
Chief Executive Officer
John J. O'Connor III........... 66 Proposed Director
N. Alexander MacColl, Jr. ..... 62 Proposed Director
</TABLE>
The following is a summary of the experience of the executive officers and
current and proposed directors of the Company:
ALEXANDER R. M. BOYLE has been Vice Chairman of the Board of Directors of
the Bank since 1985. Prior to beginning service in this position, Mr. Boyle
was the President and a member of the Board of Directors of Government
Services Savings and Loan, Inc. from 1975 until its merger with the Bank in
1985. He has served as a director of the U.S. League of Savings Institutions
and as chairman of the Maryland League of Financial Institutions. He currently
serves as a director of the Association of Financial Services Holding
Companies and serves on the Chancellor's Advisory Council of the University of
Maryland and is a member of the Rotary Club of Bethesda-Chevy Chase.
STEPHEN R. HALPIN, JR. serves as Executive Vice President and Chief
Financial Officer of the Bank. Mr. Halpin is also the Chief Financial Officer
for the B. F. Saul Company and B. F. Saul Real Estate Investment Trust. He is
a Trustee of the B. F. Saul Employees Profit Sharing Retirement Trust. In
addition, Mr. Halpin is a Trustee for Hospice Caring, Inc. Before joining the
Bank in 1983, Mr. Halpin was with a regional accounting firm.
LESLIE A. NICHOLSON has been an Executive Vice President and the General
Counsel of the Bank since June 1996. Prior to joining the Bank, he was a
partner at Shaw, Pittman, Potts & Trowbridge from January 1972 until May 1996.
B. FRANCIS SAUL II serves as Chairman of the Board and Chief Executive
Officer of the Bank. He also has been President and Chief Operating Officer of
B. F. Saul Company since 1969. Mr. Saul has served as the Chairman of B. F.
Saul Real Estate Investment Trust since 1969 and as a trustee since 1964. He
is also a director of Derwood Investment Corporation. At September 30, 1996,
B. F. Saul Real Estate Investment Trust and Derwood Investment Corporation
owned of record 80% and 16%, respectively, of the Bank's outstanding
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common stock. Mr. Saul is also Chairman of the Board of Directors of Chevy
Chase Financial Limited and Chevy Chase Property Company Limited and a past
Chairman of Financial General Bankshares. He serves as Chairman of the Board
and Chief Executive Officer of Saul Centers, Inc., a public real estate
investment trust. He also serves as a Trustee of the National Geographic
Society, a member of the Trustees Council of the National Gallery of Art and
an Honorary Trustee of the Brookings Institute. In addition, Mr. Saul is a
director of Colonial Williamsburg Hotel Properties, Inc., a member of the
Folger Shakespeare Library and the Board of Visitors and Governors of
Washington College.
JOHN J. O'CONNOR III has been engaged in the practice of law since 1957. He
has been a partner in Bryan Cave LLP since 1988.
N. ALEXANDER MACCOLL, JR. was Senior Vice President of the Union Trust
Company Loan Production Office from 1982 until 1990 when he retired. He served
as Corporate Vice President of Colonial Bancorp. from 1977 until 1981. Prior
to his position at Colonial Bancorp., he served as Second Vice President of
the National Bank of Detroit from 1962 until 1977.
INDEPENDENT DIRECTORS
The Company's Articles Supplementary establishing the Series A Preferred
Shares require that, as long as any Series A Preferred Shares are outstanding,
certain actions by the Company be approved by a majority of the Independent
Directors of the Company. See "Description of Series A Preferred Shares--
Independent Director Approval." John J. O'Connor III and N. Alexander MacColl,
Jr. will be the Company's initial Independent Directors. As long as there are
only two Independent Directors, any action that requires the approval of a
majority of Independent Directors must be approved by both Independent
Directors.
If at any time the Company fails to declare and pay a quarterly dividend
payment on the Series A Preferred Shares, the number of directors then
constituting the Board of Directors of the Company will be increased by two at
the Company's next annual meeting and the holders of Series A Preferred
Shares, voting together with the holders of any other outstanding series of
Preferred Stock as a single class, will be entitled to elect two additional
directors to serve on the Company's Board of Directors. Any member of the
Board of Directors elected by holders of the Company's Preferred Stock will be
deemed to be an Independent Director for purposes of the actions requiring the
approval of a majority of the Independent Directors. See "Description of
Series A Preferred Shares--Voting Rights."
AUDIT COMMITTEE
Upon consummation of the Offering, the Company will establish an audit
committee which will review the engagement of independent accountants and
review their independence. The audit committee will also review the adequacy
of the Company's internal accounting controls. The audit committee will be
comprised of John J. O'Connor III and N. Alexander MacColl, Jr.
COMPENSATION OF DIRECTORS AND OFFICERS
The Company intends to pay the Independent Directors of the Company fees for
their services as directors. The Independent Directors will receive annual
compensation of $10,000 plus a fee of $750 for attendance (in person or by
telephone) at each meeting of the Board of Directors.
The Company will not pay any compensation to its officers or employees or to
directors who are not Independent Directors.
LIMITATIONS ON LIABILITY OF DIRECTORS AND OFFICERS
The Company's Articles of Incorporation eliminate, to the fullest extent
permitted by the Maryland General Corporation Law, the personal liability of a
director to the Company or its stockholders for monetary damages
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for breach of such director's fiduciary duty. The Company's Articles of
Incorporation and bylaws (the "Bylaws") empower the Company to indemnify, to
the fullest extent permitted by the Maryland General Corporation Law, any
director or officer of the Company. The Bylaws also empower the Company to
purchase and maintain insurance to protect any director or officer against any
liability asserted against him or her, or incurred by him or her, arising out
of his or her status as such.
The Bylaws require indemnification of the Company's directors and officers
and specify that the right to indemnification is a contract right, setting
forth certain procedural and evidentiary standards applicable to the
enforcement of a claim under the Bylaws. The Bylaws also entitle any director
or officer to be reimbursed for the expenses of prosecuting any claim against
him or her arising out of his or her status as such.
THE ADVISOR
In connection with the consummation of the Offering and the formation of the
Company as described herein, the Company will enter into the Advisory
Agreement with the Bank to administer the day-to-day operations of the
Company. The Bank in its role as advisor under the terms of the Advisory
Agreement is herein referred to as the "Advisor." The Advisor will be
responsible for (i) monitoring the credit quality of the Mortgage Assets held
by the Company, (ii) advising the Company with respect to the acquisition,
management, financing and disposition of the Company's Mortgage Assets, and
(iii) maintaining custody of the documents related to the Company's Mortgage
Loans . The Advisor may from time to time subcontract all or a portion of its
obligations under the Advisory Agreement to one or more of its affiliates
involved in the business of managing Mortgage Assets. If no affiliate of the
Advisor is engaged in the business of managing Mortgage Assets, the Advisor
may, with the approval of a majority of the Board of Directors, as well as a
majority of the Independent Directors, subcontract all or a portion of its
obligations under the Advisory Agreement to unrelated third parties. The
Advisor will not, in connection with the subcontracting of any of its
obligations under the Advisory Agreement, be discharged or relieved in any
respect from its obligations under the Advisory Agreement.
The Advisor and its affiliates have substantial experience in the mortgage
lending industry, both in the origination and in the servicing of mortgage
loans. At June 30, 1996, the Advisor and its affiliates owned approximately
$1.5 billion of residential mortgage loans. In their residential mortgage loan
business, the Advisor and its affiliates originate and purchase residential
mortgage loans and then sell such loans to investors, primarily in the
secondary market, while generally retaining the rights to service such loans.
The Advisor and its affiliates also purchase servicing rights on residential
mortgage loans. At June 30, 1996, in addition to loans serviced for its own
portfolio, the Advisor and its affiliates serviced residential mortgage loans
having an aggregate principal balance of approximately $3.1 billion.
The Advisory Agreement has an initial term of three years, and will be
renewed automatically for additional one-year periods unless notice of
nonrenewal is delivered to the Advisor by the Company. The Advisory Agreement
may be terminated by the Company at any time upon 60 days' prior written
notice. As long as any Series A Preferred Shares remain outstanding, any
decision by the Company either not to renew the Advisory Agreement or to
terminate the Advisory Agreement must be approved by a majority of the Board
of Directors, as well as by a majority of the Independent Directors. The
Advisor will be entitled to receive an advisory fee equal to $200,000 payable
in equal quarterly installments with respect to the advisory and management
services provided by it to the Company.
As a result of the relationship between the Bank and the Company, certain
conflicts of interest may arise. See "Risk Factors--Relationship with the Bank
and its Affiliates; Conflicts of Interest."
The principal executive offices of the Advisor are located at 8401
Connecticut Avenue, Chevy Chase, Maryland 20815, and its telephone number at
such address is (301) 986-7000; and the home office of the Advisor is located
at 7926 Jones Branch Drive, McLean, Virginia 22102, and its telephone number
at such address is (703) 893-1504.
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<PAGE>
CERTAIN TRANSACTIONS CONSTITUTING THE FORMATION
THE FORMATION
Prior to or simultaneously with the consummation of the Offering, the
Company and the Bank will engage in the transactions described below, which
are designed to (i) facilitate the Offering, (ii) transfer the ownership of
the Initial Portfolio to the Company, and (iii) enable the Company to qualify
as a REIT for federal income tax purposes commencing with its taxable year
ending December 31, 1996.
The transactions constituting the formation of the Company will include the
following:
. The Articles of Incorporation of the Company will be amended to provide
for 1,000 authorized shares of Common Stock and 10,000,000 authorized
shares of Preferred Stock, and the Company will file Articles Supplementary
with the Maryland State Department of Assessments and Taxation establishing
the terms of the Series A Preferred Shares.
. The Company will sell to the public 3,000,000 Series A Preferred Shares
in the Offering (assuming the Underwriters' over-allotment option is not
exercised).
. The Bank has acquired 100 shares of Common Stock and will make
additional capital contributions with respect thereto equal to
approximately $150 million. In addition, the Bank will make additional
capital contributions equal to the aggregate amount of underwriting
discounts and expenses of the Offering and the formation of the Company.
. The Company will acquire the Initial Portfolio from the Bank for an
aggregate purchase price equal to approximately $300 million pursuant to
the terms of the Residential Mortgage Loan Purchase Agreements.
. The Company will enter into the Advisory Agreement with the Advisor
pursuant to which the Advisor will manage the Mortgage Assets held by the
Company and administer the day-to-day operations of the Company. See
"Management--The Advisor."
. The Company will enter into the Servicing Agreement with the Servicer
pursuant to which the Servicer will service the Mortgage Loans included in
the Initial Portfolio. See "Business and Strategy--Servicing."
The Bank currently owns, and following the consummation of the Offering will
continue to own, all of the issued and outstanding shares of Common Stock of
the Company. In addition to its ownership of 100% of the Common Stock of the
Company, the Bank will also have responsibility for the day-to-day management
and custody of the Company's assets, in its capacity as Advisor under the
Advisory Agreement. The Bank has indicated to the Company that, for as long as
any Series A Preferred Shares are outstanding, the Bank intends to maintain
direct or indirect ownership of 80% of the outstanding Common Stock of the
Company. See "Management--The Advisor" and "Risk Factors--Relationship with
the Bank and its Affiliates; Conflicts of Interest."
The Company and the Bank intend that the fair value of the Initial Portfolio
will equal the amount (approximately $300 million) that the Company will pay
for the Initial Portfolio. However, no third party valuations of the Mortgage
Assets constituting the Initial Portfolio have been or will be obtained for
purposes of the Offering, and there can be no assurance that the fair value of
the Initial Portfolio will not differ from the purchase price to be paid by
the Company. See "Risk Factors--No Third Party Valuation of the Mortgage
Assets; No Arm's-Length Negotiations with Affiliates" and "--Relationship with
the Bank and its Affiliates; Conflicts of Interest."
BENEFITS TO THE BANK
The Bank expects to realize the following benefits in connection with the
Offering and other transactions constituting the formation of the Company:
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<PAGE>
. The Bank has advised the Company that the Bank has received approval
from the OTS to include the Series A Preferred Shares as core capital of
the Bank under relevant regulatory capital guidelines. However, there can
be no assurances that the OTS will not exercise its sole discretion to
exclude the Series A Preferred Shares from core capital if such shares
cease to provide meaningful capital support and a realistic ability to
absorb losses of the Bank or other supervisory concerns. The increase in
the Bank's core capital, Tier 1 risk-based and total risk-based capital
levels that will result from the treatment of the Series A Preferred Shares
as core capital will enable the Bank to increase its capital ratios beyond
those established for well-capitalized institutions for purposes of the
prompt corrective action regulations and to increase its total assets while
continuing to meet the well-capitalized ratios. As of September 30, 1996,
only $98.8 million from the Offering would have qualified as core capital
of the Bank because relevant guidance from the OTS limits the amount that
may qualify as core capital of the Bank to 25% of the Bank's total core
capital. The Bank expects that the remaining proceeds from the Offering
will qualify as core capital in the future as the Bank's core capital
increases through an increase in the amount of the common stockholders'
equity of the Bank due to expected profitable operations of the Bank.
However, there can be no assurances that the Bank's operations will be
profitable in the future. For a discussion of the capital requirements
applicable to the Bank, see "Certain Information Regarding the Bank--Risk
Factors and Other Considerations--Regulatory Capital Levels."
. The dividends payable on the Series A Preferred Shares will be
deductible for income tax purposes as a result of the Company's
qualification as a REIT.
. The Bank has advised the Company that the treatment of the Series A
Preferred Shares as core capital of the Bank and the Company's ability to
deduct, for income tax purposes, the dividends payable on the Series A
Preferred Shares as a result of the Company's qualification as a REIT will
provide the Bank with a more cost-effective means of obtaining regulatory
capital than if the Bank were to issue preferred stock itself. Further, if
the Bank issued a class of preferred stock with dividend rights, the
dividends payable on such Bank preferred stock would not be deductible by
the Bank for income tax purposes.
. The Bank has informed the Company that the increase in the Bank's core
capital that will result from the treatment of the Series A Preferred
Shares as core capital of the Bank will permit the Bank to include all of
the $100 million aggregate principal amount of % Subordinated Debentures
due 2008, to be offered immediately prior to or concurrently with the
Offering (the "Debentures"), as supplementary capital of the Bank for
purposes of computing the Bank's total risk-based capital. The amount of
supplementary capital that may be included by the Bank for purposes of
computing its total risk-based capital ratio is limited to 100% of the
Bank's core capital. The increase in the Bank's supplementary capital and
total risk-based capital levels that will result from the treatment of the
Debentures as supplementary capital will enable the Bank to expand its
business by allowing it to increase its total assets while maintaining
capital ratios in excess of those established for well-capitalized
institutions. For a discussion of the Debenture offering of the Bank, see
"Certain Information Regarding the Bank--Operations of the Bank--Debenture
Offering."
. The Bank will receive approximately $300 million upon consummation of
the Offering (assuming no exercise by the Underwriters of their over-
allotment option) in connection with the sale of the Initial Portfolio to
the Company (approximately $144 million of which represents new funds after
giving effect to the Bank's expense of purchasing the Company's Common
Stock and additional capital contributions).
. The Bank will be entitled to receive annual advisory and servicing fees
and annual dividends in respect of the Common Stock. For the first 12
months following completion of the Offering, these annual fees and
dividends are anticipated to be as follows:
<TABLE>
<S> <C>
Advisory Fee................................................. $ 200,000
Servicing Fee................................................ 1,125,000(1)
Common Stock Dividend........................................ (2)
---------
$
=========
</TABLE>
37
<PAGE>
- --------
(1) Assumes that for the first 12 months following completion of the Offering,
the Company holds Residential Mortgage Loans with the same outstanding
principal balances as those Residential Mortgage Loans included in the
Initial Portfolio. See "Business and Strategy--Servicing" for a
description of the basis upon which the servicing fees will be calculated.
(2) The amount of dividends to be paid in respect of the Common Stock is
expected to be equal to the excess of the Company's "REIT taxable income"
(excluding capital gains) over the amount of dividends paid in respect of
Preferred Stock. The aggregate annual dividend amount of the Series A
Preferred Shares is $ million. Assuming that (i) the Mortgage Assets
included in the Initial Portfolio are held for the12-month period
following consummation of the Offering, (ii) principal repayments are
reinvested in additional Mortgage Assets with characteristics similar to
those of the Mortgage Assets included in the Initial Portfolio, and (iii)
interest rates remain constant during such 12-month period, the Company
anticipates that the Initial Portfolio will generate "REIT taxable income"
(excluding capital gains) of approximately $22.1 million, after payment of
servicing and advisory fees, during such 12-month period.
. The Bank also will be entitled to retain any ancillary fees, including,
but not limited to, late payment charges, prepayment fees, penalties and
assumption fees collected in connection with the Mortgage Loans serviced by
it. In addition, the Bank, as Servicer, will receive any benefit derived
from interest earned on collected principal and interest payments between
the date of collection and the date of remittance to the Company and from
interest earned on tax and insurance impound funds with respect to Mortgage
Loans serviced by the Servicer.
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<PAGE>
DESCRIPTION OF SERIES A PREFERRED SHARES
The following summary sets forth the material terms and provisions of the
Series A Preferred Shares, and is qualified in its entirety by reference to
the terms and provisions of the Articles Supplementary establishing the Series
A Preferred Shares and the Company's Articles of Incorporation, the forms of
which have been filed with the Commission as exhibits to the Registration
Statement of which this Prospectus forms a part. See "Description of Capital
Stock."
GENERAL
The Series A Preferred Shares form a series of the Preferred Stock of the
Company, which Preferred Stock may be issued from time to time in one or more
series with such rights, preferences and limitations as are determined by the
Company's Board of Directors. The Board of Directors has authorized the
Company to issue the Series A Preferred Shares.
When issued, the Series A Preferred Shares will be validly issued, fully
paid and nonassessable. The holders of the Series A Preferred Shares will have
no preemptive rights with respect to any shares of the capital stock of the
Company or any other securities of the Company convertible into or carrying
rights or options to purchase any such shares. The Series A Preferred Shares
will not be subject to any sinking fund or other obligation of the Company for
their repurchase or retirement. The Series A Preferred Shares will be
exchanged automatically on a one-for-one basis for Bank Preferred Shares upon
the occurrence of the Exchange Event.
The transfer agent, registrar and dividend disbursement agent for the
Preferred Stock will be Bankers Trust Company. The registrar for shares of
Preferred Stock will send notices to shareholders of any meetings at which
holders of the Preferred Stock have the right to elect directors of the
Company.
DIVIDENDS
Holders of Series A Preferred Shares shall be entitled to receive, if, when
and as declared by the Board of Directors of the Company out of assets of the
Company legally available therefor, cash dividends at the rate of % per
annum of the initial liquidation preference (equivalent to $ per share per
annum). If declared, dividends on the Series A Preferred Shares shall be
payable quarterly in arrears on January 15, April 15, July 15 and October 15
of each year, at such annual rate, commencing on January 15, 1997. Dividends
in each quarterly period will accrue from the first day of such period,
whether or not declared or paid for the prior quarterly period. Each declared
dividend shall be payable to holders of record as they appear at the close of
business on the stock register of the Company on such record dates, not
exceeding 45 days preceding the payment dates thereof, as shall be fixed by
the Board of Directors of the Company.
The right of holders of Series A Preferred Shares to receive dividends is
noncumulative. Accordingly, if the Board of Directors fails to declare a
dividend on the Series A Preferred Shares for a quarterly dividend period,
then holders of the Series A Preferred Shares will have no right to receive a
dividend for that period, and the Company will have no obligation to pay a
dividend for that period, whether or not dividends are declared and paid for
any future period with respect to either the Series A Preferred Shares or the
Common Stock. If the Company fails to pay or declare and set aside for payment
a quarterly dividend on the Series A Preferred Shares, holders of the
Preferred Stock of the Company, including the Series A Preferred Shares, will
be entitled to elect two directors. See "--Voting Rights."
If full dividends on the Series A Preferred Shares for any dividend period
shall not have been declared and paid, or declared and a sum sufficient for
the payment thereof shall not have been set apart for such payments, no
dividends shall be declared or paid or set aside for payment and no other
distribution (including any Balancing Distribution) shall be declared or made
or set aside for payment upon the Common Stock or any other capital stock of
the Company ranking junior to or on a parity with the Series A Preferred
Shares as to dividends or amounts upon liquidation, nor shall any Common Stock
or any other capital stock of the Company ranking junior to or on a parity
with the Series A Preferred Shares as to dividends or amounts upon liquidation
be redeemed,
39
<PAGE>
purchased or otherwise acquired for any consideration (or any monies to be
paid to or made available for a sinking fund for the redemption of any such
stock) by the Company (except by conversion into or exchange for other capital
stock of the Company ranking junior to the Series A Preferred Shares as to
dividends and amounts upon liquidation), until such time as dividends on all
outstanding Series A Preferred Shares have been (i) declared and paid for
three consecutive dividend periods and (ii) declared and paid or declared and
a sum sufficient for the payment thereof has been set apart for payment for
the fourth consecutive dividend period.
When dividends are not paid in full (or a sum sufficient for such full
payment is not set apart) upon the Series A Preferred Shares and the shares of
any other series of capital stock ranking on a parity as to dividends with the
Series A Preferred Shares, all dividends declared upon Series A Preferred
Shares and any other series of capital stock ranking on a parity as to
dividends with the Series A Preferred Shares shall be declared pro rata so
that the amount of dividends declared per share on the Series A Preferred
Shares and such other series of capital stock shall in all cases bear to each
other the same ratio that full dividends, for the then-current dividend
period, per share on the Series A Preferred Shares (which shall not include
any accumulation in respect of unpaid dividends for prior dividend periods)
and full dividends, including required or permitted accumulations, if any, on
such other series of capital stock bear to each other.
For a discussion of the tax treatment of distributions to stockholders, see
"Federal Income Tax Considerations--Taxation of United States Stockholders"
and "--Taxation of Foreign Stockholders," and for a discussion of certain
potential regulatory limitations on the Company's ability to pay dividends,
see "Risk Factors--Dividend and Other Regulatory Restrictions on Operations of
the Company."
AUTOMATIC EXCHANGE
Each Series A Preferred Share will be exchanged automatically for one newly
issued Bank Preferred Share if the appropriate federal regulatory agency
directs in writing an exchange of the Series A Preferred Shares for Bank
Preferred Shares because (i) the Bank becomes "undercapitalized" under prompt
corrective action regulations, (ii) the Bank is placed into conservatorship or
receivership or (iii) the appropriate federal regulatory agency, in its sole
discretion, anticipates the Bank becoming "undercapitalized" in the near term
(i.e., the Exchange Event). Upon the Exchange Event, each holder of Series A
Preferred Shares shall be unconditionally obligated to surrender to the Bank
the certificates representing each Series A Preferred Share of such holder,
and the Bank shall be unconditionally obligated to issue to such holder in
exchange for each such Series A Preferred Share a certificate representing one
Bank Preferred Share. Until such certificates are exchanged, the certificates
for the Series A Preferred Stock will represent an equivalent number of shares
of the Bank Preferred Stock. Any Series A Preferred Shares purchased or
redeemed by the Company prior to the Time of Exchange (as defined below) shall
not be deemed outstanding and shall not be subject to the Automatic Exchange.
The Automatic Exchange shall occur as of 8:00 a.m. Eastern Time on the date
for such exchange set forth in the Directive, or, if such date is not set
forth in the Directive, as of 8:00 a.m. on the earliest possible date such
exchange could occur consistent with the Directive (the "Time of Exchange"),
as evidenced by the issuance by the Bank of a press release prior to such
time. As of the Time of Exchange, all shares of Series A Preferred Shares will
be deemed cancelled without any further action by the Company, all rights of
the holders of Series A Preferred Shares as stockholders of the Company will
cease, and such persons shall thereupon and thereafter be deemed to be and
shall be for all purposes the holders of Bank Preferred Shares. The Company
will mail notice of the occurrence of the Exchange Event to each holder of
Series A Preferred Shares within 30 days of such event, and the Bank will
deliver to each such holder certificates for Bank Preferred Shares upon
surrender of certificates for Series A Preferred Shares. Until such
replacement stock certificates are delivered (or in the event such replacement
certificates are not delivered), certificates previously representing Series A
Preferred Shares shall be deemed for all purposes to represent Bank Preferred
Shares. All corporate action necessary for the Bank
40
<PAGE>
to issue the Bank Preferred Shares will be completed upon completion of the
Offering. Accordingly, once the Directive is issued, no action will be
required to be taken by holders of Series A Preferred Shares, by the Bank or
by the Company in order to effect the Automatic Exchange as of the Time of
Exchange, except the delivery of certificates representing the Bank Preferred
Shares.
Absent the occurrence of the Exchange Event, no shares of Bank Preferred
Shares will be issued. Upon the occurrence of the Exchange Event, the Bank
Preferred Shares to be issued as part of the Automatic Exchange would
constitute a newly issued series of preferred stock of the Bank and would
constitute 100% of the issued and outstanding shares of Bank Preferred Shares.
Holders of Bank Preferred Shares would have the same dividend rights,
liquidation preference, redemption options and other attributes as to the Bank
as holders of Series A Preferred Shares have as to the Company, except that
the Bank Preferred Shares would not be listed on the NYSE. Any accrued and
unpaid dividends on the Series A Preferred Shares as of the Time of Exchange
would be deemed to be accrued and unpaid dividends on the Bank Preferred
Shares. The Bank Preferred Shares would rank pari passu in terms of dividend
payment and liquidation preference with any outstanding shares of preferred
stock of the Bank. See "Certain Information Regarding the Bank--
Capitalization." The Bank intends to register the Bank Preferred Shares with
the OTS pursuant to an Offering Circular, a copy of which is affixed to this
Prospectus as Annex I and incorporated herein by reference. The Bank Preferred
Shares will not be registered with the Commission and will be offered pursuant
to an exemption from registration under Section 3(a)(5) of the Securities Act
of 1933, as amended (the "Securities Act"). The Bank does not intend to apply
for listing of the Bank Preferred Shares on any national securities exchange
or for quotation of the Bank Preferred Shares through the National Association
of Securities Dealers Automated Quotation System. Absent the occurrence of the
Exchange Event, however, the Bank will not issue any Bank Preferred Shares,
although the Bank will be able to issue preferred stock in series other than
that of the Bank Preferred Shares. There can be no assurance as to the
liquidity of the trading markets for the Bank Preferred Shares, if issued, or
that an active public market for the Bank Preferred Shares would develop or be
maintained.
Holders of Series A Preferred Shares cannot exchange their Series A
Preferred Shares for Bank Preferred Shares voluntarily. In addition, absent
the occurrence of the Automatic Exchange, holders of Series A Preferred Shares
will have no dividend, voting, liquidation preference or other rights with
respect to any security of the Bank; such rights as are conferred by the
Series A Preferred Shares exist solely as to the Company.
VOTING RIGHTS
Except as expressly required by applicable law, or except as indicated
below, the holders of the Series A Preferred Shares will not be entitled to
vote. In the event the holders of Series A Preferred Shares are entitled to
vote as indicated below, each Series A Preferred Share will be entitled to one
vote on matters on which holders of the Series A Preferred Shares are entitled
to vote.
If at the time of any annual meeting of the Company's stockholders for the
election of directors the Company has failed to pay or declare and set aside
for payment a quarterly dividend during any of the four preceding quarterly
dividend periods on any series of Preferred Stock of the Company, including
the Series A Preferred Shares, the number of directors then constituting the
Board of Directors of the Company will be increased by two (if not already
increased by two due to a default in preference dividends), and the holders of
the Series A Preferred Shares, voting together with the holders of all other
series of Preferred Stock as a single class, will be entitled to elect such
two additional directors to serve on the Company's Board of Directors at each
such annual meeting. Each director elected by the holders of shares of the
Preferred Stock shall continue to serve as such director until the later of
(i) the full term for which he or she shall have been elected or (ii) the
payment of four quarterly dividends on the Preferred Stock, including the
Series A Preferred Shares.
The affirmative vote or consent of the holders of at least 67% of the
outstanding shares of each series of Preferred Stock of the Company, including
the Series A Preferred Shares, will be required (a) to create any class or
series of stock which shall, as to dividends or distribution of assets, rank
prior to or on a parity with any
41
<PAGE>
outstanding series of Preferred Stock of the Company other than a series which
shall not have any right to object to such creation or (b) alter or change the
provisions of the Company's Articles of Incorporation (including the Articles
Supplementary establishing the Series A Preferred Shares) so as to adversely
affect the voting powers, preferences or special rights of the holders of a
series of Preferred Stock of the Company; provided that if such amendment
shall not adversely affect all series of Preferred Stock of the Company, such
amendment need only be approved by at least 67% of the holders of shares of
all series of Preferred Stock adversely affected thereby.
REDEMPTION
The Series A Preferred Shares will not be redeemable prior to , 2001
(except upon the occurrence of a Tax Event). On or after such date, the Series
A Preferred Shares will be redeemable at the option of the Company, in whole
or in part, at any time or from time to time on not less than 30 nor more than
60 days' notice by mail, at a redemption price of $50.00 per share, plus
accrued and unpaid dividends to the date of redemption, if any, thereon. Any
such redemption must comply with the prompt corrective action and capital
distribution regulations of the OTS, which may prohibit a redemption and will
require the OTS' prior written approval. Unless full dividends on the Series A
Preferred Shares have been or contemporaneously are declared and paid or
declared and a sum sufficient for the payment thereof has been set apart for
payment for the then-current dividend period, no Series A Preferred Shares
shall be redeemed unless all outstanding Series A Preferred Shares are
redeemed and the Company shall not purchase or otherwise acquire any Series A
Preferred Shares; provided, however, that the Company may purchase or acquire
Series A Preferred Shares pursuant to a purchase or exchange offer made on the
same terms to holders of all outstanding Series A Preferred Shares.
The Company will also have the right at any time, upon the occurrence of a
Tax Event and with the prior written approval of the OTS, to redeem the Series
A Preferred Shares, in whole (but not in part) at a redemption price of $50.00
per share, plus the quarterly accrued and unpaid dividend to the date of
redemption, if any, thereon. "Tax Event" means the receipt by the Company of
an opinion of a nationally recognized law firm experienced in such matters to
the effect that, as a result of (i) any amendment to, clarification of, or
change (including any announced prospective change) in, the laws or treaties
(or any regulations thereunder) of the United States or any political
subdivision or taxing authority thereof or therein affecting taxation, (ii)
any judicial decision, official administrative pronouncement, published or
private ruling, regulatory procedure, notice or announcement (including any
notice or announcement of intent to adopt such procedures or regulations)
("Administrative Action") or (iii) any amendment to, clarification of, or
change in the official position or the interpretation of such Administrative
Action or any interpretation or pronouncement that provides for a position
with respect to such Administrative Action that differs from the theretofore
generally accepted position, in each case, by any legislative body, court,
governmental authority or regulatory body, irrespective of the manner in which
such amendment, clarification or change is made known, which amendment,
clarification or change is effective or such pronouncement or decision is
announced on or after the date of issuance of the Series A Preferred Shares,
there is more than an insubstantial risk that (a) dividends paid or to be paid
by the Company with respect to the capital stock of the Company are not, or
will not be, fully deductible by the Company for United States federal income
tax purposes or (b) the Company is, or will be, subject to more than a de
minimis amount of other taxes, duties or other governmental charges.
RIGHTS UPON LIQUIDATION
In the event of any voluntary or involuntary liquidation, dissolution or
winding up of the Company, the holders of the Series A Preferred Shares at the
time outstanding will be entitled to receive out of assets of the Company
available for distribution to stockholders, before any distribution of assets
is made to holders of Common Stock or any other class of stock ranking junior
to the Series A Preferred Shares upon liquidation, liquidating distributions
in the amount of $50.00 per share, plus the quarterly accrued and unpaid
dividend thereon, if any, to the date of liquidation.
After payment of the full amount of the liquidating distributions to which
they are entitled, the holders of Series A Preferred Shares will have no right
or claim to any of the remaining assets of the Company. In the
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<PAGE>
event that, upon any such voluntary or involuntary liquidation, dissolution or
winding up, the available assets of the Company are insufficient to pay the
amount of the liquidation distributions on all outstanding Series A Preferred
Shares and the corresponding amounts payable on all shares of other classes or
series of capital stock of the Company ranking on a parity with the Series A
Preferred Shares in the distribution of assets upon any liquidation,
dissolution or winding up of the affairs of the Company, then the holders of
the Series A Preferred Shares and such other classes or series of capital
stock shall share ratably in any such distribution of assets in proportion to
the full liquidating distributions to which they would otherwise be
respectively entitled.
For such purposes, the consolidation or merger of the Company with or into
any other entity, or the sale, lease or conveyance of all or substantially all
of the property or business of the Company, shall not be deemed to constitute
liquidation, dissolution or winding up of the Company.
INDEPENDENT DIRECTOR APPROVAL
The Articles Supplementary establishing the Series A Preferred Shares
require that, as long as any Series A Preferred Shares are outstanding,
certain actions by the Company be approved by a majority of the Independent
Directors. John J. O'Connor III and N. Alexander MacColl, Jr. will be the
Company's initial Independent Directors. See "Management--Independent
Directors." As long as there are only two Independent Directors, any action
that requires the approval of a majority of Independent Directors must be
approved by both Independent Directors. In order to be considered
"independent," a director must not be a current officer or employee of the
Company or a current director, officer or employee of the Bank or any
affiliate of the Bank. In addition, any members of the Board of Directors of
the Company elected by holders of Preferred Stock, including the Series A
Preferred Shares, will be deemed to be Independent Directors for purposes of
approving actions requiring the approval of a majority of the Independent
Directors. The actions which require approval of a majority of the Independent
Directors include (i) the issuance of additional Preferred Stock ranking on a
parity with the Series A Preferred Shares, (ii) the incurrence of debt for
borrowed money in excess of 25% of the Company's total stockholders' equity,
(iii) the modification of the general distribution policy or the declaration
of any distribution in respect of Common Stock for any year if, after taking
into account any such proposed distribution, total distributions on the Series
A Preferred Shares and the Common Stock would exceed an amount equal to the
sum of 105% of the Company's "REIT taxable income" (excluding capital gains)
for such year plus net capital gains of the Company for that year, (iv) the
acquisition of real estate assets other than Mortgage Loans or Mortgage-Backed
Securities, (v) the redemption of any shares of Common Stock, (vi) the
termination or modification of, or the election not to renew, the Advisory
Agreement or the Servicing Agreement or the subcontracting of any duties under
the Servicing Agreement to third parties unaffiliated with the Bank, (vii) any
dissolution, liquidation or termination of the Company prior to , 2026,
(viii) any material amendment to or modification of any of the Residential
Mortgage Loan Purchase Agreements, and (ix) the determination to revoke the
Company's REIT status. The Articles Supplementary require that, in assessing
the benefits to the Company of any proposed action requiring their consent,
the Independent Directors take into account the interests of holders of both
the Common Stock and the Preferred Stock, including, without limitation,
holders of the Series A Preferred Shares. In considering the interests of the
holders of the Preferred Stock, including, without limitation, holders of the
Series A Preferred Shares, the Independent Directors shall owe the same duties
that the Independent Directors owe to holders of Common Stock.
RESTRICTIONS ON OWNERSHIP
For information regarding restrictions on ownership of the Series A
Preferred Shares, see "Description of Capital Stock--Restrictions on Ownership
and Transfer."
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DESCRIPTION OF CAPITAL STOCK
The following summary of the terms of the capital stock of the Company does
not purport to be complete and is subject in all respects to the applicable
provisions of the Maryland General Corporation Law and the Articles of
Incorporation of the Company.
COMMON STOCK
General. The Company has issued 100 shares of Common Stock. Upon
consummation of the Offering and the transactions described in "Transactions
Constituting the Formation," the Company will have outstanding 100 shares of
Common Stock, all of which will be held by the Bank.
Dividends. Holders of Common Stock are entitled to receive dividends when,
as and if declared by the Board of Directors out of funds legally available
therefor, provided that, if the Company fails to declare and pay full
dividends on the Series A Preferred Shares in any dividend period, the Company
may not make any dividends or other distributions (including Balancing
Distributions, redemptions and purchases) with respect to the Common Stock
until such time as dividends on all outstanding Series A Preferred Shares have
been (i) declared and paid for three consecutive dividend periods and (ii)
declared and paid or declared and a sum sufficient for the payment thereof has
been set apart for payment for the fourth consecutive dividend period. In
order to remain qualified as a REIT, the Company must distribute annually at
least 95% of its annual "REIT taxable income" (not including capital gains) to
stockholders. See "Federal Income Tax Considerations--Organizational
Requirements."
Voting Rights. Subject to the rights, if any, of the holders of any class or
series of Preferred Stock, all voting rights are vested in the Common Stock.
The holders of Common Stock are entitled to one vote per share. All of the
issued and outstanding shares of Common Stock are currently held by the Bank.
Rights Upon Liquidation. In the event of the liquidation, dissolution or
winding up of the Company, whether voluntary or involuntary, after there have
been paid or set aside for the holders of all series of Preferred Stock the
full preferential amounts to which such holders are entitled, the holders of
Common Stock will be entitled to share equally and ratably in any assets
remaining after the payment of all debts and liabilities.
PREFERRED STOCK
Subject to limitations prescribed by Maryland law and the Company's Articles
of Incorporation, the Board of Directors or, if then constituted, a duly
authorized committee thereof, is authorized to issue, from the authorized but
unissued shares of capital stock of the Company, Preferred Stock in such
classes or series as the Board of Directors may determine and to establish,
from time to time, the number of shares of Preferred Stock to be included in
any such class or series and to fix the designation and any preferences,
conversion and other rights, voting powers, restrictions, limitations as to
dividends, qualifications and terms and conditions of redemption of the shares
of any such class or series, and such other subjects or matters as may be
fixed by resolution of the Board of Directors.
Preferred Stock, upon issuance against full payment of the purchase price
therefor, will be fully paid and nonassessable. The specific terms of a
particular class or series of Preferred Stock will be described in the
Articles Supplementary relating to that class or series.
Articles Supplementary relating to each class or series of Preferred Stock
will set forth the preferences and other terms of such class or series,
including without limitation the following: (1) the title and stated value of
such class or series; (2) the number of shares of such class or series offered
and the liquidation preference per share of such class or series; (3) the
dividend rate(s), period(s), and/or payment date(s) or method(s) of
calculation thereof applicable to such class or series; (4) whether such class
or series of Preferred Stock is cumulative or not and, if cumulative, the date
from which dividends on such class or series shall accumulate; (5) the
provision for a sinking fund, if any, for such class or series; (6) the
provision for redemption, if applicable, of such class or series; (7) the
relative ranking and preferences of such class or series as to dividend rights
and rights upon liquidation, dissolution or winding up of the affairs of the
Company; (8) any limitations on issuance of any class or series of Preferred
Stock ranking senior to or on a parity with such class or series of Preferred
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Stock as to dividend rights and rights upon liquidation, dissolution or
winding up of the affairs of the Company; (9) any other specific terms,
preferences, rights, limitations or restrictions of such class or series; and
(10) any voting rights of such class or series.
RESTRICTIONS ON OWNERSHIP AND TRANSFER
The Company's Articles of Incorporation contain certain restrictions on the
number of shares of Preferred Stock that individual stockholders may directly
or beneficially own. For the Company to qualify as a REIT under the Code, no
more than 50% of the value of its outstanding shares of capital stock may be
owned, directly or indirectly, by five or fewer individuals (as defined in the
Code to include certain entities) during the last half of a taxable year
(other than the first year) or during a proportionate part of a shorter
taxable year (the "Five or Fewer Test"). The capital stock of the Company must
also be beneficially owned by 100 or more persons during at least 335 days of
a taxable year or during a proportionate part of a shorter taxable year (the
"One Hundred Persons Test"). Because a significant percentage of the Bank is
considered to be held by two individuals, and because the Bank owns 100% of
the Common Stock of the Company, these two individuals are considered to own a
significant percentage of the Common Stock of the Company. Absent the
restrictions on the number of shares of Preferred Stock that individual
stockholders may acquire and own (directly or indirectly), there would be a
possibility that the deemed Common Stock ownership of these two individuals,
in combination with the ownership by other holders of the Preferred Stock,
would cause the Company to fail the Five or Fewer Test. Further, the Articles
of Incorporation of the Company contain restrictions on the acquisition and
ownership of Preferred Stock intended to ensure compliance with the One
Hundred Persons Test. Such provisions include a restriction that if any
transfer of shares of capital stock of the Company would cause the Company to
be owned by fewer than 100 persons, such transfer shall be null and void and
the intended transferee will acquire no rights to the stock.
Subject to certain exceptions specified in the Company's Articles of
Incorporation, no natural person or entity which is considered to be an
individual under Section 542(a)(2) of the Code is permitted to own (including
shares deemed to be owned by virtue of the relevant attribution provisions of
the Code), more than 1% (the "Ownership Limit") of any issued and outstanding
class or series of Preferred Stock. The Board of Directors may (but in no
event will be required to), upon receipt of a ruling from the IRS or an
opinion of counsel satisfactory to it, raise or waive the Ownership Limit with
respect to a holder if such holder's ownership will not then or in the future
jeopardize the Company's status as a REIT.
The Articles of Incorporation provide that shares of any class or series of
Preferred Stock owned, or deemed to be owned, by, or transferred to a
stockholder in excess of the Ownership Limit, or which would otherwise cause
the Company to fail to qualify as a REIT (the "Excess Shares"), will
automatically be transferred, by operation of law, to a trustee as a trustee
of a trust for the exclusive benefit of a charity to be named by the Company
as of the day prior to the day the prohibited transfer took place. Any
distributions paid prior to the discovery of the prohibited transfer or
ownership are to be repaid by the original transferee to the Company and by
the Company to the trustee; any vote of the shares while the shares were held
by the original transferee prior to the Company's discovery thereof shall be
void ab initio and the original transferee shall be deemed to have given its
proxy to the trustee. Any unpaid distributions with respect to the original
transferee will be rescinded as void ab initio. In liquidation, the original
transferee stockholder's ratable share of the Company's assets would be
limited to the price paid by the original transferee for the Excess Shares or,
if no value was given, the price per share equal to the closing market price
on the date of the purported transfer. The trustee of the trust shall promptly
sell the shares to any person whose ownership is not prohibited, whereupon the
interest of the trust shall terminate. Proceeds of the sale shall be paid to
the original transferee up to its purchase price (or, if the original
transferee did not purchase the shares, the value on its date of acquisition)
and any remaining proceeds shall be paid to a charity to be named by the
Company.
The constructive ownership rules of the Code are complex and may cause
Preferred Stock owned, directly or indirectly, by a group of related
individuals and/or entities to be deemed to be constructively owned by one
individual or entity. As a result, the acquisition or ownership of less than
1% of a class or series of issued and
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outstanding Preferred Stock (or the acquisition or ownership of an interest in
an entity that owns shares of such series of Preferred Stock) by an individual
or entity could cause that individual or entity (or another individual or
entity) to own constructively in excess of 1% of such class or series of
Preferred Stock, and thus subject such stock to the applicable Ownership
Limit. Direct or constructive ownership in excess of the Ownership Limit would
cause ownership of the shares in excess of the limit to be transferred to the
trustee.
All certificates representing shares of Preferred Stock will bear a legend
referring to the restrictions described above.
The Ownership Limit provisions will not be automatically removed even if the
REIT Provisions (as defined herein) are changed so as to eliminate any
ownership concentration limitation or if the ownership concentration
limitation is increased.
The Articles of Incorporation require that any person who beneficially owns
0.5% (or such lower percentage as may be required by the Code or the Treasury
Regulations) of the outstanding shares of any class or series of Preferred
Stock of the Company must provide certain information to the Company within 30
days of June 30 and December 31 of each year. In addition, each stockholder
shall upon demand be required to disclose to the Company in writing such
information as the Company may request in order to determine the effect, if
any, of such stockholder's actual and constructive ownership on the Company's
status as a REIT and to ensure compliance with the Ownership Limit.
SUPER-MAJORITY DIRECTOR APPROVAL
The Articles of Incorporation require approval by two-thirds of the
Company's Board of Directors in order for the Company to file a voluntary
petition of bankruptcy.
BUSINESS COMBINATIONS
The Maryland General Corporation Law as in effect from time to time or any
successor statute thereto (the "MGCL") establishes special requirements with
respect to "business combinations" (including a merger, consolidation, share
exchange, or, in certain circumstances, an asset transfer or issuance or
reclassification of equity securities) between a Maryland corporation and any
person who beneficially owns, directly or indirectly, 10% or more of the
voting power of the corporation's shares (an "Interested Stockholder"),
subject to certain exemptions. In general, an Interested Stockholder or any
affiliate thereof may not engage in a "business combination" with the
corporation for a period of five years following the date he becomes an
Interested Stockholder. Thereafter, such transactions must be (i) approved by
the board of directors of such corporation and (ii) approved by the
affirmative vote of at least (a) 80% of the votes entitled to be cast by
holders of outstanding voting shares of the corporation and (b) two-thirds of
the votes entitled to be cast by holders of voting shares other than voting
shares held by the Interested Stockholder with whom the business combination
is to be effected, unless, among other things, the corporation's common
stockholders receive a minimum price (as defined in the statute) for their
shares and the consideration is received in cash or in the same form as
previously paid by the Interested Stockholder for his shares. These provisions
of the MGCL do not apply, however, to business combinations that are approved
or exempted by the board of directors of such corporation prior to the time
that the Interested Stockholder becomes an Interested Stockholder. The Board
of Directors of the Company has exempted from the MGCL any business
combination with any or all of B. Francis Saul II, Chairman of the Board and
President and Chief Executive Officer of the Company, and lineal descendants,
the Bank, the B.F. Saul Company, the B.F. Saul Real Estate Investment Trust,
and any and all other entities whether currently existing or formed in the
future affiliated with any of the foregoing.
CONTROL SHARE ACQUISITIONS
The MGCL provides that "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights except to the extent
approved by a vote of two-thirds of the votes entitled to
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be cast by stockholders, excluding shares owned by the acquiror and officers
and directors who are employees of the corporation. "Control shares" are
shares which, if aggregated with all other shares previously acquired which
the person is entitled to vote, would entitle the acquiror to vote (i) 20% or
more but less than one-third; (ii) one-third or more but less than a majority;
or (iii) a majority of the outstanding shares. Control shares do not include
shares that the acquiring person is entitled to vote on the basis of prior
stockholder approval. A "control share acquisition" means the acquisition of
control shares subject to certain exemptions.
The control share acquisition statute does not apply to shares acquired in a
merger, consolidation or share exchange if the corporation is a party to the
transaction, or if the acquisition is approved or excepted by the articles of
incorporation or bylaws of the corporation prior to a control share
acquisition. Pursuant to the statute, the Company has exempted control share
acquisitions involving B. Francis Saul II, Chairman of the Board and President
and Chief Executive Officer of the Company, and lineal descendants, the Bank,
the B.F. Saul Company, the B.F. Saul Real Estate Investment Trust, and any and
all other entities whether currently existing or formed in the future
affiliated with any of the foregoing; directors, officers and employees of the
Company and of any partnership in which the Company is a general partner; and
any persons authorized by resolution of the Board of Directors of the Company,
in its discretion. Consequently, the prohibition on voting control shares will
not apply to B. Francis Saul II and lineal descendants, the Bank, the B.F.
Saul Company, the B.F. Saul Real Estate Investment Trust and such other
persons.
FEDERAL INCOME TAX CONSIDERATIONS
The following summary of material federal income tax considerations
regarding the Offering is based upon current law, is for general information
only and is not tax advice. The information set forth below, to the extent
that it constitutes summaries of legal matters or legal conclusions, has been
reviewed by Shaw, Pittman, Potts & Trowbridge, and it is such firm's opinion
that such information is accurate in all material respects. The discussion
below is based on existing federal income tax law, which is subject to change,
with possible retroactive effect. The discussion below does not address all
aspects of taxation that may be relevant in the particular circumstances of
each stockholder or to certain types of stockholders (including insurance
companies, tax-exempt entities, financial institutions or broker-dealers,
foreign corporations and persons who are not citizens or residents of the
United States, except to the extent discussed) subject to special treatment
under the federal income tax laws.
EACH PROSPECTIVE PURCHASER IS URGED TO CONSULT HIS OR HER OWN TAX ADVISOR
REGARDING THE SPECIFIC TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP, AND SALE
OF THE SHARES AND OF THE COMPANY'S ELECTION TO BE TAXED AS A REAL ESTATE
INVESTMENT TRUST, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN, AND OTHER TAX
CONSEQUENCES OF SUCH PURCHASE, OWNERSHIP, SALE AND ELECTION AND OF POTENTIAL
CHANGES IN APPLICABLE TAX LAWS.
TAXATION OF THE COMPANY
General. The Company will elect to be taxed as a REIT under Sections 856
through 860 of the Code and the applicable Treasury Regulations (the "REIT
Requirements" or the "REIT Provisions"), which are the requirements for
qualifying as a REIT, commencing with its taxable year ending December 31,
1996. The Company believes that, commencing with its taxable year ending
December 31, 1996, it will be owned and organized and will operate in such a
manner as to qualify for taxation as a REIT under the Code, and the Company
intends to continue to operate in such a manner, but no assurance can be given
that it will operate in a manner so as to qualify or remain qualified.
The REIT Requirements are technical and complex. The following discussion
sets forth only the material aspects of those requirements. This summary is
qualified in its entirety by the applicable Code provisions, rules and
regulations promulgated thereunder, and administrative and judicial
interpretations thereof.
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In the opinion of Shaw, Pittman, Potts & Trowbridge, commencing with the
Company's taxable year ending December 31, 1996, the Company will be organized
in conformity with the requirements for qualification as a REIT, and its
proposed method of operation will enable it to meet the requirements for
qualification and taxation as a REIT under the Code. It must be emphasized
that this opinion is based on certain factual assumptions relating to the
organization and operation of the Company and is conditioned upon certain
representations made by the Company as to factual matters, such as the
organization and expected manner of operation of the Company. In addition,
this opinion is based upon the factual representations of the Company
concerning its business and Mortgage Assets set forth in this Prospectus.
Moreover, such qualification and taxation as a REIT depends upon the Company's
ability to meet, through actual annual operating results, distribution levels
and diversity of stock ownership, the various qualification tests imposed
under the Code discussed below, the results of which will not be reviewed by
Shaw, Pittman, Potts & Trowbridge on a continuing basis. No assurance can be
given that the actual results of the Company's operation for any one taxable
year will satisfy such requirements. See "--Failure to Qualify."
If the Company qualifies for taxation as a REIT, it generally will not be
subject to federal corporate income taxes on that portion of its ordinary
income or capital gain that is currently distributed to stockholders. Such
treatment substantially eliminates the federal "double taxation" on earnings
(at the corporate and the stockholder levels) that generally results from
investment in a corporation.
Despite the REIT election, the Company may be subject to federal income and
excise tax as follows:
First, the Company will be taxed at regular corporate rates on any
undistributed REIT taxable income, including undistributed net capital
gains.
Second, under certain circumstances, the Company may be subject to the
"alternative minimum tax" on certain of its items of tax preferences, if
any.
Third, if the Company has (i) net income from the sale or other
disposition of "foreclosure property" that is held primarily for sale to
customers in the ordinary course of business or (ii) other nonqualifying
net income from foreclosure property, it will be subject to tax at the
highest corporate rate on such income.
Fourth, if the Company has net income from prohibited transactions (which
are, in general, certain sales or other dispositions of property held
primarily for sale to customers in the ordinary course of business, other
than sales of foreclosure property and sales that qualify for a statutory
safe harbor), such income will be subject to a 100% tax.
Fifth, if the Company should fail to satisfy the 75% gross income test or
the 95% gross income test (as discussed below), but has nonetheless
maintained its qualifications as a REIT because certain other requirements
have been met, it will be subject to a 100% tax on the net income
attributable to the greater of the amount by which the Company fails the
75% or 95% test, multiplied by a fraction intended to reflect the Company's
profitability.
Sixth, if the Company should fail to distribute, or fail to be treated as
having distributed, with respect to each calendar year at least the sum of
(i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT
capital gain net income for such year, and (iii) any undistributed taxable
income from prior periods, the Company would be subject to a 4% excise tax
on the excess of such required distribution over the amounts actually
distributed.
The Company does not now intend to acquire any appreciated assets from a
corporation generally subject to full corporate-level tax in a transaction in
which any gain on the transfer is not fully recognized. However, in the event
of such an acquisition, the Company could, under certain circumstances, be
subject to tax upon disposition of such assets.
Organizational Requirements. The Code defines a REIT as a corporation,
trust, or association (i) that is managed by one or more trustees or
directors; (ii) the beneficial ownership of which is evidenced by transferable
shares, or by transferable certificates of beneficial interest; (iii) that
would be taxable as a domestic corporation, but for the REIT Requirements;
(iv) that is neither a financial institution nor an insurance company subject
to
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certain provisions of the Code; (v) the beneficial ownership of which is held
by 100 or more persons; (vi) not more than 50% in value of the outstanding
stock of which is owned, directly or indirectly, by five or fewer individuals
(as defined in the Code to include certain entities) at any time during the
last half of each taxable year; and (vii) meets certain other tests, described
below, regarding the nature of its income and assets. The Code provides that
conditions (i) through (iv), inclusive, must be met during the entire taxable
year and that condition (v) must be met during at least 335 days of a taxable
year of 12 months, or during a proportionate part of a taxable year of less
than 12 months. Conditions (v) and (vi) will not apply until after the first
taxable year for which an election is made to be taxed as a REIT. For purposes
of condition (vi), certain tax-exempt entities are generally treated as
individuals, and the beneficiaries of a pension trust that qualifies under
Section 401(a) of the Code and that holds shares of a REIT will be treated as
holding shares of the REIT in proportion to their actuarial interests in the
pension trust. See "--Taxation of United States Stockholders--Treatment of
Tax-Exempt Stockholders." In the opinion of Shaw, Pittman, Potts & Trowbridge,
the Company does not constitute a financial institution within the meaning of
condition (iv).
In the opinion of Shaw, Pittman, Potts & Trowbridge, preferred stock is
taken into account for purposes of determining whether a REIT satisfies
conditions (v) and (vi) above. The Company believes that it will issue
sufficient shares pursuant to the Offering to allow it to satisfy conditions
(v) and (vi) above. Because a significant percentage of the Bank is considered
to be held by two individuals, and because the Bank owns 100% of the Common
Stock of the Company, these two individuals are considered to own a
significant percentage of the Common Stock of the Company. In order that the
deemed Common Stock ownership of these two individuals, in combination with
the ownership by other holders of the Preferred Stock, not result in a failure
to satisfy condition (vi) above, it is necessary to ensure that the value of
the Common Stock not materially exceed 50% of the total value of the Company.
The relationship between the value of the Common Stock and the total value of
the Company will be influenced by economic factors, such as changes in
prevailing interest rates, which can affect the total value of the Company's
assets, or the total value of the Preferred Stock, or both. For example, a
rise in interests rates might cause a reduction in the total value of the
Preferred Stock, which in turn would cause a greater portion of the Company's
value to be attributable to the Common Stock. In order to further the
objective of limiting the relative value of the Common Stock, the Company's
Articles of Incorporation generally authorize the distribution of cash or
property to holders of its Common Stock where the value of the Common Stock
would otherwise exceed 52% of the total value of the stock of the Company, the
size of such Balancing Distribution being sufficient to reduce the value of
the Common Stock to not less than 50% of the total value of the Company. There
are, however, certain limitations on the payment of any distributions to the
holders of the Common Stock. See "Description of Series A Preferred Shares--
Dividends." It is not possible to state that in all cases such distributions
to the holders of the Common Stock will enable the Company to satisfy the
share ownership requirement described in condition (vi). In addition, the
Company's Articles of Incorporation include certain restrictions regarding
transfer of its shares, which restrictions are intended to assist the Company
in continuing to satisfy the share ownership requirements described in (v) and
(vi) above. Such transfer and ownership restrictions are described under
"Description of Capital Stock--Restrictions on Ownership and Transfer." Also,
while certain options to acquire stock would be taken into account for the
purpose of determining whether conditions (v) and (vi) are satisfied, in the
opinion of Shaw, Pittman, Potts & Trowbridge, because of the contingent nature
of the Automatic Exchange, the Automatic Exchange does not constitute an
option to acquire the Series A Preferred Shares for this purpose and the
possibility that the Automatic Exchange might occur will not affect the status
of the Company as a REIT prior to an actual occurrence of the Automatic
Exchange.
In addition, a corporation may not elect to become a REIT unless its taxable
year is the calendar year. The Company satisfies this requirement.
Income Tests. In order to maintain qualification as a REIT, the Company must
annually satisfy three gross income requirements. First, at least 75% of the
Company's gross income (excluding gross income from prohibited transactions)
for each taxable year must be derived directly or indirectly from investments
relating to real property or mortgages on real property (as interest on
obligations secured by mortgages on real property, certain "rents from real
property" or as gain on the sale or exchange of such property and certain fees
with
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respect to agreements to make or acquire mortgage loans), from certain types
of temporary investments or certain other types of gross income. Second, at
least 95% of the Company's gross income (excluding gross income from
prohibited transactions) for each taxable year must be derived from such real
property investments as aforesaid and from dividends, interest, and gain from
the sale or other disposition of stock or securities and certain other types
of gross income (or from any combination of the foregoing). Third, short-term
gain from the sale or other disposition of stock or securities, gain from
prohibited transactions, and gain on the sale or other disposition of real
property held for less than four years (apart from involuntary conversions and
sales of foreclosure property) from the date of acquisition must represent
less than 30% of the Company's gross income (including gross income from
prohibited transactions) for each taxable year.
For interest to qualify as "interest on obligations secured by mortgages on
real property or on interests in real property," the obligation must be
secured by real property having a fair market value at the time of acquisition
at least equal to the principal amount of the loan. The term "interest"
includes only an amount that constitutes compensation for the use or
forbearance of money. For example, a fee received or declared by a lender
which is in fact a charge for services performed for a borrower rather than a
charge for the use of borrowed money is not includable as interest; amounts
earned as consideration for entering into agreements to make loans secured by
real property, although not interest, are otherwise treated as within the 75%
and 95% classes of gross income so long as the determination of those amounts
does not depend on the income or profits of any person. By statute, the term
interest does not include any amount based on income or profits except that
the Code provides that (i) interest "based on a fixed percentage or
percentages of receipts or sales" is not excluded and (ii) when the REIT makes
a loan that provides for interest based on the borrower's receipts or sales
and a portion of such receipts or sales under one or more leases is based on
income or profits, only a proportionate amount of the contingent interest paid
by the borrower will be disqualified as interest.
The Company anticipates that all the interest on the Mortgage Assets will
satisfy the 75% and 95% gross income tests.
Relief Provisions. If the Company fails to satisfy one or both of the 75% or
95% gross income tests for any taxable year, it may nevertheless qualify as a
REIT for such year if it is entitled to relief under certain provisions of the
Code. These relief provisions will be generally available if the Company's
failure to meet such tests was due to reasonable cause and not due to willful
neglect, the Company attaches a schedule of the sources of its income to its
return, and any incorrect information on the schedule was not due to fraud
with intent to evade tax. It is not possible, however, to state whether in all
circumstances the Company would be entitled to the benefit of these relief
provisions. As discussed above in "--Taxation of the Company--General," even
if these relief provisions apply, a tax would be imposed with respect to the
excess net income.
Asset Tests. At the close of each quarter of its taxable year, the Company
must satisfy three tests relating to the nature of its assets. First, at least
75% of the value of the Company's total assets must be represented by real
estate assets (including stock or debt instruments held for not more than one
year that were purchased with the proceeds of a stock offering or long-term
(at least five years) debt offering of the Company), cash, cash items, and
government securities. The Company anticipates that substantially all of its
assets will fall in this category. Second, not more than 25% of the Company's
total assets may be represented by securities other than those in the 75%
asset class. Third, of the investments included in the 25% asset class, the
value of any one issuer's securities owned by the Company may not exceed 5% of
the value of the Company's total assets and the Company may not own more than
10% of any one issuer's outstanding voting securities.
After initially meeting the asset tests at the close of any quarter, the
Company will not lose its status as a REIT if it fails to satisfy the asset
tests at the end of a later quarter solely by reason of changes in asset
values. If the failure to satisfy the asset tests results from an acquisition
of securities or other property during a quarter, the failure can be cured by
disposition of sufficient nonqualifying assets within 30 days after the close
of that quarter. The Company intends to maintain adequate records of the value
of its assets to ensure compliance with the asset tests, and to take such
action within 30 days after the close of any quarter as may be required to
cure any noncompliance but no assurance can be given that such asset tests
will be met.
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Annual Distribution Requirements. In order to be treated as a REIT, the
Company is required to distribute dividends (other than capital gain
dividends) to its stockholders in an amount at least equal to (A) the sum of
(i) 95% of the Company's "REIT taxable income" (computed without regard to the
dividends paid deduction and the Company's net capital gain) plus (ii) 95% of
the net income, if any, from foreclosure property in excess of the special tax
on income from foreclosure property, minus (B) the sum of certain items of
noncash income. Such distributions must be paid in the taxable year to which
they relate or in the following taxable year if declared before the Company
timely files its tax return for such year and if paid on or before the first
regular dividend payment after such declaration. To the extent that the
Company does not distribute (or is not treated as having distributed) all of
its net capital gain or distributes (or is treated as having distributed) at
least 95%, but less than 100% of its "REIT taxable income," as adjusted, it
will be subject to tax thereon at regular ordinary and capital gains corporate
tax rates. The Code permits a stockholder to elect to be treated for tax
purposes as having (i) received a distribution in the amount specified in the
election and (ii) contributed the amount thereof to the capital of the
Company. In the event the Company fails to distribute 100% of its income and
capital gains, the Bank may elect to be so treated. Furthermore, if the
Company should fail to distribute during each calendar year at least the sum
of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT
capital gain net income for such year, and (iii) any undistributed taxable
income from prior periods, the Company would be subject to a 4% excise tax on
the excess of such required distribution over the amounts actually
distributed. The Company intends to make timely distributions sufficient to
satisfy the annual distribution requirement. However, under some
circumstances, the payment of dividends on the Series A Preferred Shares could
be subject to regulatory limitations. See "Risk Factors--Dividend and Other
Regulatory Restrictions on Operations of the Company." If the Company fails to
declare and pay full dividends on the Series A Preferred Shares in any
dividend period, the Company may not make any dividends or other distributions
(including Balancing Distributions, redemptions and purchases) with respect to
the Common Stock until such time as dividends on all outstanding Series A
Preferred Shares have been (i) declared and paid for three consecutive
dividend periods and (ii) declared and paid or declared and a sum sufficient
for the payment thereof has been set apart for payment for the fourth
consecutive dividend period. If the Company becomes subject to this
prohibition, it could have REIT taxable income during a taxable year in excess
of the distributions with respect to the Series A Preferred Shares. It is
anticipated that if this should occur, the Company would be eligible to make
and would in fact make so-called consent dividends, where no actual
distributions are made but the Company and the holders of the Common Stock
would be treated solely for tax purposes as if distributions in the amount of
the consent dividends were made.
"REIT taxable income" is the taxable income of a REIT, which generally is
computed in the same fashion as the taxable income of any corporation, except
that (i) certain deductions are not available, such as the deduction for
dividends received, (ii) it may deduct dividends paid (or deemed paid) during
the taxable year, (iii) net capital gains and losses are excluded, and (iv)
certain other adjustments are made.
It is possible that, from time to time, the Company may not have sufficient
cash or other liquid assets to meet the 95% distribution requirement due to
timing differences between (i) the actual receipt of income and actual payment
of deductible expenses and (ii) the inclusion of such income and deduction of
such expenses in calculating the taxable income of the Company. In the event
that such an insufficiency or such timing differences occur, in order to meet
the 95% distribution requirement the Company may find it necessary to arrange
for borrowings or to pay dividends in the form of taxable stock dividends if
it is practicable to do so.
Under certain circumstances, the Company may be able to rectify a failure to
meet the distribution requirement for a year by paying "deficiency dividends"
to stockholders in a later year, which may be included in the Company's
deduction for dividends paid for the earlier year. Thus, the Company may be
able to avoid being taxed on amounts distributed as deficiency dividends;
however, the Company will be required to pay interest based upon the amount of
any deduction taken for deficiency dividends.
FAILURE TO QUALIFY
If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions described above do not apply, the Company will be
subject to tax (including any applicable alternative minimum
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tax) on its taxable income at regular corporate rates. Distributions to
stockholders in any year in which the Company fails to qualify will not be
deductible by the Company nor will they be required to be made. In such event,
to the extent of current and accumulated earnings and profits, all
distributions to stockholders will be taxable as ordinary income, and subject
to certain limitations of the Code, corporate distributees may be eligible for
the dividends-received deduction. Unless entitled to relief under specific
statutory provisions, the Company will also be disqualified from taxation as a
REIT for the four taxable years following the year during which qualification
was lost, and will not be permitted to requalify unless it distributes any
earnings and profits attributable to the period when it failed to qualify. In
addition, it would be subject to tax on any built-in gains on property held
during the period during which it did not qualify if it sold such property
within 10 years of requalification. It is not possible to state whether in all
circumstances the Company would be entitled to such statutory relief.
TAX TREATMENT OF AUTOMATIC EXCHANGE
Upon the occurrence of the Exchange Event, the outstanding Series A
Preferred Shares will be automatically exchanged on a one-for-one basis for
Bank Preferred Shares. See "Description of Series A Preferred Shares--
Automatic Exchange." The Automatic Exchange will be a taxable exchange with
respect to which each holder of the Series A Preferred Shares will have a gain
or loss, as the case may be, measured by the difference between the basis of
such holder in the Series A Preferred Shares and the fair market value of the
Bank Preferred Shares received in the Automatic Exchange. Assuming that such
holder's Series A Preferred Shares were held as capital assets for more than
one year prior to the Automatic Exchange, any gain or loss will be long-term
capital gain or loss. Long-term capital losses are deductible, subject to
certain limitations. The basis of the holder in the Bank Preferred Shares will
be their fair market value at the time of the Automatic Exchange.
TAXATION OF UNITED STATES STOCKHOLDERS
As used herein, the term "United States Stockholder" means a holder of
Series A Preferred Shares that is for United States federal income tax
purposes (i) a citizen or resident or the United States, (ii) a corporation,
partnership, or other entity created or organized in or under the laws of the
United States or of any political subdivision thereof, or (iii) an estate or
trust the income of which is subject to United States federal income taxation
regardless of its source.
Distributions Generally. As long as the Company qualifies as a REIT,
distributions to a United States Stockholder up to the amount of the Company's
current or accumulated earnings and profits (and not designated as capital
gains dividends) will be taken into account as ordinary income and will not be
eligible for the dividends-received deduction for corporations. Distributions
that are designated by the Company as capital gains dividends will be treated
as long-term capital gain (to the extent they do not exceed the Company's
actual net capital gain) for the taxable year without regard to the period for
which the stockholder has held its stock. However, corporate stockholders may
be required to treat up to 20% of certain capital gains dividends as ordinary
income, pursuant to Section 291(d) of the Code. A distribution in excess of
current or accumulated earnings and profits will first be treated as a tax-
free return of capital, reducing the tax basis in the United States
Stockholder's Series A Preferred Shares, and a distribution in excess of the
United States Stockholder's tax basis in its Series A Preferred Shares will be
taxable gain realized from the sale of such shares. Dividends declared by the
Company in October, November or December of any year payable to a stockholder
of record on a specified date in any such month shall be treated as both paid
by the Company and received by the stockholder on December 31 of such year,
provided that the dividend is actually paid by the Company during January of
the following calendar year. Stockholders may not claim the benefit of any tax
losses of the Company on their own income tax returns.
The Company will be treated as having sufficient earnings and profits to
treat as a dividend any distribution by the Company up to the amount required
to be distributed in order to avoid imposition of the 4% excise tax discussed
under "--Taxation of the Company--General" and "--Taxation of the Company--
Annual Distribution Requirements," above. As a result, stockholders may be
required to treat as taxable dividends
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certain distributions that would otherwise result in a tax-free return of
capital. Moreover, any "deficiency dividend" will be treated as a "dividend"
(an ordinary dividend or a capital gain dividend, as the case may be),
regardless of the Company's earnings and profits.
Losses incurred on the sale or exchange of Series A Preferred Shares held
for less than six months will be deemed a long-term capital loss to the extent
of any capital gain dividends received by the selling stockholder with respect
to such stock.
Treatment of Tax-Exempt Stockholders. Distributions from the Company to a
tax-exempt employee's pension trust or other domestic tax-exempt stockholder
will not constitute "unrelated business taxable income" unless the stockholder
has borrowed to acquire or carry its shares of the Company. A tax-exempt
employee's pension trust that holds more than 10% of the shares of the capital
stock of the Company may under certain circumstances be required to treat a
certain percentage of dividends as unrelated business taxable income if the
Company is "predominantly held" by qualified trusts. For these purposes, a
qualified trust is any trust defined under Section 401(a) of the Code and
exempt from tax under Section 501(a) of the Code. As a consequence of the
look-through provisions of Code Section 856(h)(3), which generally affects
ownership by pension trusts of shares of REITs, any qualified pension trust
that owns more than 10% of the shares of the capital stock of the Company
might be required to treat a certain portion of the dividends paid as
unrelated business taxable income, if the conditions set forth in Code Section
856(h)(3) are satisfied. The Company does not anticipate that such conditions
will be satisfied.
TAXATION OF FOREIGN STOCKHOLDERS
The rules governing United States income taxation of non-resident alien
individuals, foreign corporations, foreign partnerships, and foreign trusts
and estates holding Series A Preferred Shares (collectively, "Foreign
Stockholders") are complex, and no attempt will be made herein to provide more
than a summary of such rules. A Foreign Stockholder should consult with its
own tax advisor to determine the effect of federal, state, and local and
country of tax residence income tax laws on an investment in the Company,
including any reporting requirements.
In general, a Foreign Stockholder will be subject to regular United States
income tax to the same extent as a United States Stockholder with respect to
income or gain derived from its investment in the Company if under all facts
and circumstances such income or gain is "effectively connected" with such
stockholder's conduct of a trade or business in the United States. See "--
Taxation of United States Stockholders." A corporate Foreign Stockholder that
receives income that is effectively connected with a United States trade or
business may also be subject to the branch profits tax under Section 884 of
the Code, which is payable in addition to the regular United States corporate
income tax. The following discussion will apply to a Foreign Stockholder whose
income or gain derived from investment in the Company is not so effectively
connected in light of the facts and circumstances.
The Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA")
significantly affects the federal income tax treatment of the sale or exchange
of shares in REITs held by a Foreign Stockholder. Under FIRPTA, gain or loss
realized on the sale or exchange of a "United States real property interest"
("USRPI") by a foreign taxpayer is treated by statute as effectively connected
with a United States trade or business as a matter of law, without regard to
the particular facts and circumstances. Shares of a corporation are treated as
a USRPI only if the fair market value of USRPIs owned by the corporation
equals or exceeds 50% of the fair market value of its total assets. If at no
time within the five years preceding the sale or exchange of shares in the
Company the shares constituted a USRPI, gain or loss on the sale or exchange
will not be treated as effectively connected with a United States trade or
business by reason of FIRPTA. While ownership of real property within the
United States (including ownership of interests in certain entities) is always
a USRPI, a loan secured by a mortgage on United States real property
constitutes a USRPI only if the amounts payable by the borrower are contingent
on the income or receipts of the borrower or the property or otherwise based
on the property. Because such contingent interest is not likely to be present
in the home mortgage loans to be owned by the Company that are expected to
represent approximately % of the assets of the Company (although such
interest is fairly common
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in commercial loans) the Company believes it is unlikely that its shares will
be USRPIs or that it will derive significant gain from the sale or exchange of
USRPIs, although whether its shares are a USRPI or it derives income from
USRPIs will depend upon the facts as they ultimately develop. A distribution
of cash to a Foreign Stockholder that is not attributable to gain from sales
or exchanges by the Company of USRPIs and not designated by the Company as
capital gain dividend are not subject to FIRPTA but generally will be subject
to the withholding of United States federal income tax at a rate of 30%,
unless (i) a lower treaty rate applies or (ii) the Foreign Stockholder files
an IRS Form 4224 with the withholding agent certifying that the investment to
which the distribution relates is effectively connected to a United States
trade or business of such Foreign Stockholder. A Foreign Stockholder who
receives a distribution that has been subject to such withholding tax may file
a claim for refund to the extent the withholding has been imposed on a portion
of such distributions representing amounts in excess of current and
accumulated earnings and profits. Under FIRPTA, distributions of proceeds
attributable to gain from the Company's sale or exchange of a USRPI are
subject to income tax at the normal capital gains rates applicable to United
States Stockholders (subject to applicable alternative minimum tax and a
special alternative minimum tax in the case of a nonresident alien
individual). Also, these distributions may be subject to a 30% branch profits
tax in the hands of a corporate Foreign Stockholder not entitled to a treaty
exemption or reduced rate of tax. Treasury Regulations require the withholding
of 35% of any distribution that could be designated by the Company as a
capital gain dividend. This amount is creditable against the Foreign
Stockholder's tax liability. It should be noted that the 35% withholding tax
rate on capital gain dividends is higher than the 28% maximum rate on capital
gains of individuals. Capital gains dividends not attributable to gain on the
sale or exchange of USRPIs are not subject to United States taxation if there
is no requirement of withholding.
If the shares of the Company do constitute a USRPI (or did so constitute
within the previous five years), gain or loss on the sale or exchange of the
shares will be treated as effectively connected with the conduct of a United
States trade or business unless one or more special rules apply to preclude
United States taxation.
If the Company is a "domestically-controlled REIT," a sale of Series A
Preferred Shares by a Foreign Stockholder generally will not be subject to
United States taxation. A domestically controlled REIT is a REIT in which, at
all times during a specified testing period, less than 50% in value of its
shares is held directly or indirectly, under Code attribution rules, by
Foreign Stockholders. Because the Series A Preferred Shares will be publicly
traded, no assurance can be given that the Company will constitute a
domestically-controlled REIT or that it will be possible to ascertain whether
or not it is domestically-controlled.
If the Company is not a domestically-controlled REIT, a sale of Series A
Preferred Shares would be subject to tax under FIRPTA as a sale of a USRPI and
gain or loss would be effectively connected with a United States trade or
business if either (i) the Series A Preferred Shares were not "regularly
traded" (as defined by applicable Treasury Regulations) on an established
securities market (e.g., the NYSE, on which the Series A Preferred Shares will
be listed) during the quarter in which the Series A Preferred Shares were sold
or (ii) even if the Series A Preferred Shares were "regularly traded," the
selling stockholder held, directly or indirectly, more than 5% of the Series A
Preferred Shares during the five-year period ending on the date of
disposition. The applicable Treasury Regulations that define "regularly
traded" for this purpose provide that a security will not be "regularly
traded" for any calendar quarter during which 100 or fewer persons (treating
related persons as one person) in the aggregate own 50% or more of such
security or the quarterly trading volume is less than 7.5% of the average
number of the issued and outstanding shares of such security (2.5% if there
are 2,500 or more stockholders of record). In the event that the Series A
Preferred Shares were not "regularly traded" and the Company did not at that
time constitute a domestically-controlled REIT, a Foreign Stockholder (without
regard to its ownership percentage of Series A Preferred Shares) must treat as
effectively connected with a United States trade or business any gain or loss
on any sale or other disposition of Series A Preferred Shares that occurs
within a calendar quarter during which the Series A Preferred Shares were not
"regularly traded" and the shares were a USRPI.
If the gain on the sale of the Company's Series A Preferred Shares were
subject to taxation under FIRPTA, the Foreign Stockholder would be subject to
the same treatment as a United States Stockholder with respect to
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such gain (subject to applicable alternative minimum tax and a special
alternative minimum tax in the case of a nonresident alien individual).
Notwithstanding the foregoing, capital gain from the sale of shares of a REIT
not subject to FIRPTA will nonetheless be taxable to a Foreign Stockholder who
is an individual (under rules generally applicable to United States
Stockholders) if such person is in the United States for 183 days or more
during the taxable year of disposition and certain other conditions apply. In
any event, a purchaser of Series A Preferred Shares from a Foreign Stockholder
will not be required under FIRPTA to withhold on the purchase price if the
purchased Series A Preferred Shares are "regularly traded" on an established
securities market or if the Company is a domestically-controlled REIT.
Otherwise, under FIRPTA the purchaser of Series A Preferred Shares may be
required to withhold 10% of the purchase price and remit such amount to the
IRS.
Shares of the Company owned by a nonresident alien decedent are subject to
United States federal estate tax (which is imposed at rates up to 55%) unless
an estate tax treaty binding upon the United States provides otherwise.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING TAX
The Company will report to its stockholders and the IRS the amount of
dividends paid or deemed paid during each calendar year, and the amount of tax
withheld, if any.
United States Stockholders. Under certain circumstances, a United States
Stockholder of Series A Preferred Shares may be subject to backup withholding
at a rate of 31% on payments made with respect to, or cash proceeds of a sale
or exchange of, Series A Preferred Shares. Backup withholding will apply only
if the holder (i) fails to furnish the person required to withhold with its
Taxpayer Identification Number ("TIN") which, for an individual, would be his
or her Social Security Number, (ii) furnishes an incorrect TIN, (iii) is
notified by the IRS that it has failed properly to report payments of interest
and dividends, or (iv) under certain circumstances, fails to certify, under
penalty of perjury, that it has furnished a correct TIN and has not been
notified by the IRS that it is subject to backup withholding for failure to
report interest and dividend payments. Backup withholding will not apply with
respect to payments made to certain exempt recipients, such as corporations
and tax-exempt organizations. A United States Stockholder should consult with
a tax advisor regarding qualification for exemption from backup withholding
and the procedure for obtaining such an exemption. Backup withholding is not
an additional tax. Rather, the amount of any backup withholding with respect
to a payment to a United States Stockholder will be allowed as a credit
against such United States Stockholder's United States federal income tax
liability and may entitle such United States Stockholder to a refund, provided
that the required information is furnished to the IRS.
Foreign Stockholders. Additional issues may arise pertaining to information
reporting and backup withholding with respect to Foreign Stockholders, and a
Foreign Stockholder should consult with a tax advisor with respect to any such
information reporting and backup withholding requirements. Backup withholding
with respect to a Foreign Stockholder is not an additional tax. Rather, the
amount of any backup withholding with respect to a payment to a Foreign
Stockholder will be allowed as a credit against any United States federal
income tax liability of such Foreign Stockholder. If withholding results in an
overpayment of taxes, a refund may be obtained, provided that the required
information is furnished to the IRS.
OTHER TAX CONSEQUENCES
The Company and its stockholders may be subject to state or local taxation
in various state or local jurisdictions, including those in which it or they
transact business or reside. The state and local tax treatment of the Company
and its stockholders may not conform to the federal income tax consequences
discussed above. Consequently, prospective stockholders should consult their
own tax advisors regarding the effect of state and local tax laws on an
investment in the Company.
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ERISA CONSIDERATIONS
GENERAL
In evaluating the purchase of Series A Preferred Shares, a fiduciary of a
qualified profit-sharing, pension or stock bonus plan, including a plan for
self-employed individuals and their employees or any other employee benefit
plan subject to the Employee Retirement Income Security Act of 1974, as
amended ("ERISA"), a collective investment fund or separate account in which
such plans invest and any other investor using assets that are treated as the
assets of an employee benefit plan subject to ERISA (each, a "Plan" and
collectively, "Plans") should consider (a) whether the ownership of Series A
Preferred Shares is in accordance with the documents and instruments governing
such Plan; (b) whether the ownership of Series A Preferred Shares is solely in
the interest of Plan participants and beneficiaries and otherwise consistent
with the fiduciary's responsibilities and in compliance with the requirements
of Part 4 of Title I of ERISA, including, in particular, the diversification,
prudence and liquidity requirements of Section 404 of ERISA and the prohibited
transaction provisions of Section 406 of ERISA and Section 4975 of the Code;
(c) whether the Company's assets are treated as assets of the Plan; and (d)
the need to value the assets of the Plan annually. In addition, the fiduciary
of an individual retirement arrangement under Section 408 of the Code (an
"IRA") considering the purchase of Series A Preferred Shares should consider
whether the ownership of Series A Preferred Shares would result in a non-
exempt prohibited transaction under Section 4975 of the Code.
The fiduciary investment considerations summarized below provide a general
discussion that does not include all of the fiduciary investment
considerations relevant to Plans and, where indicated, IRAs. This summary is
based on the current provisions of ERISA and the Code and regulations and
rulings thereunder, and may be changed (perhaps adversely and with retroactive
effect) by future legislative, administrative or judicial actions. PLANS AND
IRAS THAT ARE PROSPECTIVE PURCHASERS OF SERIES A PREFERRED SHARES SHOULD
CONSULT WITH AND RELY UPON THEIR OWN ADVISORS IN EVALUATING THESE MATTERS IN
LIGHT OF THEIR OWN PARTICULAR CIRCUMSTANCES.
PLAN ASSET REGULATION
Under Department of Labor regulations governing what constitutes the assets
of a Plan or IRA ("Plan Assets") for purposes of ERISA and the related
prohibited transaction provisions of the Code (the "Plan Asset Regulation," 29
C.F.R. Sec. 2510.3-101), when a Plan or IRA makes an equity investment in
another entity, the underlying assets of the entity will not be considered
Plan Assets if the equity interest is a "publicly-offered security."
For purposes of the Plan Asset Regulation, a "publicly-offered security" is
a security that is (a) "freely transferable," (b) part of a class of
securities that is "widely held," and (c) sold to the Plan or IRA as part of
an offering of securities to the public pursuant to an effective registration
statement under the Securities Act and part of a class of securities that is
registered under the Exchange Act within 120 days (or such later time as may
be allowed by the Commission) after the end of the fiscal year of the issuer
during which the offering of such securities to the public occurred. The
Series A Preferred Shares will be registered under the Securities Act and the
Exchange Act within the time periods specified in the Plan Asset Regulation.
The Plan Asset Regulation provides that a security is "widely held" only if
it is a part of the class of securities that is owned by 100 or more investors
independent of the issuer and of one another. A security will not fail to be
"widely held" because the number of independent investors falls below 100
subsequent to the initial offering as a result of events beyond the control of
the issuer. The Company expects the Series A Preferred Shares to be "widely
held" upon the completion of the Offering.
The Plan Asset Regulation provides that whether a security is "freely
transferable" is a factual question to be determined on the basis of all the
relevant facts and circumstances. The Plan Asset Regulation further provides
that when a security is part of an offering in which the minimum investment is
$10,000 or less, as is the case
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with the Offering, certain restrictions ordinarily will not, alone or in
combination, affect the finding that such securities are "freely
transferable." The Company believes that any restrictions imposed on the
transfer of the Series A Preferred Shares are limited to the restrictions on
transfer generally permitted under the Plan Asset Regulation and are not
likely to result in the failure of the Series A Preferred Shares to be "freely
transferable."
A Plan should not acquire or hold the Series A Preferred Shares if the
Company's underlying assets will be treated as the assets of such Plan.
However, the Company believes that under the Plan Asset Regulation the Series
A Preferred Shares should be treated as "publicly-offered securities" and,
accordingly, the underlying assets of the Company should not be considered to
be assets of any Plan or IRA investing in the Series A Preferred Shares.
EFFECT OF PLAN ASSET STATUS
ERISA generally requires that the assets of a Plan be held in trust and that
the trustee, or an investment manager (within the meaning of Section 3(38) of
ERISA), have exclusive authority and discretion to manage and control the
assets of the Plan. As discussed above, the assets of the Company under
current law do not appear likely to be assets of the Plans receiving Series A
Preferred Shares as a result of the Offering. However, if the assets of the
Company were deemed to be assets of the Plans under ERISA, certain directors
and officers of the Company might be deemed fiduciaries with respect to the
Plans that invest in the Company and the prudence and other fiduciary
standards set forth in ERISA would apply to them and to all investments.
If the assets of the Company were deemed to be Plan Assets, transactions
between the Company and parties in interest or disqualified persons with
respect to the investing Plan or IRA could be prohibited transactions unless a
statutory or administrative exemption is available. In addition, investment
authority would also have been improperly delegated to such fiduciaries, and,
under certain circumstances, Plan fiduciaries who make the decision to invest
in the Series A Preferred Shares could be liable as co-fiduciaries for actions
taken by the Company that do not conform to the ERISA standards for
investments under Part 4 of Title I of ERISA.
PROHIBITED TRANSACTIONS
Section 406 of ERISA provides that Plan fiduciaries are prohibited from
causing the Plan to engage in certain types of transactions. Section 406(a)
prohibits a fiduciary from knowingly causing a Plan to engage directly or
indirectly in, among other things: (a) a sale or exchange, or leasing, of
property with a party in interest; (b) a loan or other extension of credit
with a party in interest; (c) a transaction involving the furnishing of goods,
services or facilities with a party in interest; or (d) a transaction
involving the transfer of Plan assets to, or use of Plan assets by or for the
benefit of, a party in interest. Additionally, Section 406 prohibits a Plan
fiduciary from dealing with Plan assets in its own interest or for its own
account, from acting in any capacity in any transaction involving the Plan on
behalf of a party (or representing a party) whose interests are adverse to the
interests of the Plan, and from receiving any consideration for its own
account from any party dealing with the Plan in connection with a transaction
involving Plan assets. Similar provisions in Section 4975 of the Code apply to
transactions between disqualified persons and Plans and IRAs and result in the
imposition of excise taxes on such disqualified persons.
If a prohibited transaction has occurred, Plan fiduciaries involved in the
transaction could be required to (a) undo the transaction, (b) restore to the
Plan any profit realized on the transaction and (c) make good to the Plan any
loss suffered by it as a result of the transaction. In addition, parties in
interest or disqualified persons would be required to pay excise taxes or
penalties.
If the investment constituted a prohibited transaction under Section
408(e)(2) of the Code by reason of the Company engaging in a prohibited
transaction with the individual who established an IRA or his or her
beneficiary, the IRA would lose its tax-exempt status. The other penalties for
prohibited transactions would not apply.
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Thus, the acquisition of the Series A Preferred Shares by a Plan could
result in a prohibited transaction if an Underwriter, the Company, the Bank or
any of their affiliates is a party in interest or disqualified person with
respect to the Plan. Any such prohibited transaction could be treated as
exempt under ERISA and the Code if the Series A Preferred Shares were acquired
pursuant to and in accordance with one or more "class exemptions" issued by
the Department of Labor, such as Prohibited Transaction Class Exemption
("PTCE") 75-1 (an exemption for certain transactions involving employee
benefit plans and broker-dealers (such as the Underwriters), reporting
dealers, and banks), PTCE 84-14 (an exemption for certain transactions
determined by an independent qualified professional asset manager), PTCE 90-1
(an exemption for certain transactions involving insurance company pooled
separate accounts), PTCE 91-38 (an exemption for certain transactions
involving bank collective investment funds), PTCE 95-60 (an exemption for
certain transactions involving an insurance company's general account) and
PTCE 96-23 (an exemption for certain transactions determined by a qualifying
in-house asset manager).
A Plan should not acquire the Series A Preferred Shares pursuant to the
Offering if such acquisition will constitute a non-exempt prohibited
transaction.
UNRELATED BUSINESS TAXABLE INCOME
Plan fiduciaries should also consider the consequences of holding more than
10% of the Series A Preferred Shares if the Company is "predominantly held" by
qualified trusts. See "Federal Income Tax Considerations--Taxation of United
States Stockholders--Treatment of Tax-Exempt Stockholders."
CERTAIN INFORMATION REGARDING THE BANK
The following is a summary of certain information regarding the Bank. As an
integral part of this Prospectus, a copy of the Bank's offering circular filed
with the Office of Thrift Supervision relating to the Bank Preferred Shares to
be issued upon the Exchange Event (the "Offering Circular"), including
exhibits and copies of the Bank's Annual Report on Form 10-K for the fiscal
year ended September 30, 1995 (the "Form 10-K") and its Quarterly Report on
Form 10-Q for the quarter ended June 30, 1996 (the "Form 10-Q"), is attached
hereto as Annex I and is incorporated by reference herein. All material
information relating to the Bank as of these periods, including information
relating to the Bank's financial position and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," can be found in
these documents. There has been no material change in the Bank's affairs since
the conclusion of the fiscal year ended September 30, 1995 which has not
otherwise been disclosed by the Bank in the Form 10-Q.
OPERATIONS OF THE BANK
General. The Bank is a federally chartered and federally insured stock
savings bank which at June 30, 1996 was conducting business from 101 full-
service offices and 497 automated teller machines ("ATMs") in Maryland,
Virginia and the District of Columbia. The Bank has its home office in McLean,
Virginia and its executive offices in Montgomery County, Maryland, which are
both suburban communities of Washington, D.C. The Bank also maintains 21
mortgage loan production offices in the mid-Atlantic region, 20 of which are
operated by a wholly-owned mortgage banking subsidiary. At June 30, 1996, the
Bank had total assets of $5.0 billion, total deposits of $4.2 billion and
total stockholders' equity of $357.0 million. Based on total consolidated
assets at June 30, 1996, the Bank is the largest bank headquartered in the
Washington, D.C. metropolitan area.
The Bank is a consumer oriented, full-service banking institution
principally engaged in the business of attracting deposits from the public and
using such deposits, together with borrowings and other funds, to make loans
secured by real estate, primarily residential mortgage loans, and credit card
and other types of consumer
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loans. The Bank is also developing an active commercial lending program. The
Bank's principal deposit and lending markets are located in the Washington,
D.C. metropolitan area. 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.
For the nine months ended June 30, 1996, Chevy Chase reported pre-tax income
of $67.6 million and net income of $39.8 million, compared to pre-tax income
of $41.4 million and net income of $27.9 million in the corresponding period
of the prior fiscal year. At June 30, 1996, the Bank's tangible, core capital
(or leverage), Tier 1 risk-based and total risk-based regulatory capital
ratios were 6.30%, 6.30%, 6.91% and 12.04%, respectively. As of such date, the
Bank's capital ratios exceeded the requirements under the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989, as amended
("FIRREA"), as well as the standards established for "well capitalized"
institutions under the prompt corrective action regulations established
pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991,
as amended ("FDICIA") (both as applicable on June 30, 1996 and on a fully
phased-in basis). Based on unaudited results, the Bank reported pre-tax income
of $44.2 million and net income of $27.6 million for the year ended September
30, 1996, and at September 30, 1996, the Bank's tangible, core, Tier 1 risk-
based and total risk-based regulatory capital ratios decreased to 5.21%,
5.21%, 5.80% and 10.14%, respectively. As of such date, the Bank's capital
ratios exceeded the requirements under FIRREA as well as the standards
established for "adequately capitalized" institutions under the prompt
corrective action regulations established pursuant to FDICIA. See "--Risk
Factors and Other Considerations--Regulatory Capital Levels" and "--Recent
Developments."
The Bank is subject to comprehensive regulation, examination and supervision
by the OTS and, to a lesser extent, by the Federal Deposit Insurance
Corporation (the "FDIC"). The Bank's deposit accounts are fully insured up to
$100,000 per insured depositor by the Savings Association Insurance Fund (the
"SAIF"), which is administered by the FDIC. See "--Risk Factors and Other
Considerations--Risks Relating to Elimination of Thrift Charter" and "--Risks
Related to SAIF Insurance."
Because of the continued improvement in the financial condition of the Bank,
on March 29, 1996, the OTS released the Bank from a written agreement it had
entered into with the OTS on September 30, 1991, and the board of directors of
the Bank adopted a resolution addressing certain issues previously addressed
by the written agreement. See "Notes to Consolidated Financial Statements" in
the Form 10-Q.
Business of the Bank. The Bank historically has relied on retail deposits
originated in its branch network as its primary funding source. The Bank'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 26.0% of the Bank's deposits at June 30, 1996 were obtained from
depositors residing outside of Maryland, primarily in Northern Virginia. As of
June 30, 1996, the Bank had 101 full-service banking facilities, 42 of which
were located in Montgomery County, 19 in Prince George's County and 18 in
Fairfax County. As of that date, the Bank also operated 497 ATMs. According to
published industry statistics, as of June 30, 1995, the Bank had the leading
market share of deposits in Montgomery County and the third largest share of
deposits in Prince George's County. 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 Montgomery and Fairfax Counties in June
1996 (2.9% and 3.2%, respectively) was below the national rate (5.5%) and
state rates (5.1% for Maryland and 4.8% for Virginia) for the same month.
The Bank historically has concentrated its lending activities in the
Washington, D.C. metropolitan area. In recent periods, the Bank and its
subsidiaries have expanded the geographic region in which they purchase and
originate loans to include the northern and southern areas of the Eastern
United States. The Bank has not changed its underwriting standards for loans
purchased or originated in these areas, although the pricing of the loans may
be different based upon local market conditions.
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As of June 30, 1996, the Bank's loan portfolio consisted primarily of
single-family residential loans (at approximately 51%), credit card loans (at
approximately 32%) and non-credit card consumer loans (at approximately 8%).
The Bank originates VA-guaranteed, FHA-insured 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. The Bank currently offers fixed-rate
loans with maturities of 15 to 30 years and adjustable-rate residential
mortgage loans, principally with maturities of 30 years. The Bank also offers
revolving home equity credit line loans secured principally by a second
mortgage on the borrowers' homes. In addition to revenue generated from
interest on the loan portfolio, the Bank also recognizes income from loan
origination and servicing fees. See "Business--Lending Activities--
Origination, Purchase and Sale of Real Estate Loans" in the Form 10-K.
With respect to its credit card program, the Bank offers Chevy Chase
"Classic" and "Gold" VISA (R) and MasterCard (R) cards. The Bank issues the
credit cards and receives 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. The Bank believes its credit card
program contributes to market share growth in its local market by attracting
new depositors, promoting a high degree of customer loyalty and providing
opportunities to cross-market other products of the Bank. See "Business--
Lending Activities--Credit Card Lending" in the Form 10-K and "--Risk Factors
and Other Considerations--Risks of Credit Card Lending."
During fiscal 1996, the Bank continued to increase its portfolio of non-
credit card consumer loans. These loans primarily include automobile loans,
home improvement loans and other secured and unsecured loans for traditional
consumer purchases and needs. The majority of these loans are made on an
indirect basis. The Bank makes these loans in the Southern United States as
well as the mid-Atlantic region. During the nine months ended June 30, 1996,
the Bank purchased or originated $398.1 million of automobile loans and $103.9
million of home improvement loans. See "Business--Lending Activities--Consumer
and Other Lending" in the Form 10-K, Notes 4 and 5 to the "Condensed
Consolidated Financial Statements" in the Form 10-Q and "--Risk Factors and
Other Considerations--Risks of Other Consumer Lending."
Beginning in late fiscal 1995, the Bank began to diversify its loan
portfolio by developing a middle-market commercial lending program. In
addition to extending credit, the Bank seeks to become the customer's primary
source of deposit products. Management believes that these types of banking
relationships are a natural extension and complement to the Bank's existing
deposit and lending base. At June 30, 1996, the Bank's outstanding commercial
loans totaled $48.0 million, the majority of which were adjustable-rate lines
of credit and term loans.
Non-performing Assets. At June 30, 1996, the Bank had $166.9 million of non-
performing assets (after valuation allowances on real estate held for sale of
$127.8 million) which represented 1.89% of total assets. Non-performing assets
are comprised of $30.5 million of non-performing loans and $136.4 million of
real estate held for sale ("REO"). Non-performing credit card loans represent
67.5% of the Bank's non-performing loans and represent 2.2% of the Bank's
total credit card loans outstanding. At June 30, 1996, the Bank maintained a
valuation allowance against its credit card portfolio of $51.1 million, or
5.3% of outstanding credit card loans. Reflecting in part the results of a
consumer loan portfolio review by the OTS, during the September 1996 quarter
the Bank increased its valuation allowance on such loans by $28.6 million to
$79.7 million at September 30, 1996, or 7.1% of outstanding credit card loans.
See "--Recent Developments."
The majority of the Bank's REO is residential property, consisting primarily
of five planned unit developments (the "Communities"), which had an aggregate
book value of $102.8 million as of June 30, 1996. Four of the five Communities
are under active development and, as a result of the sale in the December 1995
quarter of the remaining residential lots in two of the Communities, the Bank
owns only commercial land in two of the four active Communities. The level of
REO and of non-performing assets has decreased substantially over the past
four years as the Bank has disposed of the bulk of the assets it acquired
through foreclosure or deed-in-lieu of foreclosure in 1990 and 1991. See "--
Risk Factors and Other Considerations--Risks Relating to Reserve Levels and
REO" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Financial Condition--Asset Quality--Disposition of REO"
in the Form 10-K.
60
<PAGE>
Asset Securitizations. The Bank has accessed the capital markets as an
additional means of funding its operations and managing its capital ratios and
asset growth. Since 1988, the Bank has securitized approximately $8.0 billion
of credit card, home equity credit line, automobile and home loan receivables.
These transactions depend on sophisticated back-office systems to service
complex securitization structures and on personnel with the experience to
design, install and manage those systems. At June 30, 1996, the Bank serviced
$3.8 billion, $348.0 million, $565.2 million and $153.5 million of securitized
credit card, home equity credit line, automobile and home loan receivables,
respectively. The Bank derives fee-based income from servicing these
securitized portfolios. However, such fee-based income may be adversely
affected by increases in delinquencies and charge-offs related to the
receivables placed in these securitized pools. See "--Risk Factors and Other
Considerations--Reliance on Non-Interest Income."
History and Ownership. The Bank was organized in 1969 as a stock savings
institution under Maryland law. On May 22, 1985, the Bank obtained federal
insurance of its deposit accounts, and on April 8, 1986, it became a federally
chartered stock savings bank. Eighty percent of the outstanding common stock
of the Bank is owned by B.F. Saul Real Estate Investment Trust (the "Trust").
See "--Risk Factors and Other Considerations--Holding Company Matters." B.
Francis Saul II is the Bank's founder and principal executive officer. Through
his significant equity interest and management positions in the Bank's major
stockholders, Mr. Saul has the ability to effectively control the affairs and
direct the policies of the Bank.
Debenture Offering. The Bank has filed a registration statement on Form OC
with the OTS covering the issuance of $100 million aggregate principal amount
of Debentures in an underwritten public offering immediately prior to or
concurrently with the Offering. The Debentures will mature on , 2008.
The Debentures will not be redeemable prior to 2001, except that on or
prior to , 1999, the Bank may redeem the Debentures in part at its
option with the net cash proceeds of one or more public equity offerings of
the Bank or any of its subsidiaries. The Debentures will be unsecured
obligations of the Bank ranking subordinate in right of payment to all senior
debt of the Bank, including the claims of the Bank's depositors and general
creditors, and will rank equal in right of payment with the Bank's outstanding
9 1/4% Subordinated Debentures due 2005 and the Bank's $10 million floating
rate subordinated capital note due 1996. If the Series A Preferred Shares are
exchanged for Bank Preferred Shares, the Debentures will rank senior to the
Bank Preferred Shares. The Bank has received OTS approval to include the
principal amount of the Debentures as supplementary capital. Upon consummation
of the offering of the Debentures, the Bank's total risk-based capital level
will increase, thereby enhancing the Bank's ability to maintain its regulatory
capital levels above those levels established for "well capitalized"
institutions.
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<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data of the Bank herein as of
and for the years ended September 30, 1995, 1994, 1993, 1992 and 1991 have
been derived from the Consolidated Financial Statements of the Bank, which
statements have been audited by Arthur Andersen LLP, independent public
accountants. 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 in each of the Form 10-K and
the Form 10-Q. In the opinion of the management of the Bank, the amounts shown
for the nine-months ended June 30, 1996 and 1995 include all adjustments,
which consist only of normal recurring adjustments, necessary for a fair
presentation of the consolidated results for such periods and as of such
dates. The results of operations for any interim period are not necessarily
indicative of the results for an entire fiscal year. For unaudited financial
information regarding the Bank at September 30, 1996, see "--Recent
Developments."
<TABLE>
<CAPTION>
AS OF OR FOR THE
NINE MONTHS ENDED
JUNE 30, AS OF OR FOR THE YEAR ENDED SEPTEMBER 30,
---------------------- -----------------------------------------------------------
1996 1995 1995 1994 1993 1992 1991
---------- ---------- ---------- ---------- ---------- ---------- -----------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets........... $5,020,519 $4,952,821 $4,947,995 $4,703,788 $4,918,795 $5,062,619 $ 4,904,104
Mortgage-backed
securities............ 847,029 942,085 880,208 1,025,525 1,501,192 1,599,959 443,714
Loans receivable ,
net................... 2,459,803 2,159,018 2,327,286 2,357,721 1,861,128 1,635,218 2,537,435
Loans held for sale.... 102,079 52,390 68,679 33,598 176,504 175,698 51,734
Loans held for
securitization and
sale.................. 315,000 665,000 500,000 115,000 300,000 350,000 533,628
Allowance for losses on
loans................. 71,619 57,075 60,496 50,205 68,040 78,818 89,745
Real estate held for
investment or sale,
net................... 140,033 236,510 222,860 330,032 387,583 521,051 563,261
Allowance for losses on
real estate held for
investment or sale.... 127,958 130,338 135,236 118,973 111,644 109,044 57,498
Cost in excess of net
assets acquired, net.. 41,525 45,529 44,528 48,637 52,650 56,348 60,045
Mortgage servicing
rights, net........... 33,539 14,178 28,369 15,075 20,288 12,787 13,962
Deposit accounts....... 4,225,110 4,117,663 4,159,252 4,008,761 3,870,023 3,915,958 4,263,033
Securities sold under
repurchase agreements
and other short-term
borrowings............ 17,121 142,525 10,435 8,907 88,266 450,321 3,459
Bonds payable.......... -- -- -- 24,030 24,605 25,130 25,605
Notes payable.......... 7,340 7,570 7,514 7,729 7,925 8,640 10,354
Federal Home Loan Bank
advances.............. 116,749 134,208 155,052 100,000 412,000 275,000 200,000
Capital notes-
subordinated.......... 160,000 160,000 160,000 160,000 138,500 138,500 138,500
Stockholders' equity... 356,969 321,243 328,544 289,956 284,794 177,430 156,389
Non-performing assets.. 166,889 257,695 247,185 311,898 372,031 517,639 594,069
SELECTED RATIOS:
Earnings (loss) per
common share.......... $ 3,252.30 $ 2,063.50 $ 2,757.20 $ 1,929.00 $ 3,549.50 $ 2,104.10 $ (1,028.50)
Return on average
assets................ 1.09% 0.75% 0.76% 0.58% 0.77% 0.44% -0.20%
Return on average
stockholders' equity.. 15.88% 12.71% 12.66% 9.62% 16.20% 11.87% -5.64%
Average stockholders'
equity to average
assets................ 6.85% 5.91% 5.98% 6.07% 4.72% 3.67% 3.49%
Net loan charge-offs to
average loans......... 2.77% 1.29% 1.51% 1.74% 3.33% 4.04% 3.60%
Non-performing assets,
net to total
assets(1)............. 1.89% 4.04% 3.77% 5.35% 5.97% 8.37% 10.20%
Net yield on interest
earning assets........ 4.69% 4.12% 4.24% 4.06% 4.60% 4.99% 3.80%
Average interest-
earning assets to
average interest-
bearing liabilities... 92.33% 92.20% 91.91% 90.81% 86.43% 82.81% 85.73%
REGULATORY CAPITAL
RATIOS:
Tangible............... 6.30% 5.63% 5.77% 4.96% 4.60% 2.22% 1.58%
Core (or leverage)..... 6.30% 5.63% 5.77% 5.34% 5.35% 3.22% 2.82%
Tier 1 risk-based...... 6.91% 6.79% 6.65% 6.95% 7.29% N/A N/A
Total risk-based....... 12.04% 11.76% 11.63% 12.19% 11.70% 7.72% 5.51%
Full service banking
facilities............. 101 85 88 81 74 73 74
Full service mortgage
banking facilities..... 21 18 18 17 17 13 12
</TABLE>
- --------
(1) Non-performing assets is presented after all reserves for losses on loans
and real estate held for investment or sale.
62
<PAGE>
<TABLE>
<CAPTION>
AS OF OR FOR THE
NINE MONTHS ENDED
JUNE 30, AS OF OR FOR THE YEAR ENDED SEPTEMBER 30,
------------------ -------------------------------------------------
1996 1995 1995 1994 1993 1992 1991
-------- -------- -------- -------- -------- -------- ---------
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CONDENSED CONSOLIDATED
STATEMENTS OF
OPERATIONS:
Interest income......... $284,129 $270,226 $365,336 $334,460 $349,537 $403,559 $ 487,221
Interest expense........ 140,470 140,737 189,114 165,544 167,518 214,761 325,711
-------- -------- -------- -------- -------- -------- ---------
Net interest income.... 143,659 129,489 176,222 168,916 182,019 188,798 161,510
Provision for loan
losses................. 70,825 35,829 54,979 29,222 60,372 86,453 143,544
-------- -------- -------- -------- -------- -------- ---------
Net interest income
after provision for
loan losses........... 72,834 93,660 121,243 139,694 121,647 102,345 17,966
-------- -------- -------- -------- -------- -------- ---------
Non-interest income:
Credit card fees, loan
servicing fees and
deposit servicing
fees.................. 239,585 154,241 218,572 111,279 91,216 92,291 105,441
Gain on sales of
investment securities,
net................... -- -- -- -- 8,895 -- 1,159
Gain (loss) on sales of
trading securities,
net................... 1,061 (579) (600) 1,695 -- -- 11,651
Earnings (loss) on real
estate held for
investment or sale,
net................... (19,376) 2,861 (4,672) 1,326 (12,722) (50,649) (47,339)
Gain on sales of credit
card relationships,
loans and mortgage-
backed securities,
net................... 17,092 4,721 12,882 30,522 31,338 38,716 69,096
Gain on sales of
mortgage servicing
rights, net........... -- 1,270 1,397 5,833 4,828 3,750 9,633
Other.................. 14,109 4,232 5,923 9,885 7,161 10,766 12,133
-------- -------- -------- -------- -------- -------- ---------
Total non-interest
income................ 252,471 166,746 233,502 160,540 130,716 94,874 161,774
-------- -------- -------- -------- -------- -------- ---------
Non-interest expense:
Salaries and employee
benefits.............. 93,354 78,739 108,432 87,390 69,739 62,725 78,344
Marketing expenses..... 35,568 34,835 46,117 46,441 15,138 4,632 6,831
Other non-interest
expense............... 128,796 105,445 145,544 113,739 103,492 91,718 100,399
-------- -------- -------- -------- -------- -------- ---------
Total non-interest
expense............... 257,718 219,019 300,093 247,570 188,369 159,075 185,574
-------- -------- -------- -------- -------- -------- ---------
Income (loss) before
income taxes,
extraordinary item and
cumulative effect of
change in accounting
principle............. 67,587 41,387 54,652 52,664 63,994 38,144 (5,834)
Provision for income
taxes.................. 27,751 13,439 17,330 22,394 26,603 17,103 4,451
Extraordinary loss on
early extinguishment of
debt................... -- -- -- (6,333) -- -- --
Cumulative effect of
change in accounting
for income taxes....... -- -- -- 5,103 -- -- --
-------- -------- -------- -------- -------- -------- ---------
Net income (loss)....... $ 39,836 $ 27,948 $ 37,322 $ 29,040 $ 37,391 $ 21,041 $ (10,285)
======== ======== ======== ======== ======== ======== =========
</TABLE>
RISK FACTORS AND OTHER CONSIDERATIONS
Because of the potential for the Automatic Exchange, the purchase of the
Series A Preferred Shares involves a high degree of risk with respect to the
performance and capital levels of the Bank. Prospective investors in the
Series A Preferred Shares should carefully consider the following risk factors
and other considerations relating to the Bank before deciding whether to
invest in such shares.
Risks of Credit Card Lending. At June 30, 1996, the Bank's credit card loans
of $956.5 million constituted approximately 32% of the Bank's loan portfolio.
In addition, at June 30, 1996, the Bank managed $3.8 billion in securitized
credit card loans which were not reflected on the Bank's balance sheet. Credit
card loans entail greater credit risks than residential mortgage loans.
Changes in credit card use and payment patterns by cardholders, including
increased defaults, may result from a variety of social, legal and economic
factors. The Bank 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 use
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
63
<PAGE>
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. Default rates on credit card loans generally
may be expected to exceed default rates on residential mortgage loans.
Primarily reflecting the industry-wide decline in the performance of credit
card loans, credit card delinquencies and net charge-offs on credit card loans
have increased since September 1995. The Bank regularly reviews the reasons
for delinquency and charge-off as compared to information available at the
time an account was originated to determine if such information should have
indicated the propensity for delinquency and/or loss. The results of these
reviews are used to adjust the Bank's underwriting criteria, as necessary.
Although the Bank believes it has appropriate underwriting criteria to
mitigate the risks associated with its credit card accounts, there can be no
assurance that charge-offs and delinquencies will not increase. The Bank made
certain adjustments to its reserves for losses on credit card loans at
September 30, 1996, based in part on the results of a consumer loan portfolio
review by the OTS. See "--Recent Developments." An increase in credit card
delinquencies and charge-offs also may affect the Bank's income from loan
servicing fees by reducing the amount earned on securitized credit card
receivables.
Certain jurisdictions and their residents may attempt to require out-of-
state credit card issuers to comply with such jurisdictions' consumer
protection laws that impose requirements on the making, enforcement and
collection of consumer loans. For example, in recent years, a number of
lawsuits and administrative actions have been filed in several states against
out-of-state credit card issuers (including both federally and state chartered
insured institutions) challenging various fees and charges (such as late fees,
over-the-limit fees, returned check fees and annual membership fees) assessed
against residents of the states in which such lawsuits were filed, based on
restrictions or prohibitions under the laws of such states. The Supreme Court
recently ruled that national banks may export late fees on credit cards as
interest regardless of states' usury laws; however, the law is not settled
with respect to all types of fees and charges. If it were determined that out-
of-state credit card issuers must comply with a jurisdiction's laws limiting
the charges imposed by credit card issuers, such action could have an adverse
impact on the Bank's credit card operations.
The credit card industry is highly competitive and characterized by
increased pricing competition in interest rates and annual membership fees,
use of advertising, target marketing and other features (such as buyer
protection plans), as both established and new card issuers seek to expand or
to enter the market and to retain their existing customers. The Bank has
issued credit cards to customers nationwide, and competes for those customers
with certain money center banks and other large nationwide issuers, as well as
with regional and local depository institutions and other issuers, many of
whom have sizable branch systems or other customer relationships through which
such issuers market their credit cards. The Bank anticipates that competitive
pressures will require adjustments from time to time to the pricing of the
Bank's credit card accounts. See "Business--Lending Activities--Credit Card
Lending" in the Form 10-K.
Reliance on Non-Interest Income. In recent years, non-interest income, which
is reflected as "Other Income" on the Consolidated Statements of Operations,
has become an increasingly large component of the Bank's net income. The Bank
has earned non-interest income primarily from credit card, loan servicing and
deposit servicing fees and gains on sales of credit card relationships, loans
and mortgage-backed securities. In fiscal 1995, 1994 and 1993, the Bank
recognized non-interest income of $233.5 million, $160.5 million and $130.7
million, respectively. Of those amounts, $184.3 million, $69.9 million and
$46.6 million, respectively, or 51.9%, 23.3% and 18.5%, respectively, of total
operating income, was income from loan servicing fees. The Bank's ability to
realize non-interest income is dependent upon market interest rates, the
demand for mortgage and credit card loans, conditions in the loan sale market,
the level of securitized receivables and other factors. The level of such
income, therefore, is subject to substantial fluctuations. An increase in
credit card delinquencies and charge-offs also may affect the Bank's income
from loan servicing fees by reducing the amount earned on securitized credit
card receivables. Such charge-offs have increased significantly during recent
periods, although the Bank's income has not been significantly affected to
date as a result of the counterbalancing effects of such
64
<PAGE>
items as the expiration of introductory rates, repricing of existing
portfolios and new fee-based strategies. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Results of
Operations" in the Form 10-K.
Effect of an Increase in Interest Rates on Operating Results. The Bank's
operating results depend to a large extent on its net interest income, which
is the difference between the interest the Bank receives from its loans,
securities and other assets and the interest the Bank pays on its deposits and
other liabilities. Interest rates are highly sensitive to many factors,
including governmental monetary policies and domestic and international
economic and political conditions. Conditions such as inflation, recession,
unemployment, money supply, international disorders and other factors beyond
the control of the Bank may affect interest rates. If generally prevailing
interest rates increase, the "net interest spread" of the Bank, which is the
difference between the rates of interest earned and the rates of interest paid
by the Bank, is likely to contract, resulting in less net interest income.
Although the Bank pursues an asset-liability management strategy designed to
control its risk from changes in market interest rates, the Bank's liabilities
have shorter terms and are more interest-sensitive than its assets. At June
30, 1996, the Bank's one-year interest-sensitivity "gap" (the sum of all
interest earning assets to be re-priced within one year minus all interest-
bearing liabilities to be re-priced within one year, as a percentage of total
assets) was negative 13.7%. As a result of its gap position, the Bank's net
interest spread will narrow, and its operating results will be adversely
affected, during periods of rising market interest rates if the Bank is unable
to reduce its gap. There can be no assurance that the Bank will be able to
adjust its gap sufficiently to offset any negative effect of changing market
interest rates. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Financial Condition--Asset and Liability
Management" in the Form 10-K.
Regulatory Capital Levels. As a federal savings association, the Bank is
subject to minimum capital requirements prescribed by federal statute and OTS
regulations. At June 30, 1996, the Bank was in compliance with all of its
regulatory capital requirements under FIRREA, with tangible, core and total
risk-based regulatory capital ratios of 6.30%, 6.30% and 12.04%, respectively,
compared to the regulatory requirements of 1.50%, 3.00% and 8.00%,
respectively. Effective July 1, 1996, certain additional deductions from
capital were phased in. If this phase-in had been in effect at June 30, 1996,
the Bank's tangible, core and risk-based regulatory capital ratios would have
been 6.27%, 6.27% and 12.00%, respectively. Based on unaudited results, at
September 30, 1996, the Bank's tangible, core and total risk-based regulatory
capital ratios decreased to 5.21%, 5.21% and 10.14%, respectively. See "Recent
Developments."
The OTS' prompt corrective action regulations establish five capital
categories for thrift institutions: well capitalized, adequately capitalized,
undercapitalized, severely undercapitalized and critically undercapitalized.
These categories are determined for the supervisory purposes of section 38 of
the Federal Deposit Insurance Act (which establishes a system of mandatory and
discretionary supervisory actions which generally become more severe as
capital levels decline) and may not necessarily constitute an accurate measure
of the Bank's current overall financial condition or its future prospects. A
thrift will be considered "well capitalized" if it has a core capital (or
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%. A thrift will
be considered "adequately capitalized" if it has a core capital (or leverage)
ratio of at least 4.0%, a Tier 1 risk-based capital ratio of at least 4.0%,
and a total risk-based capital ratio of at least 8.0%. Based on unaudited
results, the Bank's core (or leverage), Tier 1 risk-based and total risk-based
capital ratios at September 30, 1996 of 5.21%, 5.80% and 10.14%, respectively,
exceeded the capital ratios established for "adequately capitalized"
institutions. See "Recent Developments." The OTS has the discretion to
reclassify an institution from "well capitalized" to "adequately capitalized"
and to treat an "adequately capitalized" institution as an "undercapitalized"
institution for purposes of the prompt corrective action regulations
(including imposing restrictions on the payment of dividends) if, after notice
and an opportunity for a hearing, the OTS determines that the institution (i)
is in an unsafe or unsound condition or (ii) has received and has not
corrected a less than satisfactory examination rating for asset quality,
management, earnings or liquidity.
65
<PAGE>
Deteriorating collateral values or general economic conditions could result
in recognition of losses on the Bank's loan and REO portfolios and a
consequent reduction in capital. In addition, OTS capital regulations provide
a five-year holding period (or such longer period approved by the OTS) for REO
to qualify for an exception from treatment as an equity investment. If REO 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, then the Bank would be required to
deduct the then-current book value of the REO from risk-based capital. In
November 1996, the Bank received an extension through November 12, 1997 of the
holding periods for certain of its REO properties acquired through foreclosure
in fiscal 1990, fiscal 1991 and fiscal 1992. There can be no assurances that
the Bank will be able to dispose of all of its REO properties within the
applicable time period or obtain any necessary extensions. Accordingly, there
can be no assurance that the Bank will be able to maintain levels of capital
sufficient to meet the standards for classification as "adequately
capitalized" under the prompt corrective action regulations.
Risks Relating to Reserve Levels and REO. At June 30, 1996, the Bank's non-
performing assets were $166.9 million (net of valuation allowances for losses
on REO), or 1.89% of total assets. As of such date, the ratio of the Bank's
reserves to non-performing assets was 67.7%. Although the Bank believes it has
a reasonable basis for estimating reserves, no assurance can be given that the
Bank will not sustain losses in any particular period that exceed the amount
of the reserves at the beginning of that period, or that subsequent
evaluations of the asset portfolio, in light of factors then prevailing
(including economic conditions, the Bank's internal review process and the
results of regulatory examinations), will not require significant increases in
the reserves. See "--Recent Developments" and "Business--Delinquencies,
Foreclosures and Reserves for Losses--Allowances for Losses" in the Form 10-K.
At June 30, 1996, approximately $102.8 million (or 75.4%), after valuation
allowances on such assets, of the Bank's aggregate book value of REO was
attributable to five planned unit developments over which the Bank took active
control, through foreclosure or deeds-in-lieu of foreclosure, in 1990 and
1991, four of which are under active development. The Bank from time to time
obtains updated appraisals on its REO and, in the past, has been directed to
do so by the OTS in connection with regulatory examinations. As a result of
such updated appraisals, the Bank could be required to increase its reserves.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Financial Condition--Asset Quality--Disposition of REO" in the
Form 10-K.
Risks of Other Consumer Lending. The Bank is actively expanding its non-
credit card consumer lending business, focusing on automobile and home
improvement loans. While such loans generally have shorter terms to maturity
and carry higher rates than residential mortgage loans, they generally entail
greater risk than residential mortgage loans, particularly when secured by
rapidly depreciable assets, such as automobiles. In such cases, any collateral
repossessed for a defaulted consumer loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of damage, loss or
depreciation. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability and, thus, are more likely to be
affected by adverse personal circumstances.
The Bank also makes automobile loans through one of its operating
subsidiaries. The underwriting guidelines for this subsidiary apply to a
category of lending in which loans may be made to applicants who have
experienced certain adverse credit events (and, therefore, would not
necessarily meet all of the Bank's guidelines for its traditional loan
program), but who meet certain other creditworthiness tests. Such loans may
experience higher rates of delinquencies, repossessions and losses, especially
under adverse economic conditions, compared with loans originated pursuant to
the Bank's traditional lending program. See "Business--Lending Activities--
Other Consumer Loan Underwriting" in the Form 10-K.
Risks Relating to Elimination of Thrift Charter. During the past year,
Congress has been considering legislation in various forms that would require
federal thrifts, like the Bank, to convert their charters to national or state
bank charters. Recent legislation requires the merger of the Bank Insurance
Fund ("BIF") and the SAIF
66
<PAGE>
into a single Deposit Insurance Fund on January 1, 1999 but only if the thrift
charter is eliminated by that date. The Treasury Department is required to
submit a comprehensive study on thrift charter issues by March 31, 1997. In
the absence of appropriate "grandfather" provisions, legislation eliminating
the thrift charter could have a material adverse effect on the Bank and the
Trust because, among other things, the Trust engages in activities that are
not permissible to bank holding companies and the regulatory capital and
accounting treatment for banks and thrifts differs in certain significant
respects. The Bank cannot determine whether, or in what form, such legislation
will eventually be enacted and there can be no assurance that any such
legislation that is enacted will contain adequate grandfather rights for the
Bank and the Trust. See "Recent Developments--Legislative Developments."
Risks Related to SAIF Insurance. Legislation was enacted on September 30,
1996 that among other things, imposes on thrift institutions a one-time
assessment of 65.7 cents for every $100 of SAIF-insured deposits to
recapitalize the SAIF. Following such legislation, the Bank and other
institutions with SAIF-assessable deposits will continue to pay somewhat
higher deposit insurance premiums than institutions with BIF-assessable
deposits, which could lead to a competitive disadvantage in the pricing of
loans and deposits and additional operating expenses. In addition, regulators
have recently begun approving applications by several thrift organizations to
establish or acquire BIF-insured affiliates and prolonged continuation of the
disparity in deposit insurance premiums could lead to more widespread efforts
to shift insured deposits from SAIF to BIF, thus further destabilizing the
SAIF. However, the new legislation contains provisions designed to prohibit
deposit transfers from SAIF to BIF under certain circumstances.
Holding Company Matters. The Trust owns 80% of the Bank's common stock.
Payments from the Bank to the Trust in the form of tax sharing payments and
dividends are a principal source of funding for the Trust. The Bank made tax
sharing payments to the Trust of $20.5 million in fiscal 1995 and $20.0
million in the nine months ended June 30, 1996. Subsequent to June 30, 1996,
the Bank made additional tax sharing payments of $5 million to the Trust. In
addition, during the June 1996 quarter, the Bank paid cash dividends on its
common stock of $500 per share (of which the Trust's portion was $4.0 million)
and subsequent to June 30, 1996, declared and paid a cash dividend of $350 per
share (of which the Trust's portion was $2.8 million).
To the extent the Trust experiences liquidity problems, there can be no
assurance that the Trust will be able to satisfy, in whole or in part, any tax
liability that it may incur or any reimbursement or other obligation to the
Bank that may arise under a tax sharing agreement to which the Trust, the Bank
and other companies in the Trust's affiliated group are parties (the "Tax
Sharing Agreement"). The Bank, as a member of the Trust's affiliated group of
corporations filing consolidated income tax returns, is liable for the group's
tax liability (whether or not the Bank has made any tax sharing payments). The
Tax Sharing Agreement provides for payments to be made by members of the
affiliated group to the Trust based on their respective allocable shares of
the overall tax liability of the group and the benefits of any net operating
losses and similar items used by the group for specified taxable years. In
certain circumstances, the Bank would be entitled under the Tax Sharing
Agreement to be reimbursed by the Trust.
Absence of a Public Market for Bank Preferred Shares. If Bank Preferred
Shares are issued, the Bank does not intend to apply for listing of the Bank
Preferred Shares on any national securities exchange or for quotation of the
Bank Preferred Shares through the National Association of Securities Dealers
Automated Quotation System. There can be no assurance as to the liquidity of
the trading markets for the Bank Preferred Shares or that an active public
market for the Bank Preferred Shares would develop or be maintained.
67
<PAGE>
RECENT DEVELOPMENTS
Summarized below are certain unaudited selected financial data of Chevy
Chase on a consolidated basis for the periods and at the dates indicated.
<TABLE>
<CAPTION>
AS OF OR FOR THE YEAR ENDED
SEPTEMBER 30,
--------------------------------
1996 1995
----------------- -------------
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C>
SUMMARY OF OPERATIONS DATA:
Interest income............................. $ 387,566 $ 365,336
Interest expense............................ 188,836 189,114
------------- -------------
Net interest income....................... 198,730 176,222
Provision for loan losses................... 115,740 54,979
------------- -------------
Net interest income after provision for
loan losses.............................. 82,990 121,243
------------- -------------
Non-interest income:
Credit card, loan servicing and deposit
servicing fees............................ 324,761 218,572
Gain (loss) on sales of trading securities,
net....................................... 1,158 (600)
Loss on real estate held for investment or
sale, net................................. (24,413) (5,164)
Gain on sales of loans, net................ 23,242 12,882
Gain on sales of mortgage servicing rights,
net....................................... -- 1,397
Other...................................... 19,713 5,923
------------- -------------
Total non-interest income................. 344,461 233,010
------------- -------------
Non-interest expense........................ 383,269 299,601
------------- -------------
Income before income taxes.................. 44,182 54,652
Provision for income taxes.................. 16,553 17,330
------------- -------------
Net income.................................. $ 27,629 $ 37,322
============= =============
SUMMARY OF FINANCIAL CONDITION DATA:
Total assets................................ $ 5,727,604 $ 4,947,995
Mortgage-backed securities.................. 1,306,417 880,208
Loans receivable, net....................... 2,773,024 2,327,286
Loans held for sale......................... 76,064 68,679
Loans held for securitization and sale...... 450,000 500,000
Allowance for losses on loans............... 95,523 60,496
Real estate held for investment or sale,
net........................................ 123,489 222,860
Allowance for losses on real estate held for
investment or sale......................... 126,710 135,236
Cost in excess of net assets acquired, net.. 40,523 44,528
Mortgage servicing rights, net.............. 32,607 28,369
Deposit accounts............................ 4,164,037 4,159,252
Securities sold under repurchase agreements
and other short-term borrowings............ 637,141 10,435
Federal Home Loan Bank advances............. 269,065 155,052
Capital notes-subordinated.................. 160,000 160,000
Stockholders' equity........................ 339,160 328,544
Nonperforming assets........................ 154,650 247,185
SELECTED RATIOS:
Return on average assets.................... 0.56% 0.76%
Return on average stockholders' equity...... 8.14% 12.66%
Average stockholders' equity to average
assets..................................... 6.85% 5.98%
Net loan charge-offs to average loans....... 2.75% 1.51%
Non-performing assets, net to total
assets(1).................................. 1.03% 3.77%
Net yield on interest-earning assets........ 4.80% 4.24%
Average interest-earning assets to average
interest-bearing liabilities............... 92.35% 91.91%
REGULATORY CAPITAL RATIOS:
Tangible.................................... 5.21%(2) 5.77%
Core (or leverage).......................... 5.21%(2) 5.77%
Tier 1 risk-based........................... 5.80%(2) 6.65%
Total risk-based............................ 10.14%(2) 11.63%
</TABLE>
- --------
(1) Non-performing assets is presented after all reserves for losses on loans
and real estate held for investment or sale.
(2) The Bank's tangible, core, Tier 1 risk-based and total risk-based capital
ratios would have been 5.53%, 5.53%, 6.14% and 10.61%, respectively,
without the charge for the SAIF assessment described under "--Operating
Results."
68
<PAGE>
Operating Results. THE FOLLOWING DISCLOSURE IS BASED ON UNAUDITED OPERATING
RESULTS AS OF SEPTEMBER 30, 1996.
The Bank recorded pre-tax income of $44.2 million and net income of $27.6
million for the year ended September 30, 1996, compared to pre-tax income of
$54.7 million and net income of $37.3 million for the year ended September 30,
1995. The decrease in pre-tax income for fiscal 1996 was primarily
attributable to a $60.8 million increase in the provision for loan losses and
an $83.7 million increase in non-interest expense (which included the $26.5
million SAIF assessment discussed below), the effect of which was partially
offset by a $111.5 million increase in non-interest income and a $22.5 million
increase in net interest income.
Legislation was enacted on September 30, 1996 that, among other things,
imposed on thrift institutions a one-time assessment of 65.7 basis points on
their SAIF-insured deposits to recapitalize the SAIF. At September 30, 1996,
the Bank accrued approximately $26.5 million for the SAIF assessment.
Net interest income increased $22.5 million in fiscal 1996 as the average
yield on interest-earning assets increased at a rate greater than the rate of
increase in the average cost of interest-bearing liabilities.
The Bank's provision for loan losses increased to $115.7 million in fiscal
1996 from $55.0 million in fiscal 1995 primarily as a result of a $56.7
million increase in the provision for losses on credit card loans. The
increase in the provision for losses on credit card loans was primarily due to
increased charge-offs of such loans reflecting an industry-wide decline in the
performance of credit card loans and reflected in part the results of a
consumer loan portfolio review by the OTS. The increase in the provision
resulted in an increase in the Bank's allowance for losses on loans of $35.0
million which reflected mainly an increase in the allowance for losses on
credit cards of $33.4 million. As a result of this increase, the Bank's
valuation allowance on credit card loans increased from $46.3 million, or 4.6%
of such loans at September 30, 1995, to $79.7 million, or 7.1% of such loans
at September 30, 1996.
Other income increased to $344.5 million in fiscal 1996 from $233.0 million
in fiscal 1995 primarily as a result of an increase of $79.8 million in loan
servicing fees earned by the Bank for servicing its portfolios of securitized
loans and an increase of $20.9 million in credit card fees which was primarily
attributable to changes in the fee structure for the Bank's credit card
program during fiscal 1996. In addition, loss on real estate held for
investment or sale, net, increased $19.2 million due primarily to a decrease
of $4.5 million on equity earnings in partnership income and a decrease of
$12.5 million in the gain recorded on sales of the Bank's REO properties.
Operating expenses increased to $383.3 million in fiscal 1996 from $299.6
million in fiscal 1995 which increase included the $26.5 million SAIF
assessment. Other increases included a $19.2 million increase in salaries and
employee benefits, a $12.5 million increase in loan expenses, a $7.6 million
increase in marketing expenses and an $8.8 million increase in data processing
expenses.
During the quarter ended September 30, 1996, the Bank securitized and sold
$220.0 million of credit card receivables and $96.5 million of home equity
credit line receivables. No gain or loss was recognized in connection with the
credit card transaction and a gain of $4.7 million was recognized in
connection with the home equity credit line transaction.
Non-performing assets decreased to $154.7 million, after REO valuation
allowances of $126.5 million, at September 30, 1996 from $247.2 million, after
REO valuation allowances of $135.0 million, at September 30, 1995. The
decrease was primarily attributable to a decline in REO of $99.4 million to
$119.9 million, after valuation allowances of $126.5 million, at September 30,
1996 from $219.2 million, after valuation allowances of $135.0 million, at
September 30, 1995. REO decreased primarily due to sales of residential lots
or units in the Communities and other smaller residential properties and the
sale of five residential ground properties with an aggregate book value of
$23.8 million, after all valuation allowances on such assets. Partially
offsetting the decrease in REO was an increase in non-accrual loans primarily
due to a $6.8 million increase in non-accrual credit card loans.
69
<PAGE>
At September 30, 1996, the Bank's tangible, core (or leverage), Tier 1 risk-
based and total risk-based regulatory capital ratios were 5.21%, 5.21%, 5.80%
and 10.14%, respectively, which exceeded the ratios established for
"adequately capitalized" institutions under the OTS prompt corrective action
regulations. If the SAIF assessment discussed above had not been made in the
quarter ended September 30, 1996, the Bank's capital ratios would have
continued to meet the standards for "well capitalized" institutions. In the
September 30, 1996 quarter, the Bank's capital ratios fell below the ratios
established for "well capitalized" institutions for the first time since June
1993.
Legislative Developments. On September 30, 1996, President Clinton signed
into law the Economic Development and Regulatory Paperwork Reduction Act of
1996 (the "Act"). The Act's principal provisions relate to recapitalization of
SAIF, but it also contains numerous regulatory relief measures, some of which
are directly applicable to the Bank.
The Act requires the FDIC to impose a one-time special assessment of 65.7
cents for every $100 of SAIF-insured deposits held on March 31, 1995 in order
to bring SAIF to its statutory reserve level. As a result of the legislation,
the Bank has experienced a one-time charge to earnings for the special
assessment as described above.
In addition, beginning on January 1, 1997, commercial banks will be required
to share in the payment of interest due on Financing Corporation ("FICO")
bonds used to rescue the savings and loan industry in the 1980s. Annual FICO
assessments to be added to deposit insurance premiums are expected to equal
approximately 6.4 basis points for SAIF members and 1.3 basis points for BIF
members from January 1, 1997 through December 31, 1999; and approximately 2.4
basis points for both BIF and SAIF members thereafter. See "--Risk Factors and
Other Considerations--Risks Related to SAIF Insurance."
The Act also requires the merger of BIF and SAIF into a single Deposit
Insurance Fund on January 1, 1999, but only if the thrift charter is
eliminated by that date. The Treasury Department is required to submit a
report on thrift charter issues by March 31, 1997. Although this provision of
the Act establishes a time frame for the eventual elimination of the thrift
charter, it contains no provisions concerning the form the current thrift
charter may be required to take. The Bank cannot determine at this time what
effect this provision will have on its financial position or operations. See
"--Risk Factors--Risks Relating to Elimination of Thrift Charter."
The Act significantly liberalizes the current qualified thrift lender
("QTL") test by, among other things, permitting inclusion of credit card and
educational loans as qualified thrift investments ("QTI") without limits
(previously, such loans could be included only up to 10% of the institution's
assets). As a result of this provision, the Bank's entire credit card
portfolio is now eligible for inclusion as QTI, thus substantially reducing
the QTL test's impact as a constraint on the Bank's business strategies.
The Act also increases the Bank's commercial lending authority from 10% to
20% of assets, provided that the additional 10% consists of small business
loans.
Finally, the Act contains several other provisions designed to reduce
regulatory burdens associated with compliance with various consumer and other
laws applicable to the Bank, including for example, provisions designed to
coordinate the disclosure and other requirements under the Truth-in-Lending
and Real Estate Settlement Procedures Acts, modify certain insider lending
restrictions, permit OTS to allow exemptions to anti-tying prohibitions and
exempt certain transactions and simplify certain disclosures under the Truth-
in-Lending Act.
RESTRICTIONS ON BANK DIVIDENDS
If the Automatic Exchange occurs and the Bank has not been placed into
conservatorship or receivership, the Bank would likely be prohibited from
paying dividends on the Bank Preferred Shares as long as the Bank remains
"undercapitalized" for purposes of the OTS prompt corrective action
regulations or the OTS anticipates
70
<PAGE>
the Bank being "undercapitalized" in the near term.The prompt corrective
action regulations prohibit thrift institutions such as the Bank from making
"capital distributions" (defined to include a cash distribution) unless the
institution is at least "adequately capitalized" after the distribution.
Currently, an institution is considered "adequately capitalized" for this
purpose if it has a total risk-based capital ratio of at least 8.0%, a Tier 1
risk-based capital ratio of at least 4.0% and a core (or leverage capital)
ratio of at least 4.0%. In addition, the Bank's ability to pay dividends on
the Bank Preferred Shares would be subject to various restrictions under OTS
regulations, a resolution of the Bank's board of directors and certain
contractual provisions. See "Business Regulation--Dividends and Other Capital
Distributions" in the Form 10-K and "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of Operations" in the
Form 10-K.
However, if the Automatic Exchange occurs after the Bank has been placed
into conservatorship or receivership, the claims of the Bank's depositors and
of its secured, senior, general and subordinated creditors would be entitled
to a priority of payment over the claims of holders of equity interests such
as the Bank Preferred Shares issued pursuant to the Automatic Exchange.
CAPITALIZATION
The following table sets forth the actual capital of the Bank at September
30, 1996 and as adjusted as of such date to give effect to the sale of the
Series A Preferred Shares in the Offering (assuming the Underwriters' over-
allotment option is not exercised) and the transactions described in "Certain
Transactions Constituting the Formation--The Formation," and the inclusion of
the proceeds therefrom in the Bank's capital, net of underwriting fees and
other estimated expenses payable in connection with such transactions. The
table also reflects the sale of the Series A Preferred Stock and the
Debentures. This table should be read in conjunction with the Consolidated
Financial Statements of the Bank and the notes thereto in the documents
incorporated herein by reference.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
------------------------------------------
ACTUAL AS ADJUSTED(1) AS ADJUSTED(2)
---------- -------------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
LIABILITIES:
Deposits......................... $4,164,037 $4,164,037 $4,164,037
Borrowings....................... 644,418 644,418 644,418
Federal Home Loan Bank advances.. 269,065 269,065 269,065
Other liabilities................ 150,924 150,924 150,924
Capital note--9 1/4% Subordinated
Debentures due 2005............. 150,000 150,000 150,000
Capital note--Private Capital
Note due 1996................... 10,000 10,000 10,000
Capital note-- % Subordinate
Debentures due 2008............. -- -- 100,000
---------- ---------- ----------
Total liabilities.............. 5,388,444 5,388,444 5,488,444
---------- ---------- ----------
MINORITY INTEREST.................. -- 144,000 144,000
---------- ---------- ----------
STOCKHOLDERS' EQUITY:
13% Noncumulative Perpetual
Preferred Stock, Series A, $0.01
par value, 3,000,000 shares
authorized, issued and
outstanding..................... 30 30 30
Common stock, $1 par value,
10,000,000 shares authorized,
510,000 shares issued, 10,000
shares outstanding.............. 10 10 10
Capital contributed in excess of
par............................. 165,704 165,704 165,704
Retained earnings................ 175,291 175,291 175,291
Net unrealized holding gains
(losses)........................ (1,875) (1,875) (1,875)
---------- ---------- ----------
Total stockholders' equity..... 339,160 339,160 339,160
---------- ---------- ----------
Total liabilities and
stockholders' equity........ $5,727,604 $5,871,604 $5,971,604
========== ========== ==========
REGULATORY CAPITAL RATIOS:
Tangible......................... 5.21% 6.78%(3) 6.67%(4)
Core (or leverage)............... 5.21% 6.78%(3) 6.67%(4)
Tier 1 risk-based................ 5.80% 7.68%(3) 7.65%(4)
Total risk-based................. 10.14% 12.63%(3) 15.15%(4)
</TABLE>
(1)As adjusted to reflect the sale of the Series A Preferred Shares.
(2)As adjusted to reflect the sale of the Series A Preferred Shares together
with the Debentures.
(3) The as adjusted "Regulatory Capital Ratios" assume approval from the OTS
to include the proceeds from the Series A Preferred Shares Offering in an
amount up to 25% of the Bank's core capital, which portion of the proceeds
is estimated to be $98.8 million.
(4) The as adjusted "Regulatory Capital Ratios" assume approval from the OTS
to include the proceeds from the Series A Preferred Shares Offering in an
amount up to 25% of the Bank's core capital, which portion of the proceeds
is estimated to be $98.8 million, and $100 million of the principal amount
of the Debentures as supplementary capital.
71
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in an underwriting agreement
(the "Underwriting Agreement") among the Company, the Bank and Merrill Lynch,
Pierce, Fenner & Smith Incorporated, Friedman, Billings, Ramsey & Co., Inc.
and Smith Barney Inc. (the "Underwriters"), the Company has agreed to sell to
the Underwriters, and the Underwriters have severally agreed to purchase, the
number of Series A Preferred Shares set forth opposite its name below. In the
Underwriting Agreement, the several Underwriters have agreed, subject to the
terms and conditions set forth therein, to purchase all the Series A Preferred
Shares offered hereby if any are purchased. In the event of default by an
Underwriter, the Underwriting Agreement provides that, in certain
circumstances, the purchase commitments of the nondefaulting Underwriters may
be increased or the Underwriting Agreement may be terminated.
<TABLE>
<CAPTION>
NUMBER OF SERIES A
UNDERWRITER PREFERRED SHARES
----------- ------------------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated..........................................
Friedman, Billings, Ramsey & Co., Inc.................
Smith Barney Inc......................................
---------
Total............................................ 3,000,000
=========
</TABLE>
The Underwriters have advised the Company that they propose initially to
offer the Series A Preferred Shares directly to the public at the initial
public offering price set forth on the cover page of this Prospectus, and to
certain dealers at such price less a concession not in excess of $ per
share. The Underwriters may allow, and such dealers may reallow, a concession
not in excess of $ per share to certain other dealers. After the initial
public offering of the Series A Preferred Shares, the public offering price,
concession and discount may be changed.
The Company has granted the Underwriters an option, exercisable for 30 days
after the date of this Prospectus, to purchase up to an aggregate of 300,000
additional Series A Preferred Shares at the public offering price set forth on
the cover page hereof, less the underwriting discount, solely to cover over-
allotments, if any. If the Underwriters exercise their over-allotment option,
the Underwriters have severally agreed, subject to certain conditions, to
purchase approximately the same percentage thereof that the number of Series A
Preferred Shares to be purchased by each of them, as shown in the foregoing
table, bears to the 3,000,000 Series A Preferred Shares offered hereby.
The Company has agreed that, during the period beginning from the date of
this Prospectus and continuing to and including the date 90 days after the
date of this Prospectus, it will not offer, sell, contract to sell or
otherwise dispose of any securities of the Company which are substantially
similar to the Series A Preferred Shares or which are exchangeable into
securities which are substantially similar to the Series A Preferred Shares
without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith
Incorporated, except for the Series A Preferred Shares offered in connection
with the Offering.
The Underwriters have informed the Company that they do not expect sales to
accounts over which the Underwriters exercise discretionary authority to
exceed 5% of the total number of shares of Series A Preferred Shares offered
by them.
Prior to the Offering, there has been no public market for the Series A
Preferred Shares. The Series A Preferred Shares have been approved for listing
on the NYSE, subject to official notice of issuance, under the trading symbol
"CCP."
The Company and the Bank have agreed to indemnify the several Underwriters
against certain liabilities, including liabilities under the Securities Act of
1933, as amended.
72
<PAGE>
Certain of the Underwriters or their affiliates have provided from time to
time, and expect to provide in the future, investment or commercial banking
services to affiliates of the Company, for which such Underwriters or their
affiliates have received or will receive customary fees and commissions. The
Underwriters are also underwriters for the proposed public offering of the
Bank's Debentures.
EXPERTS
The Company's Statement of Financial Condition as of November 5, 1996
included in this Prospectus has been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their report with respect
thereto, and is included herein in reliance upon the authority of said firm as
experts in giving said report.
The Bank's Consolidated Financial Statements included in the Form 10-K and
incorporated by reference in this Prospectus have been audited by Arthur
Andersen LLP, independent public accountants, as indicated in their report
with respect thereto, and are included herein in reliance upon the authority
of said firm as experts in giving said report.
RATINGS
It is expected that the Series A Preferred Shares will be rated by Moody's
Investors Service, Inc. and by Standard and Poor's Ratings Service. A
security rating is not a recommendation to buy, sell or hold securities and
may be subject to revision or withdrawal at any time by the assigning rating
organization. No person is obligated to maintain any rating on the Series A
Preferred Shares, and, accordingly, there can be no assurance that the ratings
assigned to the Series A Preferred Shares upon initial issuance will not be
lowered or withdrawn by the assigning rating organization at any time
thereafter.
LEGAL MATTERS
The validity of the Series A Preferred Shares offered hereby and certain tax
matters described under "Federal Income Tax Considerations" will be passed
upon for the Company by Shaw, Pittman, Potts & Trowbridge, Washington, D.C.
The validity of the Series A Preferred Shares will be passed upon for the
Underwriters by Skadden, Arps, Slate, Meagher & Flom LLP.
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement (of which
this Prospectus forms a part) on Form S-11 (the "Registration Statement")
under the Securities Act, with respect to the Series A Preferred Shares
offered hereby. This Prospectus does not contain all of the information set
forth in the Registration Statement, certain portions of which have been
omitted as permitted by the rules and regulations of the Commission.
Statements contained in this Prospectus as to the content of any contract or
other document are not necessarily complete, and in each instance reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference. For further information regarding the Company and the Series A
Preferred Shares offered hereby, reference is made to the Registration
Statement and the exhibits thereto.
The Registration Statement and the exhibits forming a part thereof filed by
the Company with the Commission can be inspected at and copies can be obtained
from the Commission, Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the following regional offices of the
Commission: 7 World Trade Center, Suite 1300, New York, New York 10048 and
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661.
Copies of such materials can be obtained from the Public Reference Section of
the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates. Such material may also be accessed electronically by means of the
Commission's home page on the Internet at http://www.sec.gov.
The Articles Supplementary establishing the rights, preferences and
limitations of the Series A Preferred Shares provide that the Company shall
maintain its status as a reporting company under the Exchange Act, for as long
as any of the Series A Preferred Shares are outstanding and pursuant thereto
will furnish shareholders with annual reports containing audited financial
statements.
73
<PAGE>
GLOSSARY
"Advisor" means the Bank in its role as advisor under the Advisory
Agreement.
"Advisory Agreement" means the agreement between the Bank and the Company
pursuant to which the Bank will (i) administer the day-to-day operations of
the Company, (ii) monitor the credit quality of the Mortgage Assets held by
the Company and (iii) advise the Company with respect to the acquisition,
management, financing and disposition of the Company's Mortgage Assets.
"ARM" or "adjustable rate mortgage" means a Mortgage Loan that features
adjustments of the underlying interest rate at predetermined times based on an
agreed margin to an established index. An ARM is usually subject to periodic
interest rate and/or payment caps and a lifetime interest rate cap.
"ATMs" means automated teller machines.
"Automatic Exchange" means the automatic exchange on a share-for-share basis
of Series A Preferred Shares for Bank Preferred Shares upon the occurrence of
the Exchange Event.
"Balancing Distribution" means a distribution made to the holders of the
Common Stock at any point in time, or from time to time, when the value of the
Common Stock exceeds 52% of the total value of the stock of the Company, but
not in an amount in excess of the distribution required to reduce the value of
the Common Stock (measured after such distribution) to less than 50% of the
total value of the stock of the Company.
"Bank" means Chevy Chase Bank, F.S.B., a federally chartered and federally
insured stock savings bank, and the parent of the Company.
"Bank Preferred Shares" means the newly issued series of preferred stock of
the Bank for which the Series A Preferred Shares will be exchanged
automatically upon the occurrence of the Exchange Event.
"BIF" means the Bank Insurance Fund.
"Board of Directors" means the board of directors of the Company.
"Bylaws" means the bylaws of the Company.
"Articles of Incorporation" means the Amended and Restated Articles of
Incorporation of the Company.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commercial Mortgage Loan" means a whole loan secured by a first mortgage or
deed of trust on a commercial real estate property.
"Commission" means the United States Securities and Exchange Commission.
"Common Stock" means the common stock, par value $1.00 per share, of the
Company.
"Communities" means the five planned unit developments, which comprise a
majority of the Bank's REO.
"Company" means Chevy Chase Preferred Capital Corporation, a Maryland
corporation.
"Debentures" means $100 million aggregate principal amount of %
Subordinated Debentures due 2008 of the Bank.
"Directive" means the writing issued by the appropriate federal regulatory
agency directing the Automatic Exchange.
74
<PAGE>
"DOL" means the United States Department of Labor.
"ERISA" means the Employee Retirement Income Security Act of 1914, as
amended.
"Excess Shares" means the shares of any class or series of Preferred Stock
owned, or deemed to be owned, by or transferred to a stockholder in excess of
the Ownership Limit.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Exchange Event" means the appropriate federal regulatory agency directs in
writing an exchange of the Series A Preferred Shares for Bank Preferred Shares
because (i) the Bank becomes "undercapitalized" under prompt corrective action
regulations, (ii) the Bank is placed into conservatorship or receivership or
(iii) the appropriate federal regulatory agency, in its sole discretion,
anticipates the Bank becoming "undercapitalized" in the near term.
"Executive Loan Committee" means the executive loan committee of the Bank.
"FDIC" means the Federal Deposit Insurance Corporation.
"FDICIA" means the Federal Deposit Insurance Corporation Improvement Act of
1991, as amended.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"FIRPTA" means the Foreign Investment in Real Property Tax Act of 1980, as
amended.
"FIRREA" means the Financial Institutions Reform, Recovery, and Enforcement
Act of 1989, as amended.
"5/1 ARM" means a fixed rate Residential Mortgage Loan that automatically
converts to a one-year ARM in the month in which the 60th monthly payment is
due.
"Five or Fewer Test" means the Code requirement that not more than 50% in
value of the Company's outstanding stock may be owned, directly or indirectly,
by five or fewer individuals (as defined in the Code).
"FNMA" means the Federal National Mortgage Association.
"FNMA Required Net Yield" means (i) with respect to any Mortgage Loan with
an original term of 20, 25 or 30 years, FNMA's required net yield for 30-year
fixed rate mortgages (covered by 60-day mandatory commitments) that was in
effect 45 days prior to the effective date of any conversion of such Mortgage
Loan and (ii) with respect to any Mortgage Loan with an original term of 15
years, FNMA's required net yield for 15-year fixed rate mortgages (covered by
60-day mandatory commitments) that was in effect 45 days prior to the
effective date of any conversion of such Mortgage Loan.
"Foreign Stockholders" means holders of Series A Preferred Shares that are
for United States federal income tax purposes (i) non-resident alien
individuals, (ii) foreign corporations and foreign partnerships or (iii)
foreign trusts and estates.
"Form 10-K" means the Bank's Annual Report on Form 10-K for the fiscal year
ended September 30, 1995, which is an exhibit to the Offering Circular.
"Form 10-Q" means the Bank's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1996, which is an exhibit to the Offering Circular.
75
<PAGE>
"GNMA" means the Government National Mortgage Association.
"Gross Margin" means, with respect to a Residential Mortgage Loan that is an
ARM, the applicable fixed percentage which is added to the applicable index to
calculate the current interest rate paid by the borrower of the adjustable
rate Mortgage Loan (without taking into account any interest rate caps or
minimum interest rates). Gross Margin is inapplicable to fixed rate loans.
"Independent Directors" means the members of the Board of Directors who are
not current officers or employees of the Company and who are not current
directors, officers or employees of the Bank or any affiliate of the Bank.
"Initial Portfolio" means the initial portfolio of Mortgage Assets purchased
by the Company from the Bank and affiliates of the Bank.
"Interested Stockholder" means a person beneficially owning 10% or more of
the aggregate voting power of a Maryland corporation.
"IRA" means an individual retirement arrangement under Section 408 of the
Code.
"IRS" means the United States Internal Revenue Service.
"LIBOR" means the London Inter-Bank Offered Rate.
"Lifetime interest rate cap" means, with respect to Mortgage Loans that are
ARMs, the maximum interest rate that may accrue during any period over the
term of such Mortgage Loan as stated in the governing instruments evidencing
such Mortgage Loan.
"Loan-to-Value Ratio" means, with respect to any Mortgage Loan, the ratio
(expressed as a percentage) of the original principal amount of such Mortgage
Loan to the lesser of (i) the appraised value at origination of the mortgaged
property underlying such Mortgage Loan and (ii) if the Mortgage Loan was made
to finance the acquisition of property, the purchase price of the mortgaged
property.
"MGCL" means the Maryland General Corporation Law as in effect from time to
time or any successor statute thereto.
"Mortgage Assets" means real estate mortgage assets, including but not
limited to Residential Mortgage Loans, Commercial Mortgage Loans and Mortgage-
Backed Securities.
"Mortgage-Backed Securities" means securities rated by at least one
nationally recognized independent rating organization and representing
interests in or obligations backed by pools of Mortgage Loans.
"Mortgage Loans" means whole loans secured by single-family (one- to four-
unit) residential real estate properties or by commercial real estate
properties.
"NYSE" means the New York Stock Exchange.
"Offering" means the offering of Series A Preferred Shares pursuant to the
Prospectus.
"Offering Circular" means the registration statement on Form OC pursuant to
which the Bank Preferred Shares are being registered with the OTS.
"One Hundred Persons Test" means the Code requirement that the capital stock
of the Company be owned by 100 or more persons during at least 335 days of a
taxable year or during a proportionate part of a shorter taxable year.
"One-Year ARM" means an ARM that adjusts annually beginning in the month in
which the 12th monthly payment is due.
"OTS" means the Office of Thrift Supervision.
76
<PAGE>
"Ownership Limit" means the provision in the Company's Articles of
Incorporation limiting any person from owning (including shares deemed to be
owned by the attribution provisions of the Code) more than 1% of any issued
and outstanding class or series of Preferred Stock.
"Periodic interest rate cap" means, with respect to ARMs, the maximum change
in the coupon rate permissible under the terms of the loan at each coupon
adjustment date. Periodic interest rate caps limit both the speed by which the
coupon rate can adjust upwards in a rising interest rate environment and the
speed by which the coupon rate can adjust downwards in a falling rate
environment.
"Plan" means a pension, profit-sharing, retirement or other employee benefit
plan.
"Plan Asset Regulation" means the DOL regulations determining the assets of
the Plan for purposes of ERISA and the related prohibited transaction excise
tax provisions of the Code.
"Preferred Stock" means preferred stock, par value $5.00 per share, of the
Company.
"Prime Rate" for any date means the lowest prime rate as published in the
"Money Rates" table of The Wall Street Journal for that date.
"Prospectus" means this prospectus, as the same may be amended or
supplemented.
"Rate Adjustment Date" means, with respect to any ARM, a date on which the
interest rate on such ARM adjusts.
"Registration Statement" means the registration statement filed by the
Company with the Commission on Form S-11 with respect to the Series A
Preferred Shares.
"REIT" means a real estate investment trust as defined pursuant to the REIT
Provisions, or any successor provisions thereof.
"REIT Provisions" and "REIT Requirements" means Sections 856 through 860 of
the Code and the applicable Treasury Regulations.
"REIT taxable income" shall have the meaning set forth in "Federal Income
Tax Considerations--Taxation of the Company--Annual Distribution
Requirements."
"REO" means real estate held for sale.
"Residential Mortgage Loan" means a whole loan secured by a first mortgage
or deed of trust on a single family (one- to four-unit) residential real
estate property.
"Residential Mortgage Loan Purchase Agreements" means the residential
mortgage loan purchase agreements between the Company and the Bank and
affiliates of the Bank.
"SAIF" means the Savings Association Insurance Fund.
"Securities Act" means the Securities Act of 1933, as amended.
"Series A Preferred Shares" means the shares of Preferred Stock of the
Company offered hereby.
"Servicer" means the Bank in its role as servicer under the Servicing
Agreement.
"Servicing Agreement" means the servicing agreement between the Bank and the
Company pursuant to which the Bank will service the Mortgage Loans included in
the Initial Portfolio.
77
<PAGE>
"Tax Event" means the receipt by the Company of an opinion of a nationally
recognized law firm experienced in such matters to the effect that, as a
result of (i) any amendment to, clarification of, or change (including any
announced prospective change) in, the laws or treaties (or any regulations
thereunder) of the United States or any political subdivision or taxing
authority thereof or therein affecting taxation, (ii) any judicial decision,
official administrative pronouncement, ruling, regulatory procedure, notice or
announcement (including any notice or announcement of intent to adopt such
procedures or regulations) ("Administrative Action") or (iii) any amendment
to, clarification of, or change in the official position or the interpretation
of such Administrative Action or Judicial decision or any interpretation or
pronouncement that provides for a position with respect to such Administrative
Action or judicial decision that differs from the theretofore generally
accepted position, in each case, by any legislative body, court, governmental
authority or regulatory body, irrespective of the manner in which such
amendment, clarification or change is made known, which amendment,
clarification, or change is effective or such pronouncement or decision is
announced on or after the date of issuance of the Series A Preferred Shares,
there is more than an insubstantial risk that (a) dividends payable by the
Company with respect to the capital stock of the Company are not, or will not
be, fully deductible for United States federal income tax purposes or (b) the
Company is, or will be, subject to more than a de minimis amount of other
taxes, duties or other governmental charges.
"Tax Sharing Agreement" means the tax sharing agreement to which the Trust,
the Bank and other companies in the Trust's affiliated group are parties.
"10/1 ARM" means a fixed rate Residential Mortgage Loan that automatically
converts to a one-year ARM in the month in which the 120th monthly payment is
due.
"Three Year ARM" means a fixed rate Residential Mortgage loan that is fixed
at an initial rate for the first 36 monthly payments and adjusts every three
years thereafter.
"Time of Exchange" means the time at which the Automatic Exchange occurs,
deemed to be as of 8:00 a.m. on the date for such exchange set forth in the
Directive, or, if such date is not set in the Directive, as of 8:00 a.m. on
the earliest possible date such exchange could occur consistent with the
Directive.
"TIN" means Taxpayer Identification Number.
"Treasury Index" means the weekly average yield on United States Treasury
securities adjusted to a constant maturity of one year as published by the
Federal Reserve Board in Statistical Release H.15 (519) or any similar
publication or, if not so published, as reported by any Federal Reserve Bank
or by any United States government department or agency.
"Treasury Regulations" means the income tax regulations promulgated under
the Code.
"Trust" means the B.F. Saul Real Estate Investment Trust.
"Underwriters" means those underwriters to which the Company will sell the
Series A Preferred Shares pursuant to the terms of the Underwriting Agreement.
"Underwriting Agreement" means the underwriting agreement by and among the
Company, the Bank and the Underwriters.
"United States Stockholders" means holders of Series A Preferred Shares that
are for United States federal income tax purposes (i) citizens or residents of
the United States, (ii) corporations, partnerships, or other entities created
or organized in or under the laws of the United States or of any political
subdivisions thereof, or (iii) an estate or trust the income of which is
subject to United States federal income taxation regardless of its source.
"USRPI" means United States real property interest.
78
<PAGE>
INDEX TO FINANCIAL STATEMENT
<TABLE>
<S> <C>
Report of Independent Public Accountants.................................. F-2
Statement of Financial Condition of Chevy Chase Preferred Capital
Corporation as of November 5, 1996....................................... F-3
Note to Financial Statement............................................... F-4
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors
of Chevy Chase Preferred Capital Corporation
We have audited the accompanying statement of financial condition of Chevy
Chase Preferred Capital Corporation (the "Company") as of November 5, 1996.
This financial statement is the responsibility of the Company's management.
Our responsibility is to express an opinion on this financial statement 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 statement is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statement. 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 statement referred to above presents fairly,
in all material respects, the financial position of Chevy Chase Preferred
Capital Corporation as of November 5, 1996, in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Washington, D.C.
November 5, 1996
F-2
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
STATEMENT OF FINANCIAL CONDITION
NOVEMBER 5, 1996
<TABLE>
<S> <C>
Assets
Cash.................................................................. $1,000
======
Stockholder's Equity
Common Stock, par value $1.00 per share, 100 shares authorized; 100
shares issued and outstanding........................................ $ 100
Capital contributed in excess of par.................................. 900
------
Total stockholder's equity.......................................... $1,000
======
</TABLE>
The Note to Financial Statement is an integral part of this Statement.
F-3
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTE TO FINANCIAL STATEMENT
1. ORGANIZATION
Chevy Chase Preferred Capital Corporation (the "Company"), a wholly-owned
subsidiary of Chevy Chase Bank, F.S.B. (the "Bank"), was incorporated on
August 20, 1996 in the State of Maryland.
The Company intends to invest in mortgage-related assets financed by common
and preferred stock offerings and expects to generate income for distribution
to its future preferred and common stockholders primarily from the interest
income derived from its investments in mortgage-related assets. The Company
intends to purchase these mortgage-related assets from the Bank, its
affiliates and third parties at their estimated fair values. Assets which are
purchased from the Bank or its affiliates will be recorded in the Company's
financial statements at the Bank's historical cost basis. The Company intends
to operate in a manner that permits it to elect, and it intends to elect, to
be subject to tax as a real estate investment trust for federal income tax
purposes. The Company has not had any operations as of November 5, 1996.
The Company intends to sell preferred stock in an underwritten public
offering. The cost of this public offering will be paid by the Company out of
proceeds from a sale of common stock to the Bank. If the public offering is
not consummated, the Bank will pay any offering costs.
For a discussion of risk factors associated with the Company's and the
Bank's operations, see the various "Risk Factors" sections beginning on pages
2, 9 and 63 in the Form S-11 Registration Statement for the Company's
Noncumulative Exchangeable Preferred Stock, Series A. The "Risk Factors"
sections have not been audited and are not covered by the report of
independent public accountants.
F-4
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+THIS OFFERING CIRCULAR HAS BEEN FILED WITH THE OFFICE OF THRIFT SUPERVISION, +
+BUT HAS NOT BEEN AUTHORIZED FOR USE IN FINAL FORM. INFORMATION CONTAINED +
+HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. THE SECURITIES COVERED HEREBY +
+MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE +
+OFFERING CIRCULAR IS DECLARED EFFECTIVE BY THE OFFICE OF THRIFT SUPERVISION. +
+THE OFFERING CIRCULAR SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE +
+SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION
ANNEX I
PRELIMINARY OFFERING CIRCULAR DATED NOVEMBER 13, 1996
OFFERING CIRCULAR
3,000,000 SHARES
CHEVY CHASE BANK, F.S.B.
% NONCUMULATIVE PREFERRED STOCK, SERIES B
(LIQUIDATION PREFERENCE $50.00 PER SHARE)
-----------
The % Noncumulative Preferred Stock, Series B, par value $5.00 per share
(the "Series B Preferred Shares"), of Chevy Chase Bank, F.S.B. ("Chevy Chase"
or the "Bank"), will be issued only upon the automatic exchange of the %
Noncumulative Exchangeable Preferred Stock, Series A (the "Preferred Capital
Shares") of Chevy Chase Preferred Capital Corporation, a wholly owned
subsidiary of the Bank, upon the occurrence of certain events. Dividends on the
Series B Preferred Shares will be payable at the same rate as the Preferred
Capital Shares if, when and as declared by the Board of Directors of the Bank.
For a description of the terms of the Series B Preferred Shares, see
"Description of the Series B Preferred Shares" herein.
The Bank currently has outstanding 3,000,000 shares of 13% Noncumulative
Perpetual Preferred Stock, Series A (the "Series A Preferred Shares"). The
Series B Preferred Shares will constitute a new series of preferred shares of
the Bank and will rank pari passu in terms of cash dividend payment and
liquidation preference with the Series A Preferred Shares (the Series A
Preferred Shares and the Series B Preferred Shares collectively, the "Preferred
Stock"). The Preferred Stock ranks, in priority of payment of dividends and
rights upon the voluntary or involuntary dissolution, liquidation or winding up
of the Bank, junior to all claims of the Bank's creditors, including the claims
of the Bank's depositors and holders of the Bank's outstanding subordinated
debentures. As of September 30, 1996, there were outstanding $150 million
principal amount of the Bank's 9 1/4% Subordinated Capital Debentures Due
December 1, 2005 and $10 million principal amount of the Private Capital Note
(as defined herein). The Bank was current with respect to all required payments
on its outstanding subordinated capital debentures as of that date. The
Preferred Stock ranks superior and prior to the issued and outstanding common
stock of the Bank with respect to dividend rights and rights upon voluntary or
involuntary dissolution, liquidation or winding up of the Bank, and to all
other classes and series of equity securities of the Bank hereafter issued,
other than any class or series expressly designated as being on parity with or
senior to the Preferred Stock. The common stock of the Bank is the only class
of equity securities currently outstanding other than the Series A Preferred
Shares.
The Preferred Capital Shares have been registered with the Securities and
Exchange Commission (the "SEC") and have been approved for listing on the New
York Stock Exchange (the "NYSE"), subject to notice of issuance, under the
symbol " ." In the event the Preferred Capital Shares are exchanged into
Series B Preferred Shares, the Bank does not intend to apply for listing of the
Series B Preferred Shares on any national securities exchange or for quotation
through the National Association of Securities Dealers Automated Quotation
System. The Series A Preferred Shares are not listed on any national securities
exchange or for quotation through the National Association of Securities
Dealers Automated Quotation System.
AN INVESTMENT IN THE SERIES B PREFERRED SHARES INVOLVES A HIGH DEGREE OF
RISK. INVESTORS SHOULD CAREFULLY CONSIDER THE RISK FACTORS AND OTHER
CONSIDERATIONS RELATING TO THE BANK AND THE SERIES B PREFERRED SHARES. SEE
"RISK FACTORS AND OTHER CONSIDERATIONS."
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE OFFICE OF THRIFT
SUPERVISION, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE SECURITIES
AND EXCHANGE COMMISSION OR ANY OTHER FEDERAL AGENCY, OR BY ANY
STATE SECURITIES COMMISSION, NOR HAS SUCH OFFICE, CORPORATION,
COMMISSION, OTHER AGENCY OR ANY STATE SECURITIES COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS OFFERING CIRCULAR. ANY REPRESENTATIONS
TO THE CONTRARY IS A CRIMINAL OFFENSE.
THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR SAVINGS DEPOSITS
AND ARE NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE
CORPORATION OR ANY OTHER GOVERNMENT AGENCY. THESE SECURITIES ARE BEING
OFFERED PURSUANT TO AN OFFERING CIRCULAR ON FORM OC FILED WITH THE
OFFICE OF THRIFT SUPERVISION.
The date of this Offering Circular is , 1996.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information................. 2
Incorporation of Certain Information
by Reference......................... 2
Information With Respect to the
Registrant........................... 2
Offering Circular Summary............. 3
Risk Factors and Other
Considerations....................... 10
Recent Developments................... 15
Use of Proceeds....................... 17
Debenture Offering.................... 18
Capitalization........................ 19
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Description of the Series B
Preferred Shares................. 20
Exchange.......................... 23
Experts........................... 23
Legal Matters..................... 23
Attachment A--Annual Report of the
Bank on Form 10-K for the fiscal
year ended September 30, 1995
(table of contents at page (i))
Attachment B--Quarterly Report of
the Bank on Form 10-Q for the
quarter ended June 30, 1996
</TABLE>
AVAILABLE INFORMATION
The Bank is subject to the information reporting requirements of the
Securities Exchange Act of 1934, as amended ("Exchange Act"), and, in
accordance therewith, files reports and other information with the OTS. Such
reports and other information may be inspected without charge and copied at
prescribed rates at the public reference facilities maintained by the OTS at
1700 G Street, N.W, Washington, D.C. 20552.
The Bank has filed with the OTS a Registration Statement on Form OC
(including any amendments thereto, the "Form OC") with respect to the
securities covered by this Offering Circular. This Offering Circular does not
contain all of the information set forth in the Form OC, certain items of
which are contained in or incorporated by reference as exhibits to the Form OC
as permitted by the rules and regulations of the OTS. For further information
with respect to the Bank and the securities offered hereby, reference is made
to the Form OC, including the exhibits filed or incorporated by reference as a
part thereof. Statements contained in this Offering Circular as to the
contents of any contract or other document referred to are not necessarily
complete, and in each instance reference is made to the copy of such contract
or other document filed or incorporated by reference as an exhibit to the Form
OC, each such statement being qualified in all respects by such reference. The
Form OC and the exhibits thereto may be inspected without charge and copied at
prescribed rates at the public reference facilities maintained by the OTS at
1700 G Street, N.W, Washington, D.C. 20552.
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
Certain documents previously filed by the Bank with the OTS are hereby
incorporated by reference in this Offering Circular as follows: (i) the Bank's
Annual Report on Form 10-K for the fiscal year ended September 30, 1995; and
(ii) the Bank's Quarterly Reports on Form 10-Q for the quarters ended December
31, 1995, March 31, 1996 and June 30, 1996.
Any statement contained in a document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this Offering Circular to the extent a statement contained
herein, or in any other subsequently filed document that also is or is deemed
to be incorporated by reference herein, modifies or supersedes such statement.
Any such statement so modified or superseded shall not be deemed, except as so
modified or superseded, to constitute a part of this Offering Circular. All
information appearing in this Offering Circular should be read in conjunction
with, and is qualified in its entirety by, the information and financial
statements (including notes thereto) appearing in the documents incorporated
herein by reference, except to the extent set forth in this paragraph.
The Bank will provide without charge to each person to whom this Offering
Circular is delivered, upon the written or oral request of any such person, a
copy of any or all of the information incorporated herein by reference other
than exhibits to such information (unless such exhibits are specifically
incorporated by reference into such information). If you wish to obtain copies
of such documents, please contact: Chevy Chase Bank, F.S.B., 8401 Connecticut
Avenue, Chevy Chase, Maryland 20815, Attention: Mrs. Mary Lou Hayes,
Secretary.
INFORMATION WITH RESPECT TO THE REGISTRANT
As an integral part of this Offering Circular, the Bank has attached
complete copies (including exhibits) of its Annual Report on Form 10-K for the
fiscal year ended September 30, 1995 (Attachment A) and its Quarterly Report
on Form 10-Q for the quarter ended June 30, 1996 (Attachment B). All material
information as of these periods relating to the Bank, including information
relating to the Bank's financial position and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," can be found in
these documents. There has been no material change in the Bank's affairs since
the conclusion of the fiscal year ended September 30, 1995 which has not
otherwise been disclosed by the Bank in such Form 10-K or Form 10-Q or in this
Offering Circular.
OC-2
<PAGE>
OFFERING CIRCULAR SUMMARY
This Offering Circular Summary, including the Selected Consolidated Financial
and Other Data, does not purport to be complete and is qualified in its
entirety by the more detailed information and financial statements and notes
thereto appearing elsewhere in this Offering Circular and in the documents
incorporated by reference herein. Capitalized terms used in the summary and not
defined herein have the meanings ascribed to such terms elsewhere in this
Offering Circular or in the documents incorporated by reference herein.
CHEVY CHASE BANK, F.S.B.
General. Chevy Chase Bank, F.S.B. ("Chevy Chase" or the "Bank") is a
federally chartered and federally insured stock savings bank which at June 30,
1996 was conducting business from 101 full-service offices and 497 automated
teller machines ("ATMs") in Maryland, Virginia and the District of Columbia.
The Bank has its home office in McLean, Virginia and its executive offices in
Montgomery County, Maryland, both suburban communities of Washington, D.C. The
Bank also maintains 21 mortgage loan production offices in the mid-Atlantic
region, 20 of which are operated by a wholly-owned mortgage banking subsidiary.
At June 30, 1996, the Bank had total assets of $5.0 billion, total deposits of
$4.2 billion and total stockholders' equity of $357.0 million. Based on total
consolidated assets at June 30, 1996, Chevy Chase is the largest bank
headquartered in the Washington, D.C. metropolitan area.
Chevy Chase is a consumer oriented, full-service banking institution
principally engaged in the business of attracting deposits from the public and
using such deposits, together with borrowings and other funds, to make loans
secured by real estate, primarily residential mortgage loans, and credit card
and other types of consumer loans. The Bank is also developing an active
commercial lending program. The Bank's principal deposit and lending markets
are located in the Washington, D.C. metropolitan area. 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.
For the nine months ended June 30, 1996, Chevy Chase reported pre-tax income
of $67.6 million and net income of $39.8 million, compared to pre-tax income of
$41.4 million and net income of $27.9 million in the corresponding period of
the prior fiscal year. At June 30, 1996, the Bank's tangible, core, Tier 1
risk-based and total risk-based regulatory capital ratios were 6.30%, 6.30%,
6.91% and 12.04%, respectively. As of such date, the Bank's capital ratios
exceeded the requirements under the Financial Institutions Reform, Recovery,
and Enforcement Act of 1989 ("FIRREA") as well as the standards established for
"well capitalized" institutions under the prompt corrective action regulations
established pursuant to the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA") (both as applicable on June 30, 1996 and on a fully
phased-in basis). Based on unaudited results, the Bank reported pre-tax income
of $44.2 million and net income of $27.6 million for the year ended September
30, 1996, and at September 30, 1996, the Bank's tangible, core, Tier 1 risk-
based and total risk-based regulatory capital ratios decreased to 5.21%, 5.21%,
5.80% and 10.14%, respectively. As of such date, the Bank's capital ratios
exceeded the requirements under FIRREA as well as the standards established for
"adequately capitalized" institutions under the prompt corrective action
regulations established pursuant to FDICIA. See "Risk Factors and Other
Considerations--Regulatory Capital Levels" and "Recent Developments."
Chevy Chase is subject to comprehensive regulation, examination and
supervision by the OTS and, to a lesser extent, by the Federal Deposit
Insurance Corporation (the "FDIC"). The Bank's deposit accounts are fully
insured up to $100,000 per insured depositor by the Savings Association
Insurance Fund (the "SAIF"), which is administered by the FDIC. See "Risk
Factors and Other Considerations--Risks Relating to Elimination of Thrift
Charter" and "--Risks Related to SAIF Insurance."
OC-3
<PAGE>
Because of the continued improvement in the financial condition of the Bank,
on March 29, 1996, the OTS released the Bank from a written agreement it had
entered into with the OTS on September 30, 1991, and the Board of Directors of
the Bank adopted a resolution addressing certain issues previously addressed by
the written agreement. See "Notes to Consolidated Financial Statements" in the
Bank's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996
incorporated by reference herein and attached hereto as Attachment B.
Business of the Bank. The Bank historically has relied on retail deposits
originated in its branch network as its primary funding source. The Bank'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 26.0% of the Bank's deposits at June 30, 1996 were obtained from
depositors residing outside of Maryland, primarily in Northern Virginia. As of
June 30, 1996, the Bank had 101 full-service banking facilities, 42 of which
were located in Montgomery County, 19 in Prince George's County and 18 in
Fairfax County. As of that date, the Bank also operated 497 ATMs. According to
published industry statistics, as of June 30, 1995, the Bank had the leading
market share of deposits in Montgomery County and the third largest share of
deposits in Prince George's County. 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 Montgomery and Fairfax Counties in June 1996 (2.9% and 3.2%,
respectively) was below the national rate (5.5%) and state rates (5.1% for
Maryland and 4.8% for Virginia) for the same month.
The Bank historically has concentrated its lending activities in the
Washington, D.C. metropolitan area. In recent periods, the Bank and its
subsidiaries have expanded the geographic region in which they purchase and
originate loans to include the northern and southern areas of the Eastern
United States. The Bank has not changed its underwriting standards for loans
purchased or originated in these areas, although the pricing of the loans may
be different based upon local market conditions.
As of June 30, 1996, the Bank's loan portfolio consisted primarily of single-
family residential loans (at approximately 51%), credit card loans (at
approximately 32%) and non-credit card consumer loans (at approximately 8%).
The Bank originates VA-guaranteed, FHA-insured 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. The Bank currently offers fixed-rate loans
with maturities of 15 to 30 years and adjustable-rate residential mortgage
loans, principally with maturities of 30 years. The Bank also offers revolving
home equity credit line loans secured principally by a second mortgage on the
borrowers' homes. In addition to revenue generated from interest on the loan
portfolio, the Bank also recognizes income from loan origination and servicing
fees. See "Business--Lending Activities--Origination, Purchase and Sale of Real
Estate Loans" in the Bank's Annual Report on Form 10-K for the year ended
September 30, 1995 incorporated by reference herein and attached hereto as
Attachment A.
With respect to its credit card program, the Bank offers Chevy Chase
"Classic" and "Gold" VISA(R) and MasterCard(R) cards. Chevy Chase issues the
credit cards and receives 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. The Bank believes its credit card
program contributes to market share growth in its local market by attracting
new depositors, promoting a high degree of customer loyalty and providing
opportunities to cross-market other products of the Bank. See "Business--
Lending Activities--Credit Card Lending" in the Bank's Annual Report on Form
10-K for the year ended September 30, 1995 incorporated by reference herein and
attached hereto as Attachment A and "Risk Factors and Other Considerations--
Risks of Credit Card Lending."
During fiscal 1996, the Bank continued to increase its portfolio of non-
credit card consumer loans. These loans primarily include automobile loans,
home improvement loans and other secured and unsecured loans for
OC-4
<PAGE>
traditional consumer purchases and needs. The majority of these loans are on an
indirect basis. The Bank makes these loans in the Southern United States as
well as the mid-Atlantic region. During the nine months ended June 30, 1996,
the Bank purchased or originated $398.1 million of automobile loans and $103.9
million of home improvement loans. See "Business--Lending Activities--Consumer
and Other Lending" in the Bank's Annual Report on Form 10-K for the year ended
September 30, 1995 incorporated by reference herein and attached hereto as
Attachment A, Notes 4 and 5 to the "Condensed Consolidated Financial
Statements" in the Bank's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1996 incorporated by reference herein and attached hereto as
Attachment B and "Risk Factors and Other Considerations--Risks of Other
Consumer Lending."
Beginning in late fiscal 1995, the Bank has diversified its loan portfolio by
developing a middle-market commercial lending program. In addition to extending
credit, the Bank seeks to become the customer's primary source of deposit
products. Management believes that these types of banking relationships are a
natural extension and complement to the Bank's existing deposit and lending
base. At June 30, 1996, the Bank's outstanding commercial loans totaled $48.0
million, the majority of which were adjustable-rate lines of credit and term
loans.
Non-performing Assets. At June 30, 1996, the Bank had $166.9 million of non-
performing assets (after valuation allowances on real estate held for sale of
$127.8 million) which represented 1.89% of total assets. Non-performing assets
are comprised of $30.5 million of non-performing loans and $136.4 million of
real estate held for sale ("REO"). Non-performing credit card loans represent
67.5% of the Bank's non-performing loans and represent 2.2% of the Bank's total
credit card loans outstanding. At June 30, 1996, the Bank maintained a
valuation allowance against its credit card portfolio of $51.1 million, or 5.3%
of outstanding credit card loans. Reflecting in part the results of a consumer
loan portfolio review by the OTS, during the September 1996 quarter the Bank
increased its valuation allowance on such loans by $28.6 million to $79.7
million at September 30, 1996, or 7.1% of outstanding credit card loans. See
"Recent Developments."
The majority of the Bank's REO is residential property, consisting primarily
of five planned unit developments (the "Communities") which had an aggregate
book value of $102.8 million as of June 30, 1996. Four of the five Communities
are under active development and, as a result of the sale in the December 1995
quarter of the remaining residential lots in two of the Communities, the Bank
owns only commercial land in two of the four active Communities. The level of
REO and of non-performing assets has decreased substantially over the past four
years as the Bank has disposed of the bulk of the assets it acquired through
foreclosure or deed-in-lieu of foreclosure in 1990 and 1991. See "Risk Factors
and Other Considerations--Risks Relating to Reserve Levels and REO" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Asset Quality--Disposition of REO" in the
Bank's Annual Report on Form 10-K for the fiscal year ended September 30, 1995
incorporated by reference herein and attached hereto as Attachment A.
Asset Securitizations. Chevy Chase has accessed the capital markets as an
additional means of funding its operations and managing its capital ratios and
asset growth. Since 1988, the Bank has securitized approximately $8.0 billion
of credit card, home equity credit line, automobile and home loan receivables.
These transactions depend on sophisticated back-office systems to service
complex securitization structures and on personnel with the experience to
design, install and manage those systems. At June 30, 1996, the Bank serviced
$3.8 billion, $348.0 million, $565.2 million and $153.5 million of securitized
credit card, home equity credit line, automobile and home loan receivables,
respectively. Chevy Chase derives fee-based income from servicing these
securitized portfolios. However, such fee-based income may be adversely
affected by increases in delinquencies and charge-offs related to the
receivables placed in these securitized pools. See "Risk Factors and Other
Considerations--Reliance on Non-Interest Income."
History and Ownership. The Bank was organized in 1969 as a stock savings
institution under Maryland law. On May 22, 1985, the Bank obtained federal
insurance of its deposit accounts and on April 8, 1986 it became a federally
chartered stock savings bank. Eighty percent (80%) of the outstanding common
stock of the Bank is owned by B.F. Saul Real Estate Investment Trust (the
"Trust"). See "Risk Factors and Other Considerations--Holding Company Matters."
B. Francis Saul II is the Bank's founder and principal executive officer.
Through his significant equity interest and management positions in the Bank's
major stockholders, Mr. Saul has the ability to effectively control the affairs
and direct the policies of the Bank.
For unaudited financial information regarding the Bank at September 30, 1996,
see "Recent Developments."
OC-5
<PAGE>
THE OFFERING
Securities Offered..........
3,000,000 Series B Preferred Shares.
Exchange....................
The Series B Preferred Shares are to be issued,
if ever, in connection with an exchange of the
% Noncumulative Exchangeable Preferred Stock,
Series A (the "Preferred Capital Shares") of
Chevy Chase Preferred Capital Corporation, a
wholly owned subsidiary of the Bank. See
"Exchange."
Ranking.....................
The Series B Preferred Shares rank senior to the
Bank's common stock, par value $1.00 per share
(the "Common Stock"), pari passu with the Series
A Preferred Shares with respect to cash dividend
payments and rights upon liquidation and junior
to all claims of the Bank's creditors, including
the claims of the Bank's depositors and holders
of the Bank's outstanding subordinated
debentures. Additional shares of preferred stock
ranking senior to the Series B Preferred Shares
may not be issued without the approval of holders
of at least 2/3 of both series of Preferred
Stock.
Dividends...................
Dividends on the Series B Preferred Shares are
payable at the rate of % per annum of the
initial liquidation preference (an amount equal
to $ per annum per share), if, when and as
declared by the Board of Directors of the Bank.
If declared, dividends are payable quarterly in
arrears on the 15th day of January, April, July
and October in each year, or, if such day is not
a business day, on the next business day.
Dividends on the Series B Preferred Shares are
not cumulative and, accordingly, if no dividend
is declared on the Series B Preferred Shares by
the Bank for a quarterly dividend period, holders
of the Series B Preferred Shares will have no
right to receive a dividend for that period, and
the Bank will have no obligation to pay a
dividend for that period, whether or not
dividends are declared and paid for any future
period. Upon the exchange of Preferred Capital
Shares for Series B Preferred Shares, any
quarterly accrued and unpaid dividends of the
Preferred Capital Shares at the time of the
exchange will be deemed to be accrued and unpaid
dividends on the Series B Preferred Shares. See
"Description of the Series B Preferred Shares--
Dividends." The Bank's ability to pay cash
dividends is subject to regulatory and other
restrictions described herein.
Liquidation Preference......
The liquidation preference for each Series B
Preferred Share is $50.00, plus an amount equal
to the quarterly accrued and unpaid dividends, if
any, thereon for the then-current dividend period
to, but excluding, the date fixed for
liquidation. See "Description of Series B
Preferred Shares--Rights Upon Liquidation."
Redemption.................. The Bank may not redeem the Series B Preferred
Shares before , 2001. After such date, the
Series B Preferred Shares may be redeemed for
cash at the option of the Bank, in whole or in
part,
OC-6
<PAGE>
at any time and from time to time, at a
redemption price of $50.00 per share, plus the
quarterly accrued and unpaid dividends, if any,
thereon for the then-current dividend period to,
but excluding, the date fixed for redemption.
Redemption of the Series B Preferred Stock will
be subject to compliance with applicable
regulatory and other restrictions. See
"Description of Series B Preferred Shares--
Redemption."
Voting Rights............... Holders of Series B Preferred Shares will not
have any voting rights, except as expressly
provided herein. On any matter on which holders
of the Series B Preferred Shares may vote, each
Series B Preferred Share will be entitled to one
vote. See "Description of Series B Preferred
Shares--Voting Rights."
Use of Proceeds............. The Series B Preferred Shares will only be issued
in connection with an exchange for the Preferred
Capital Shares. The proceeds from the sale of the
Preferred Capital Shares were used by Chevy Chase
Preferred Capital Corporation to purchase a
portfolio of mortgage assets and to pay expenses
associated with the formation and offering of the
Preferred Capital Shares. The conversion of
Preferred Capital Shares into Class B Preferred
Shares will produce no proceeds to the Bank. See
"Use of Proceeds."
Absence of a Public
Market...................... There is currently no public market for the
Series B Preferred Shares and such shares will
not be listed on any securities exchange or for
quotation through the National Association of
Securities Dealers Automated Quotation System.
RISK FACTORS
See "Risk Factors and Other Considerations" for a discussion of the risk
factors and other considerations relating to the Bank and the Series B
Preferred Shares.
OC-7
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data of the Bank herein as of
and for the years ended September 30, 1995, 1994, 1993, 1992 and 1991 have been
derived from the Consolidated Financial Statements of the Bank, which
statements have been audited by Arthur Andersen LLP, independent public
accountants. 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 in the documents incorporated by
reference in this Offering Circular. In the opinion of the management of the
Bank, the amounts shown for the nine-months ended June 30, 1996 and 1995
include all adjustments, which consist only of normal recurring adjustments,
necessary for a fair presentation of the consolidated results for such periods
and as of such dates. The results of operations for any interim period are not
necessarily indicative of the results for an entire fiscal year.
FOR UNAUDITED FINANCIAL INFORMATION REGARDING THE BANK AT SEPTEMBER 30, 1996,
SEE "RECENT DEVELOPMENTS."
<TABLE>
<CAPTION>
AS OF OR FOR THE
NINE MONTHS ENDED
JUNE 30, AS OF OR FOR THE YEAR ENDED SEPTEMBER 30,
---------------------- ----------------------------------------------------------
1996 1995 1995 1994 1993 1992 1991
---------- ---------- ---------- ---------- ---------- ---------- ----------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets........... $5,020,519 $4,952,821 $4,947,995 $4,703,788 $4,918,795 $5,062,619 $4,904,104
Mortgage-backed securi-
ties.................. 847,029 942,085 880,208 1,025,525 1,501,192 1,599,959 443,714
Loans receivable ,
net................... 2,459,803 2,159,018 2,327,286 2,357,721 1,861,128 1,635,218 2,537,435
Loans held for sale.... 102,079 52,390 68,679 33,598 176,504 175,698 51,734
Loans held for
securitization and
sale.................. 315,000 665,000 500,000 115,000 300,000 350,000 533,628
Allowance for losses on
loans................. 71,619 57,075 60,496 50,205 68,040 78,818 89,745
Real estate held for
investment or sale,
net................... 140,033 236,510 222,860 330,032 387,583 521,051 563,261
Allowance for losses on
real estate held for
investment or sale.... 127,958 130,338 135,236 118,973 111,644 109,044 57,498
Cost in excess of net
assets acquired, net.. 41,525 45,529 44,528 48,637 52,650 56,348 60,045
Mortgage servicing
rights, net........... 33,539 14,178 28,369 15,075 20,288 12,787 13,962
Deposit accounts....... 4,225,110 4,117,663 4,159,252 4,008,761 3,870,023 3,915,958 4,263,033
Securities sold under
repurchase agreements
and other short-term
borrowings............ 17,121 142,525 10,435 8,907 88,266 450,321 3,459
Bonds payable.......... -- -- -- 24,030 24,605 25,130 25,605
Notes payable.......... 7,340 7,570 7,514 7,729 7,925 8,640 10,354
Federal Home Loan Bank
advances.............. 116,749 134,208 155,052 100,000 412,000 275,000 200,000
Capital notes-subordi-
nated................. 160,000 160,000 160,000 160,000 138,500 138,500 138,500
Stockholders' equity... 356,969 321,243 328,544 289,956 284,794 177,430 156,389
Non-performing assets.. 166,889 257,695 247,185 311,898 372,031 517,639 594,069
SELECTED RATIOS:
Earnings (loss) per
common share.......... $ 3,252.30 $ 2,063.50 $ 2,757.20 $ 1,929.00 $ 3,549.50 $ 2,104.10 $(1,028.50)
Return on average as-
sets.................. 1.09% 0.75% 0.76% 0.58% 0.77% 0.44% (0.20)%
Return on average
stockholders' equity.. 15.88% 12.71% 12.66% 9.62% 16.20% 11.87% (5.64)%
Average stockholders'
equity to average
assets................ 6.85% 5.91% 5.98% 6.07% 4.72% 3.67% 3.49%
Net loan charge-offs to
average loans......... 2.77% 1.29% 1.51% 1.74% 3.33% 4.04% 3.60%
Non-performing assets,
net to total
assets(1)............. 1.89% 4.04% 3.77% 5.35% 5.97% 8.37% 10.20%
Net yield on interest
earning assets........ 4.69% 4.12% 4.24% 4.06% 4.60% 4.99% 3.80%
Average interest-
earning assets to
average interest-
bearing liabilities... 92.33% 92.20% 91.91% 90.81% 86.43% 82.81% 85.73%
REGULATORY CAPITAL RA-
TIOS:
Tangible............... 6.30% 5.63% 5.77% 4.96% 4.60% 2.22% 1.58%
Core (or leverage)..... 6.30% 5.63% 5.77% 5.34% 5.35% 3.22% 2.82%
Tier 1 risk-based...... 6.91% 6.79% 6.65% 6.95% 7.29% N/A N/A
Total risk-based....... 12.04% 11.76% 11.63% 12.19% 11.70% 7.72% 5.51%
Full service banking fa-
cilities............... 101 85 88 81 74 73 74
Full service mortgage
banking facilities..... 21 18 18 17 17 13 12
</TABLE>
(1)Non-performing assets is presented after all reserves for losses on loans
and real estate held for sale.
OC-8
<PAGE>
<TABLE>
<CAPTION>
AS OF OR FOR THE
NINE MONTHS ENDED
JUNE 30, AS OF OR FOR THE YEAR ENDED SEPTEMBER 30,
------------------ -------------------------------------------------
1996 1995 1995 1994 1993 1992 1991
-------- -------- -------- -------- -------- -------- ---------
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CONDENSED CONSOLIDATED
STATEMENTS OF
OPERATIONS:
Interest income......... $284,129 $270,226 $365,336 $334,460 $349,537 $403,559 $487,221
Interest expense........ 140,470 140,737 189,114 165,544 167,518 214,761 325,711
-------- -------- -------- -------- -------- -------- ---------
Net interest income.... 143,659 129,489 176,222 168,916 182,019 188,798 161,510
Provision for loan loss-
es..................... 70,825 35,829 54,979 29,222 60,372 86,453 143,544
-------- -------- -------- -------- -------- -------- ---------
Net interest income
after provision for
loan losses........... 72,834 93,660 121,243 139,694 121,647 102,345 17,966
-------- -------- -------- -------- -------- -------- ---------
Non-interest income:
Credit card fees, loan
servicing fees and
deposit servicing
fees.................. 239,585 154,241 218,572 111,279 91,216 92,291 105,441
Gain on sales of in-
vestment securities,
net................... -- -- -- -- 8,895 -- 1,159
Gain (loss) on sales of
trading securities,
net................... 1,061 (579) (600) 1,695 -- -- 11,651
Earnings (loss) on real
estate held for
investment or sale,
net................... (19,376) 2,861 (4,672) 1,326 (12,722) (50,649) (47,339)
Gain on sales of credit
card relationships,
loans and mortgage-
backed securities,
net................... 17,092 4,721 12,882 30,522 31,338 38,716 69,096
Gain on sales of
mortgage servicing
rights, net........... -- 1,270 1,397 5,833 4,828 3,750 9,633
Other.................. 14,109 4,232 5,923 9,885 7,161 10,766 12,133
-------- -------- -------- -------- -------- -------- ---------
Total non-interest in-
come.................. 252,471 166,746 233,502 160,540 130,716 94,874 161,774
-------- -------- -------- -------- -------- -------- ---------
Non-interest expense:
Salaries and employee
benefits.............. 93,354 78,739 108,432 87,390 69,739 62,725 78,344
Marketing expenses..... 35,568 34,835 46,117 46,441 15,138 4,632 6,831
Other non-interest ex-
pense................. 128,796 105,445 145,544 113,739 103,492 91,718 100,399
-------- -------- -------- -------- -------- -------- ---------
Total non-interest ex-
pense................. 257,718 219,019 300,093 247,570 188,369 159,075 185,574
-------- -------- -------- -------- -------- -------- ---------
Income (loss) before
income taxes,
extraordinary item and
cumulative effect of
change in accounting
principle.............. 67,587 41,387 54,652 52,664 63,994 38,144 (5,834)
Provision for income
taxes.................. 27,751 13,439 17,330 22,394 26,603 17,103 4,451
Extraordinary loss on
early extinguishment of
debt................... -- -- -- (6,333) -- -- --
Cumulative effect of
change in accounting
for income taxes....... -- -- -- 5,103 -- -- --
-------- -------- -------- -------- -------- -------- ---------
Net income (loss)....... $ 39,836 $ 27,948 $ 37,322 $ 29,040 $ 37,391 $ 21,041 $ (10,285)
======== ======== ======== ======== ======== ======== =========
</TABLE>
OC-9
<PAGE>
RISK FACTORS AND OTHER CONSIDERATIONS
An investment in the Series B Preferred Shares involves a high degree of
risk. Investors should carefully consider the following risk factors and other
considerations relating to the Bank and the Series B Preferred Shares.
RISKS OF CREDIT CARD LENDING
At June 30, 1996, Chevy Chase's credit card loans of $956.5 million
constituted approximately 32% of the Bank's loan portfolio. In addition, at
June 30, 1996, the Bank managed $3.8 billion in securitized credit card loans
which were not reflected on the Bank's balance sheet. Credit card loans entail
greater credit risks than residential mortgage loans. 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 use 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. Default rates on credit card loans
generally may be expected to exceed default rates on residential mortgage
loans.
Primarily reflecting the industry-wide decline in the performance of credit
card loans, credit card delinquencies and net charge-offs on credit card loans
have increased since September 1995. The Bank regularly reviews the reasons
for delinquency and charge-off as compared to information available at the
time an account was originated to determine if such information should have
indicated the propensity for delinquency and/or loss. The results of these
reviews are used to adjust the Bank's underwriting criteria, as necessary.
Although the Bank believes it has appropriate underwriting criteria to
mitigate the risks associated with its credit card accounts, there can be no
assurance that charge-offs and delinquencies will not increase. The Bank made
certain adjustments to its reserves for losses on credit card loans at
September 30, 1996, based in part on the results of a consumer loan portfolio
review by the OTS. See "Recent Developments." An increase in credit card
delinquencies and charge-offs also may affect the Bank's income from loan
servicing fees by reducing the amount earned on securitized credit card
receivables.
Certain jurisdictions and their residents may attempt to require out-of-
state credit card issuers to comply with such jurisdictions' consumer
protection laws that impose requirements on the making, enforcement and
collection of consumer loans. For example, in recent years, a number of
lawsuits and administrative actions have been filed in several states against
out-of-state credit card issuers (including both federally and state chartered
insured institutions) challenging various fees and charges (such as late fees,
over-the-limit fees, returned check fees and annual membership fees) assessed
against residents of the states in which such lawsuits were filed, based on
restrictions or prohibitions under the laws of such states. The Supreme Court
recently ruled that national banks may export late fees on credit cards as
interest regardless of states' usury laws, however the law is not settled with
respect to all types of fees and charges. If it were determined that out-of-
state credit card issuers must comply with a jurisdiction's laws limiting the
charges imposed by credit card issuers, such action could have an adverse
impact on the Bank's credit card operations.
The credit card industry is highly competitive and characterized by
increased pricing competition in interest rates and annual membership fees,
use of advertising, target marketing and other features (such as buyer
protection plans), as both established and new card issuers seek to expand or
to enter the market and to retain their existing customers. The Bank has
issued credit cards to customers nationwide, and competes for those customers
with certain money center banks and other large nationwide issuers, as well as
with regional and local depository institutions and other issuers, many of
whom have sizable branch systems or other customer relationships through which
such issuers market their credit cards. The Bank anticipates that competitive
pressures will require adjustments from time to time to the pricing of the
Bank's credit card accounts. See "Business--Lending Activities--Credit Card
Lending" in the Bank's Annual Report on Form 10-K for the fiscal year ended
September 30, 1995 incorporated by reference herein and attached hereto as
Attachment A.
OC-10
<PAGE>
RELIANCE ON NON-INTEREST INCOME
In recent years, non-interest income, which is reflected as "Other Income"
on the Consolidated Statements of Operations, has become an increasingly large
component of the Bank's net income. The Bank has earned non-interest income
primarily from credit card, loan servicing and deposit servicing fees and
gains on sales of credit card relationships, loans and mortgage-backed
securities. In fiscal 1995, 1994 and 1993, the Bank recognized non-interest
income of $233.5 million, $160.5 million and $130.7 million, respectively. Of
those amounts, $184.3 million, $69.9 million and $46.6 million, respectively,
or 51.9%, 23.3% and 18.5%, respectively, of total operating income, was income
from loan servicing fees. The Bank's ability to realize non-interest income is
dependent upon market interest rates, the demand for mortgage and credit card
loans, conditions in the loan sale market, the level of securitized
receivables and other factors. The level of such income, therefore, is subject
to substantial fluctuations. An increase in credit card delinquencies and
charge-offs may affect the Bank's income from loan servicing fees by reducing
the amount earned on securitized credit card receivables. Such charge-offs
have increased significantly during recent periods, although the Bank's income
has not been significantly affected to date as a result of the
counterbalancing effects of such items as the expiration of introductory
rates, repricing of existing portfolios and new fee-based strategies. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations" in the Bank's Annual Report on Form 10-K
for the fiscal year ended September 30, 1995 incorporated by reference herein
and attached hereto as Attachment A.
EFFECT OF AN INCREASE IN INTEREST RATES ON OPERATING RESULTS
The Bank's operating results depend to a large extent on its net interest
income, which is the difference between the interest the Bank receives from
its loans, securities and other assets and the interest the Bank pays on its
deposits and other liabilities. Interest rates are highly sensitive to many
factors, including governmental monetary policies and domestic and
international economic and political conditions. Conditions such as inflation,
recession, unemployment, money supply, international disorders and other
factors beyond the control of the Bank may affect interest rates. If generally
prevailing interest rates increase, the "net interest spread" of the Bank,
which is the difference between the rates of interest earned and the rates of
interest paid by the Bank, is likely to contract, resulting in less net
interest income.
Although the Bank pursues an asset-liability management strategy designed to
control its risk from changes in market interest rates, the Bank's liabilities
have shorter terms and are more interest-sensitive than its assets. At June
30, 1996, the Bank's one-year interest-sensitivity "gap" (the sum of all
interest earning assets to be re-priced within one year minus all interest-
bearing liabilities to be re-priced within one year, as a percentage of total
assets) was negative 13.7%. As a result of its gap position, the Bank's net
interest spread will narrow, and its operating results will be adversely
affected, during periods of rising market interest rates if the Bank is unable
to reduce its gap. There can be no assurance that the Bank will be able to
adjust its gap sufficiently to offset any negative effect of changing market
interest rates. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Financial Condition--Asset and Liability
Management" in the Bank's Annual Report on Form 10-K for the fiscal year ended
September 30, 1995 incorporated by reference herein and attached hereto as
Attachment A.
REGULATORY CAPITAL LEVELS
As a federal savings association, Chevy Chase is subject to minimum capital
requirements prescribed by federal statute and OTS regulations. At June 30,
1996, the Bank was in compliance with all of its regulatory capital
requirements under FIRREA, with tangible, core and total risk-based regulatory
capital ratios of 6.30%, 6.30% and 12.04%, respectively, compared to the
regulatory requirements of 1.50%, 3.00% and 8.00%, respectively. Effective
July 1, 1996, certain additional deductions from capital were phased in. If
this phase-in had been in effect at June 30, 1996, the Bank's tangible, core
and risk-based regulatory capital ratios would have been 6.27%, 6.27% and
12.00%. Based on unaudited results, at September 30, 1996, the Bank's
tangible, core and total risk-based regulatory capital decreased to 5.21%,
5.21% and 10.14%, respectively. See "Recent Developments."
The OTS's prompt corrective action regulations establish five capital
categories for thrift institutions: well capitalized, adequately capitalized,
undercapitalized, severely undercapitalized and critically undercapitalized.
These categories are determined for the supervisory purposes of Section 38 of
the Federal Deposit Insurance Act (which establishes a system of mandatory and
discretionary supervisory actions which generally become more severe as
capital levels decline) and may not necessarily constitute an accurate measure
of the Bank's current
OC-11
<PAGE>
overall financial condition or its future prospects. A thrift will be
considered "well capitalized" if it has a core capital (or 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%. A thrift will be considered
"adequately capitalized" if it has a core (or leverage) capital ratio of at
least 4.0%, a Tier 1 risk-based capital ratio of at least 4.0%, and a total
risk-based capital ratio of at least 8.0%. Based on unaudited results, the
Bank's core, Tier 1 risk-based and total risk-based capital ratios at
September 30, 1996 of 5.21%, 5.80% and 10.14%, respectively, exceeded the
capital ratios established for "adequately capitalized" institutions. See
"Recent Developments." The OTS has the discretion to reclassify an institution
from "well capitalized" to "adequately capitalized" and to treat an
"adequately capitalized" institution as an "undercapitalized" institution for
purposes of the prompt corrective action regulations (including restrictions
on the payment of dividends) if, after notice and an opportunity for a
hearing, the OTS determines that the institution (i) is in an unsafe or
unsound condition or (ii) has received and has not corrected a less than
satisfactory examination rating for asset quality, management, earnings or
liquidity.
Deteriorating collateral values or general economic conditions could result
in recognition of losses on Chevy Chase's loan and REO portfolios and a
consequent reduction in capital. In addition, OTS capital regulations provide
a five-year holding period (or such longer period approved by the OTS) for REO
to qualify for an exception from treatment as an equity investment. If REO 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, then the Bank would be required to
deduct the then-current book value of the REO from risk-based capital. In
November 1996, the Bank received an extension through November 12, 1997 of the
holding periods for certain of its REO properties acquired through foreclosure
in fiscal 1990, fiscal 1991 and fiscal 1992. There can be no assurances that
the Bank will be able to dispose of all of its REO properties within the
applicable five-year period or obtain any necessary extensions. Accordingly,
there can be no assurances that Chevy Chase will be able to maintain levels of
capital sufficient to meet the standards for classification as "adequately
capitalized" under the prompt corrective action regulations.
RISKS RELATING TO RESERVE LEVELS AND REO
At June 30, 1996, the Bank's non-performing assets were $166.9 million (net
of valuation allowances for losses on REO), or 1.89% of total assets. As of
such date, the ratio of the Bank's reserves to non-performing assets was
67.7%. Although the Bank believes it has a reasonable basis for estimating
reserves, no assurance can be given that the Bank will not sustain losses in
any particular period that exceed the amount of the reserves at the beginning
of that period, or that subsequent evaluations of the asset portfolio, in
light of factors then prevailing (including economic conditions, the Bank's
internal review process and the results of regulatory examinations), will not
require significant increases in the reserves. See "Recent Developments" and
"Business--Delinquencies, Foreclosures and Reserves for Losses--Allowances for
Losses" in the Bank's Annual Report on Form 10-K for the fiscal year ended
September 30, 1995 incorporated by reference herein and attached hereto as
Attachment A.
At June 30, 1996, approximately $102.8 million (or 75.4%), after valuation
allowances on such assets, of the Bank's aggregate book value of REO was
attributable to five planned unit developments over which the Bank took active
control, through foreclosure or deeds-in-lieu of foreclosure, in 1990 and
1991, four of which are under active development. The Bank from time to time
obtains updated appraisals on its REO and, in the past, has been directed to
do so by the OTS in connection with regulatory examinations. As a result of
such updated appraisals, the Bank could be required to increase its reserves.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Financial Condition--Asset Quality--Disposition of REO" in the
Bank's Annual Report on Form 10-K for the fiscal year ended September 30, 1995
incorporated by reference herein and attached hereto as Attachment A.
OC-12
<PAGE>
RISKS OF OTHER CONSUMER LENDING
Chevy Chase is actively expanding its non-credit card consumer lending
business, focusing on automobile and home improvement loans. While such loans
generally have shorter terms to maturity and carry higher rates than
residential mortgage loans, they generally entail greater risk than
residential mortgage loans, particularly when secured by rapidly depreciable
assets, such as automobiles. In such cases, any collateral repossessed for a
defaulted consumer loan may not provide an adequate source of repayment of the
outstanding loan balance as a result of damage, loss or depreciation. In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability and, thus, are more likely to be affected by adverse
personal circumstances.
The Bank also makes automobile loans through one of its operating
subsidiaries. The underwriting guidelines for this subsidiary apply to a
category of lending in which loans may be made to applicants who have
experienced certain adverse credit events (and, therefore, would not
necessarily meet all of the Bank's guidelines for its traditional loan
program), but who meet certain other creditworthiness tests. Such loans may
experience higher rates of delinquencies, repossessions and losses, especially
under adverse economic conditions, compared with loans originated pursuant to
the Bank's traditional lending program. See "Business--Lending Activities--
Other Consumer Loan Underwriting" in the Bank's Annual Report on Form 10-K for
the fiscal year ended September 30, 1995 incorporated by reference herein and
attached hereto as Attachment A.
RISKS RELATING TO ELIMINATION OF THRIFT CHARTER
During the past year, Congress has been considering legislation in various
forms that would require federal thrifts, like the Bank, to convert their
charters to national or state bank charters. Recent legislation requires the
merger of the Bank Insurance Fund ("BIF") and the SAIF into a single Deposit
Insurance Fund on January 1, 1999 but only if the thrift charter is eliminated
by that date. The Treasury Department is required to submit a comprehensive
study on thrift charter issues by March 31, 1997. In the absence of
appropriate "grandfather" provisions, such legislation could have a material
adverse effect on the Bank and the Trust because, among other things, the
Trust engages in activities that are not permissible to bank holding companies
and the regulatory capital and accounting treatment for banks and thrifts
differs in certain significant respects. The Bank cannot determine whether, or
in what form, such legislation will eventually be enacted and there can be no
assurances that any such legislation that is enacted will contain adequate
grandfather rights for the Bank and the Trust. See "Recent Developments--
Legislative Developments."
RISKS RELATED TO SAIF INSURANCE
Legislation was enacted on September 30, 1996 that, among other things,
imposes on thrift institutions a one-time assessment of 65.7 cents for every
$100 of SAIF-insured deposits to recapitalize the SAIF. Following such
legislation, the Bank and other institutions with SAIF-assessable deposits
will continue to pay somewhat higher deposit insurance premiums than
institutions with BIF-assessable deposits, which could lead to a competitive
disadvantage in the pricing of loans and deposits and additional operating
expenses. In addition, regulators have recently begun approving applications
by several thrift organizations to establish or acquire BIF-insured
affiliates. Prolonged continuation of the disparity in deposit insurance
premiums could lead to more widespread efforts to shift insured deposits from
SAIF to BIF, thus further destabilizing the SAIF. However, the new legislation
contains provisions designed to prohibit deposit transfers from SAIF to BIF
under certain circumstances.
HOLDING COMPANY MATTERS
The Trust owns 80% of the Bank's common stock. Payments from the Bank to the
Trust in the form of tax sharing payments and dividends are a principal source
of funding for the Trust. The Bank made tax sharing payments to the Trust of
$20.5 million in fiscal 1995 and $20.0 million in the nine months ended June
30, 1996. Subsequent to June 30, 1996, the Bank made additional tax sharing
payments of $5 million to the Trust. In addition, during the June 1996
quarter, the Bank paid cash dividends on its common stock of $500 per share
(of which the Trust's portion was $4.0 million) and subsequent to June 30,
1996, declared and paid a cash dividend of $350 per share (of which the
Trust's portion was $2.8 million).
OC-13
<PAGE>
To the extent the Trust experiences liquidity problems, there can be no
assurance that the Trust will be able to satisfy, in whole or in part, any tax
liability that it may incur or any reimbursement or other obligation to the
Bank that may arise under a tax sharing agreement to which the Trust, the Bank
and other companies in the Trust's affiliated group are parties (the "Tax
Sharing Agreement"). The Bank, as a member of the Trust's affiliated group of
corporations filing consolidated income tax returns, is liable for the group's
tax liability (whether or not the Bank has made any tax sharing payments). The
Tax Sharing Agreement provides for payments to be made by members of the
affiliated group to the Trust based on their respective allocable shares of
the overall tax liability of the group and the benefits of any net operating
losses and similar items used by the group for specified taxable years. In
certain circumstances, the Bank would be entitled under the Tax Sharing
Agreement to be reimbursed by the Trust.
DIVIDENDS NOT CUMULATIVE
Dividends on the Series B Preferred Shares are not cumulative. Consequently,
if the Board of Directors does not declare a dividend on the Series B
Preferred Shares for any period, the holders of the Series B Preferred Shares
would not be entitled to recover such dividend whether or not funds are or
subsequently become available. The Board of Directors may determine, in its
business judgment, that it would be in the best interests of the Bank to pay
less than the full amount of the stated dividends on the Series B Preferred
Shares or no dividends for any quarter notwithstanding that funds are
available. Factors that would be considered by the Board of Directors in
making this determination are the Bank's financial condition and capital
needs, the impact of legislation and regulations as then in effect or as may
be proposed, economic conditions, and such other factors as the Board may deem
relevant.
The Series B Preferred Shares will be issued upon an exchange of the
Preferred Capital Shares. The exchange of the Preferred Capital Shares may
take place under circumstances (i) in which the Bank will not be considered
"adequately capitalized" for purposes of the OTS' prompt corrective action
regulations, and such regulations prohibit "capital distributions" (including
dividends) unless the institution is at least "adequately capitalized" or (ii)
in which the Bank has been determined to be engaged in an unsafe or unsound
practice or (iii) in which a receiver or conservator has been appointed for
the Bank. Thus, at the time of the exchange, by regulation, the Bank may not
be permitted to pay dividends on the Series B Preferred Shares. In addition,
the Bank's ability to pay dividends on the Series B Preferred Shares even if
the Bank were to return to "adequately capitalized" status following the
exchange would be subject to various restrictions under OTS regulations, a
resolution of the Bank's Board of Directors and certain contractual
provisions. See "Business--Regulation--Dividends and Other Capital
Distributions" in the Bank's Annual Report on Form 10-K for the fiscal year
ended September 30, 1995 and "Notes to Consolidated Financial Statements" in
the Bank's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996,
both incorporated by reference herein and attached hereto as Attachments A and
B, respectively.
ABSENCE OF A PUBLIC MARKET
The Bank does not intend to apply for listing of the Series B Preferred
Shares on any national securities exchange or for quotation through the
National Association of Securities Dealers Automated Quotation System. If an
active public market does not develop, the market price and liquidity of the
Series B Preferred Shares may be adversely affected. There can be no assurance
as to the liquidity of the trading markets for the Series B Preferred Shares
or that an active public market for the Series B Preferred Shares will develop
or be maintained.
OC-14
<PAGE>
RECENT DEVELOPMENTS
Summarized below are certain unaudited selected financial data of Chevy Chase
on a consolidated basis for the periods and at the dates indicated.
<TABLE>
<CAPTION>
AS OF OR FOR THE YEAR ENDED
SEPTEMBER 30,
--------------------------------
1996 1995
----------------- -------------
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Summary of Operations Data:
Interest income............................. $ 387,566 $ 365,336
Interest expense............................ 188,836 189,114
------------- -------------
Net interest income......................... 198,730 176,222
Provision for loan losses................... 115,740 54,979
------------- -------------
Net interest income after provision for loan
losses..................................... 82,990 121,243
------------- -------------
Non-interest income:
Credit card, loan servicing and deposit
servicing fees............................ 324,761 218,572
Gain (loss) on sales of trading securities,
net....................................... 1,158 (600)
Loss on real estate held for investment or
sale, net................................. (24,413) (5,164)
Gain on sales of loans, net................ 23,242 12,882
Gain on sales of mortgage servicing rights,
net....................................... -- 1,397
Other...................................... 19,713 5,923
------------- -------------
Total non-interest income................... 344,461 233,010
------------- -------------
Non-interest expense........................ 383,269 299,601
------------- -------------
Income before income taxes.................. 44,182 54,652
Provision for income taxes.................. 16,553 17,330
------------- -------------
Net income.................................. $ 27,629 $ 37,322
============= =============
Summary of Financial Condition Data:
Total assets................................ $ 5,727,604 $ 4,947,995
Mortgage-backed securities.................. 1,306,417 880,208
Loans held for sale......................... 76,064 68,679
Loans held for securitization and sale...... 450,000 500,000
Loans receivable, net....................... 2,773,024 2,327,286
Allowance for losses on loans............... 95,523 60,496
Real estate held for investment or sale,
net........................................ 123,489 222,860
Allowance for losses on real estate held for
investment or sale......................... 126,710 135,236
Cost in excess of net assets acquired, net.. 40,523 44,528
Mortgage servicing rights, net.............. 32,607 28,369
Deposit accounts............................ 4,164,037 4,159,252
Securities sold under repurchase agreements
and other short-term borrowings............ 637,141 10,435
Federal Home Loan Bank advances............. 269,065 155,052
Capital notes--subordinated................. 160,000 160,000
Stockholders' equity........................ 339,160 328,544
Nonperforming assets........................ 154,650 247,185
Selected Ratios:
Return on average assets.................... 0.56% 0.76%
Return on average stockholders' equity...... 8.14% 12.66%
Average stockholders' equity to average as-
sets....................................... 6.85% 5.98%
Non-performing assets, net to total as-
sets(1).................................... 1.03% 3.77%
Net loan charge-offs to average loans....... 2.75% 1.51%
Net yield on interest-earning assets........ 4.80% 4.24%
Average interest-earning assets to average
interest-bearing liabilities............... 92.35% 91.91%
Regulatory Capital Ratios:
Tangible.................................... 5.21%(2) 5.77%
Core (or leverage).......................... 5.21%(2) 5.77%
Tier 1 risk-based........................... 5.80%(2) 6.65%
Total risk-based............................ 10.14%(2) 11.63%
</TABLE>
- --------
(1) Non-performing assets is presented after all reserves for losses on loans
and real estate held for investment or sale.
(2) The Bank's tangible, core, Tier 1 risk-based and total risk-based capital
ratios would have been 5.53%, 5.53%, 6.14% and 10.61%, respectively,
without the charge for the SAIF assessment described under "--Operating
Results."
OC-15
<PAGE>
OPERATING RESULTS
THE FOLLOWING DISCLOSURE IS BASED ON UNAUDITED OPERATING RESULTS AS OF
SEPTEMBER 30, 1996.
Chevy Chase recorded pre-tax income of $44.2 million and net income of $27.6
million for the year ended September 30, 1996, compared to pre-tax income of
$54.7 million and net income of $37.3 million for the year ended September 30,
1995. The decrease in pre-tax income for fiscal 1996 was primarily
attributable to a $60.8 million increase in the provision for loan losses and
an $83.7 million increase in non-interest expense (which included the $26.5
million SAIF assessment discussed below), the effect of which was partially
offset by a $111.5 million increase in non-interest income and a $22.5 million
increase in net interest income.
Legislation was enacted on September 30, 1996 that, among other things,
imposed on thrift institutions a one-time assessment of 65.7 basis points on
their SAIF-insured deposits to recapitalize the SAIF. At September 30, 1996,
the Bank accrued approximately $26.5 million for the SAIF assessment.
Net interest income increased $22.5 million in fiscal 1996 as the average
yield on interest-earning assets increased at a rate greater than the rate of
increase in the average cost of interest-bearing liabilities.
The Bank's provision for loan losses increased to $115.7 million in fiscal
1996 from $55.0 million in fiscal 1995 primarily as a result of a $56.7
million increase in the provision for losses on credit card loans. The
increase in the provision for losses on credit card loans was primarily due to
increased charge-offs of such loans, reflecting an industry-wide decline in
the performance of credit card loans and reflected, in part, the results of a
consumer loan portfolio review by the OTS. The increase in the provision
resulted in an increase in the Bank's allowance for losses on loans of $35.0
million which reflected mainly an increase in the allowance for losses on
credit cards of $33.4 million. As a result of this increase, the Bank's
valuation allowance on credit card loans increased from $46.3 million, or 4.6%
of such loans at September 30, 1995 to $79.7 million, or 7.1% of such loans at
September 30, 1996.
Other income increased to $344.5 million in fiscal 1996 from $233.0 million
in fiscal 1995 primarily as a result of an increase of $79.8 million in loan
servicing fees earned by the Bank for servicing its portfolios of securitized
loans and an increase of $20.9 million in credit card fees which was primarily
attributable to changes in the fee structure for the Bank's credit card
program during fiscal 1996. In addition, loss on real estate held for
investment or sale, net, increased $19.2 million due primarily to a decrease
of $4.5 million on equity earnings in partnership income and a decrease of
$12.5 million in the gain recorded on sales of the Bank's REO properties.
Operating expenses increased to $383.3 million in fiscal 1996 from $299.6
million in fiscal 1995 which increase included the $26.5 million SAIF
assessment. Other increases included a $19.2 million increase in salaries and
employee benefits, a $12.5 million increase in loan expenses, a $7.6 million
increase in marketing expenses and an $8.8 million increase in data processing
expenses.
During the quarter ended September 30, 1996, the Bank securitized and sold
$220.0 million of credit card receivables and $96.5 million of home equity
credit line receivables. No gain or loss was recognized in connection with the
credit card transaction and a gain of $4.7 million was recognized in
connection with the home equity credit line transaction.
Non-performing assets decreased to $154.7 million, after REO valuation
allowances of $126.5 million, at September 30, 1996 from $247.2 million, after
REO valuation allowances of $135.0 million, at September 30, 1995. The
decrease was primarily attributable to a decline in REO of $99.4 million to
$119.9 million, after valuation allowances of $126.5 million, at September 30,
1996 from $219.2 million, after valuation allowances of $135.0 million, at
September 30, 1995. REO decreased primarily due to sales of residential lots
or units in the Communities and other smaller residential properties and the
sale of five residential ground properties with an aggregate book value of
$23.8 million, after all valuation allowances on such assets. Partially
offsetting the decrease in REO was an increase in non-accrual loans primarily
due to a $6.8 million increase in non-accrual credit card loans.
At September 30, 1996, the Bank's tangible, core (or leverage), Tier 1 risk-
based and total risk-based regulatory capital ratios were 5.21%, 5.21%, 5.80%
and 10.14%, respectively, which exceeded the ratios established for
"adequately capitalized" institutions under the OTS prompt corrective action
regulations. If the SAIF assessment discussed above had not been made in the
quarter ended September 30, 1996, the Bank's capital
OC-16
<PAGE>
ratios would have continued to be sufficient to meet the standards established
for "well capitalized" institutions. In the September 30, 1996 quarter, the
Bank's capital ratios fell below the ratios established for "well capitalized"
institutions for the first time since June 1993.
LEGISLATIVE DEVELOPMENTS
On September 30, 1996, President Clinton signed into law the Economic
Development and Regulatory Paperwork Reduction Act of 1996 (the "Act"). The
Act's principal provisions relate to recapitalization of SAIF, but it also
contains numerous regulatory relief measures, some of which are directly
applicable to the Bank.
The Act requires the FDIC to impose a one-time special assessment of 65.7
cents for every $100 of SAIF-insured deposits held on March 31, 1995 in order
to bring SAIF to its statutory reserve level. As a result of the legislation,
Chevy Chase has experienced a one-time charge to earnings for the special
assessment as described above.
In addition, beginning on January 1, 1997, commercial banks will be required
to share in the payment of interest due on Financing Corporation ("FICO")
bonds used to rescue the savings and loan industry in the 1980s. Annual FICO
assessments to be added to deposit insurance premiums are expected to equal
approximately 6.4 basis points for SAIF members and 1.3 basis points for BIF
members from January 1, 1997 through December 31, 1999; and approximately 2.4
basis points for both BIF and SAIF members thereafter. See "Risk Factors--
Risks Related to SAIF Insurance."
The Act also requires the merger of BIF and SAIF into a single Deposit
Insurance Fund on January 1, 1999, but only if the thrift charter is
eliminated by that date. The Treasury Department is required to submit a
report on thrift charter issues by March 31, 1997. Although this provision of
the Act establishes a time frame for the eventual elimination of the thrift
charter, it contains no provisions concerning the form the current thrift
charter may be required to take. The Bank cannot determine at this time what
effect this provision will have on its financial position or operations. See
"Risk Factors--Risks Relating to Elimination of Thrift Charter."
The Act significantly liberalizes the current qualified thrift lender
("QTL") test by, among other things, permitting inclusion of credit card and
educational loans as qualified thrift investments ("QTI") without limits
(previously, such loans could be included only up to 10% of the institution's
assets). As a result of this provision, the Bank's entire credit card
portfolio is now eligible for inclusion as QTI, thus substantially reducing
the QTL test's impact as a constraint on the Bank's business strategies.
The Act also increases the Bank's commercial lending authority from 10% to
20% of assets, provided that the additional 10% consists of small business
loans.
Finally, the Act contains several other provisions designed to reduce
regulatory burdens associated with compliance with various consumer and other
laws applicable to the Bank, including for example, provisions designed to
coordinate the disclosure and other requirements under the Truth-in-Lending
and Real Estate Settlement Procedures Act, modify certain insider lending
restrictions, permit OTS to allow exemptions to anti-tying prohibitions and
exempt certain transactions and simplify certain disclosures under the Truth-
in-Lending Act.
USE OF PROCEEDS
The Series B Preferred Shares are to be issued, if ever, in connection with
an exchange of the Preferred Capital Shares, which shares were sold pursuant
to an effective registration statement filed with the SEC. The proceeds from
the sale of the Preferred Capital Shares were used by Chevy Chase Preferred
Capital Corporation to purchase a portfolio of mortgage assets. The exchange
of Preferred Capital Shares into Class B Preferred Shares will produce no
proceeds to the Bank.
OC-17
<PAGE>
DEBENTURE OFFERING
The Bank has filed a registration statement on Form OC with the OTS covering
the issuance of $100 million aggregate principal amount of % Subordinated
Debentures due 2008 (the "Debentures") in an underwritten public offering
immediately prior to or concurrently with the offering of the Preferred
Capital Shares. The Debentures will mature on , 2008. The Debentures
will not be redeemable prior to , 2001, except that on or prior to ,
1999, the Bank may redeem the Debentures in part at its option with the net
cash proceeds of one or more public equity offerings of the Bank or any of its
subsidiaries. The Debentures will be unsecured obligations of the Bank ranking
subordinate in right of payment to all senior debt of the Bank, including the
claims of the Bank's depositors and general creditors, and will rank equal in
right of payment with the Bank's outstanding 9 1/4% Subordinated Debentures
due 2005 and the Bank's $10 million floating rate subordinated capital note
due 1996. If the Preferred Capital Shares are exchanged for Series B Preferred
Shares, the Debentures will rank senior to the Series B Preferred Shares. The
Bank has received approval from the OTS to include the principal amount of the
Debentures as supplementary capital. As a result, the Bank's total risk-based
capital levels will increase, thereby enhancing the Bank's ability to maintain
its regulatory capital levels above those levels established for "well
capitalized" institutions.
OC-18
<PAGE>
CAPITALIZATION
The following table sets forth the actual capital of the Bank at September
30, 1996 and as adjusted as of such date to give effect to (i) the issuance of
the Preferred Capital Shares by Chevy Chase Preferred Capital Corporation,
(ii) an exchange of the Preferred Capital Shares into Series B Preferred
Shares of the Bank and (iii) the issuance of the Preferred Capital Shares
together with the Debentures. This table should be read in conjunction with
the Consolidated Financial Statements of the Bank and the notes thereto
included elsewhere in this Offering Circular and in the documents incorporated
herein by reference.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
-----------------------------------------------------------
ACTUAL AS ADJUSTED (1) AS ADJUSTED (2) AS ADJUSTED (3)
---------- --------------- --------------- ---------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
LIABILITIES:
Deposits.............. $4,164,037 $4,164,037 $4,164,037 $4,164,037
Borrowings............ 644,418 644,418 644,418 644,418
Federal Home Loan Bank
advances............. 269,065 269,065 269,065 269,065
Other liabilities..... 150,924 150,924 150,924 150,924
Capital note -- 9 1/4%
Subordinated Deben-
tures due 2005....... 150,000 150,000 150,000 150,000
Capital note -- Pri-
vate Capital Note due
1996................. 10,000 10,000 10,000 10,000
Capital note -- %
Subordinated Deben-
tures due 2008....... -- -- -- 100,000
---------- ---------- ---------- ----------
Total liabilities... 5,388,444 5,388,444 5,388,444 5,488,444
---------- ---------- ---------- ----------
MINORITY INTEREST -- 144,000 -- 144,000
---------- ---------- ---------- ----------
STOCKHOLDERS' EQUITY:
13% Noncumulative Per-
petual Preferred
Stock, Series A,
$0.01 par value,
3,000,000 shares au-
thorized,
issued and outstand-
ing.................. 30 30 30 30
% Noncumulative
Preferred Stock,
Series B, $5.00 par
value, 3,000,000
shares authorized,
issued and
outstanding, as
adjusted............ -- -- 15,000 --
Common stock, $1 par
value, 10,000,000
shares authorized,
510,000 shares
issued, 10,000 shares
outstanding.......... 10 10 10 10
Capital contributed in
excess of par........ 165,704 165,704 294,704 165,704
Retained earnings..... 175,291 175,291 175,291 175,291
Net unrealized holding
gains (losses)....... (1,875) (1,875) (1,875) (1,875)
---------- ---------- ---------- ----------
Total stockholders'
equity............. 339,160 339,160 483,160 339,160
---------- ---------- ---------- ----------
Total liabilities
and stockholders'
equity........... $5,727,604 $5,871,604 $5,871,604 $5,971,604
========== ========== ========== ==========
REGULATORY CAPITAL RA-
TIOS:
Tangible.............. 5.21% 6.78% 6.78% 6.67%
Core (or leverage).... 5.21% 6.78% 6.78% 6.67%
Tier 1 risk-based..... 5.80% 7.68% 7.68% 7.65%
Total risk-based...... 10.14% 12.63% 12.63% 15.15%
</TABLE>
- --------
(1) Adjusted to give effect to the issuance of the Preferred Capital Shares by
Chevy Chase Preferred Capital Corporation.
(2) Adjusted to give effect to an exchange of the Preferred Capital Shares
into Series B Preferred Shares of the Bank assuming that the limit on the
amount of Preferred Capital Shares includable as core capital is
applicable to the Series B Preferred Shares of the Bank.
(3) Adjusted to give effect to the issuance of the Preferred Capital Shares by
Chevy Chase Preferred Capital Corporation and the issuance of the
Debentures by the Bank.
OC-19
<PAGE>
DESCRIPTION OF THE SERIES B PREFERRED SHARES
The following summary sets forth the material terms and provisions of the
Series B Preferred Shares, and is qualified in its entirety by reference to
the terms and provisions of the Certificate of Designation establishing the
Series B Preferred Shares and the Bank's charter, as amended.
GENERAL
The Series B Preferred Shares form a series of the preferred stock of the
Bank, which preferred stock may be issued from time to time in one or more
series with such rights, preferences and limitations as are determined by the
Bank's Board of Directors or, if then constituted, a duly authorized committee
thereof. The Board of Directors has authorized the Bank to issue the Series B
Preferred Shares.
When issued, the Series B Preferred Shares will be validly issued, fully
paid and nonassessable. The holders of the Series B Preferred Shares will have
no preemptive rights with respect to any shares of the capital stock of the
Bank or any other securities of the Bank convertible into or carrying rights
or options to purchase any such shares. The Series B Preferred Shares will not
be convertible into shares of Common Stock or any other class or series of
capital stock of the Bank and will not be subject to any sinking fund or other
obligation of the Bank for their repurchase or retirement.
The transfer agent, registrar and dividend disbursement agent for the Series
B Preferred Shares will be Bankers Trust Company. The registrar for the Series
B Preferred Shares will send notices to shareholders of any meetings at which
holders of such shares have the right to elect directors of the Company.
DIVIDENDS
Holders of Series B Preferred Shares shall be entitled to receive, if, when
and as declared by the Board of Directors of the Bank out of assets of the
Bank legally available therefor, cash dividends at the rate of % per annum
of the initial liquidation preference (equivalent to $ per share per
annum). If declared, dividends on the Series B Preferred Shares shall be
payable quarterly in arrears on January 15, April 15, July 15 and October 15
of each year, or, if such day is not a business day, on the next business day.
Each declared dividend shall be payable to holders of record as they appear at
the close of business on the stock register of the Bank on such record dates,
not exceeding 45 days preceding the payment dates thereof, as shall be fixed
by the Board of Directors of the Bank. Upon the conversion of Preferred
Capital Shares for Series B Preferred Shares, any accrued and unpaid dividends
of the Preferred Capital Shares at the time of the conversion will be deemed
to be accrued and unpaid dividends on the Series B Preferred Shares.
The right of holders of Series B Preferred Shares to receive dividends is
noncumulative. Accordingly, if the Board of Directors fails to declare a
dividend on the Series B Preferred Shares for a quarterly dividend period,
then holders of the Series B Preferred Shares will have no right to receive a
dividend for that period, and the Bank will have no obligation to pay a
dividend for that period, whether or not dividends are declared and paid for
any future period. If the Bank fails to pay or declare and set aside for
payment a quarterly dividend on the Series B Preferred Shares, holders of the
Preferred Stock of the Bank, including the Series B Preferred Shares, will be
entitled to elect two directors. See "--Voting Rights."
If full dividends on the Series B Preferred Shares for any dividend period
shall not have been declared and paid, or declared and a sum sufficient for
the payment thereof shall not have been set apart for such payments, no
dividends shall be declared or paid or set aside for payment and no other
distribution shall be declared or made upon the Common Stock or any other
capital stock of the Bank ranking junior to or on a parity with the Series B
Preferred Shares as to dividends or amounts upon liquidation, nor shall any
Common Stock or any other capital stock of the Bank ranking junior to or on a
parity with the Series B Preferred Shares as to dividends or amounts upon
liquidation be redeemed, purchased or otherwise acquired for any consideration
(or any monies to be paid to or made available for a sinking fund for the
redemption of any such stock) by the Bank (except by
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conversion into or exchange for other capital stock of the Bank ranking junior
to the Series B Preferred Shares as to dividends and amounts upon
liquidation), until such time as dividends on all outstanding Series B
Preferred Shares have been (i) declared and paid for three consecutive
dividend periods and (ii) declared and paid or declared and a sum sufficient
for the payment thereof has been set apart for payment for the fourth
consecutive dividend period.
If any Series B Preferred Shares are outstanding, no full dividends shall be
declared or paid or set apart for payment on any series of capital stock of
the Bank ranking, as to dividends, on a parity with or junior to the Series B
Preferred Shares for any dividend period unless full dividends have been or
contemporaneously are declared and paid, or declared and a sum sufficient for
the payment thereof is set apart for such payments on the Series B Preferred
Shares, for the then-current dividend period. When dividends are not paid in
full (or a sum sufficient for such full payment is not set apart) upon the
Series B Preferred Shares and the shares of any other series of capital stock
ranking on a parity as to dividends with the Series B Preferred Shares, all
dividends declared upon Series B Preferred Shares and any other series of
capital stock ranking on a parity as to dividends with the Series B Preferred
Shares shall be declared pro rata so that the amount of dividends declared per
share on the Series B Preferred Shares and such other series of capital stock
shall in all cases bear to each other the same ratio that full dividends, for
the then-current dividend period, per share on the Series B Preferred Shares
(which shall not include any accumulation in respect of unpaid dividends for
prior dividend periods) and full dividends, including required or permitted
accumulations, if any, on such other series of capital stock bear to each
other.
REDEMPTION
The Series B Preferred Shares will not be redeemable prior to , 2001. On
or after such date, the Series B Preferred Shares will be redeemable at the
option of the Bank, in whole or in part, at any time or from time to time on
not less than 30 nor more than 60 days' notice by mail, at a redemption price
of $50.00 per share, plus the quarterly accrued and unpaid dividend to the
date of redemption, if any, thereon. Any such redemption must comply with the
prompt corrective action and capital distribution regulations of the OTS,
which may prohibit a redemption or require the OTS' prior approval of a
redemption. If there are any accrued and unpaid dividends on any Series B
Preferred Shares, no Series B Preferred Shares shall be redeemed unless all
outstanding Series B Preferred Shares are redeemed and the Bank shall not
purchase or otherwise acquire any Series B Preferred Shares; provided,
however, that the Bank may purchase or acquire Series B Preferred Shares
pursuant to a purchase or exchange offer made on the same terms to holders of
all outstanding Series B Preferred Shares.
VOTING RIGHTS
Except as expressly required by applicable law, or except as indicated
below, the holders of the Series B Preferred Shares will not be entitled to
vote. In the event the holders of Series B Preferred Shares are entitled to
vote as indicated below, each Series B Preferred Share will be entitled to one
vote on matters on which holders of the Series B Preferred Shares are entitled
to vote.
If at the time of any annual meeting of the Bank's stockholders the
aggregate amount of declared and unpaid dividends on any series of Preferred
Stock of the Bank, including the Series B Preferred Shares, equals or exceeds
an amount equal to one quarterly dividend payment on such series of Preferred
Stock, the number of directors then constituting the Board of Directors of the
Bank will be increased by two, and the holders of the Series B Preferred
Shares, voting together as a single class with the holders of any series of
Preferred Stock upon which dividends have not been paid will be entitled to
elect such two additional directors to serve on the Bank's Board of Directors
at each such annual meeting. Each director elected by the holders of shares of
the Preferred Stock shall continue to serve as such director until the later
of (i) the expiration of the term of such director or (ii) the payment of four
consecutive quarterly dividends on the Series B Preferred Shares.
The affirmative vote or consent of the holders of at least 67% of the
outstanding shares of each series of Preferred Stock of the Bank, including
the Series B Preferred Shares, will be required (a) to create any class or
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<PAGE>
series of stock which shall have preference as to cash dividends or
distribution of assets over any outstanding series of Preferred Stock of the
Bank other than a series which shall not have any right to object to such
creation or (b) to alter or change the provisions of the Bank's Articles of
Incorporation (including the Certificate of Designation establishing the
Series B Preferred Shares) so as to adversely affect the voting powers,
preferences or special rights of the holders of a series of Preferred Stock of
the Bank; provided that if such amendment shall not adversely affect all
series of Preferred Stock of the Bank, such amendment need only be approved by
at least 67% of the holders of shares of all series of Preferred Stock
adversely affected thereby.
RIGHTS UPON LIQUIDATION
In the event of any voluntary or involuntary liquidation, dissolution or
winding up of the Bank, the holders of the Series B Preferred Shares at the
time outstanding will be entitled to receive out of assets of the Bank
available for distribution to stockholders, before any distribution of assets
is made to holders of Common Stock or any other class of stock ranking junior
to the Series B Preferred Shares upon liquidation, liquidating distributions
in the amount of $50.00 per share, plus the quarterly accrued and unpaid
dividend thereon, if any, to, but excluding, the date of liquidation.
After payment of the full amount of the liquidating distributions to which
they are entitled, the holders of Series B Preferred Shares will have no right
or claim to any of the remaining assets of the Bank. In the event that, upon
any such voluntary or involuntary liquidation, dissolution or winding up, the
available assets of the Bank are insufficient to pay the amount of the
liquidation distributions on all outstanding Series B Preferred Shares and the
corresponding amounts payable on all shares of other classes or series of
capital stock of the Bank ranking on a parity with the Series B Preferred
Shares in the distribution of assets upon any liquidation, dissolution or
winding up of the affairs of the Bank, then the holders of the Series B
Preferred Shares and such other classes or series of capital stock shall share
ratably in any such distribution of assets in proportion to the full
liquidating distributions to which they would otherwise be respectively
entitled.
For such purposes, the consolidation or merger of the Bank with or into any
other entity, or the sale, lease or conveyance of all or substantially all of
the property or business of the Bank, shall not be deemed to constitute
liquidation, dissolution or winding up of the Bank.
CERTAIN DEFINITIONS
"FDIC" means the Federal Deposit Insurance Corporation or any successor
thereto.
"FHLB" means any of the regional Federal Home Loan Banks.
"GAAP" means generally accepted accounting principles, consistently applied.
"OTS" means the Office of Thrift Supervision or any successor thereto.
"Person" means any individual, corporation, limited liability company,
partnership, joint venture, association, joint-stock company, trust,
unincorporated organization or government or any agency or political
subdivisions thereof.
"Preferred Stock" means, collectively, the Series A Preferred Shares and the
Series B Preferred Shares of the Bank.
"Private Capital Note" means the $10,000,000 floating rate subordinated
capital note due 1996 of the Bank.
"Regulatory Capital Requirements" means the minimum amount of capital
required to meet each of the industry-wide regulatory capital requirements
applicable to the Bank pursuant to 12 U.S.C. Section 1464(t) and 12 C.F.R.
Section 567 (and any amendment to either thereof) or any successor law or
regulation, or such higher amount of capital as the Bank, individually, is
required to maintain in order to meet any individual minimum
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<PAGE>
capital standard applicable to the Bank pursuant to 12 U.S.C. Section 1464(s)
and 12 C.F.R. Section 567.3 (and any amendment to either such Section) or any
successor law or regulation.
"Series A Preferred Shares" means the 3,000,000 shares of the 13%
Noncumulative Perpetual Preferred Stock, Series A of the Bank.
"Series B Preferred Shares" means the 3,000,000 shares of the %
Noncumulative Preferred Stock, Series B of the Bank issued pursuant to this
Offering Circular.
EXCHANGE
The Series B Preferred Shares are to be issued, if ever, in connection with
an exchange of the Preferred Capital Shares. The Preferred Capital Shares are
subject to an automatic exchange in whole and not in part, on a share-for-
share basis, into Series B Preferred Shares if the appropriate federal
regulatory agency directs in writing an exchange of the Preferred Capital
Shares for Series B Preferred Shares because (i) the Bank becomes
"undercapitalized" under prompt corrective action regulations, (ii) the Bank
is placed into conservatorship or receivership or (iii) the appropriate
federal regulatory agency, in its sole discretion, anticipates the Bank
becoming "undercapitalized" in the near term. The Bank has registered with the
OTS a total of 3,300,000 Series B Preferred Shares to cover the exchange, if
necessary, of the 3,000,000 Capital Preferred Shares offered by Chevy Chase
Preferred Capital Corporation and the 300,000 share over-allotment option
granted to the underwriters of the Preferred Capital Shares.
EXPERTS
The Bank's Consolidated Financial Statements included in the Bank's Annual
Report on Form 10-K for the fiscal year ended September 30, 1995 and
incorporated by reference in this Offering Circular on Form OC have been
audited by Arthur Andersen LLP, independent public accountants, as indicated
in their report with respect thereto and are included herein in reliance upon
the authority of said firm as experts in giving said reports.
LEGAL MATTERS
The legality of the securities offered by this Offering Circular has been
passed upon for the Bank by Shaw, Pittman, Potts & Trowbridge, Washington,
D.C., a partnership including professional corporations. George M. Rogers,
Jr., whose professional corporation is a member of that firm, is a director of
the Bank.
OC-23
<PAGE>
CHEVY CHASE BANK, F.S.B
FORM 10-K
FOR FISCAL YEAR ENDED
SEPTEMBER 30, 1995
<PAGE>
OFFICE OF THRIFT SUPERVISION
Washington, DC. 20552
FORM 10-K
___ (Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- ---
ACT OF 1934
___ For the fiscal year ended September 30, 1995
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE OF 1934
For the transition period from _____________ to ________________________
OFFICE OF THRIFT SUPERVISION DOCKET NUMBER 08145
CHEVY CHASE BANK, F.S.B.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
UNITED STATES 52-0897004
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
8401 CONNECTICUT AVENUE
CHEVY CHASE, MARYLAND 20815
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301) 986-700
----------------------------
Securities registered pursuant to Section 12(b) of Act:
Name of each exchange on which
Title of each class registered
- ------------------- ------------------------------
N/A N/A
- ------------------- ------------------------------
Securities registered pursuant to Section 12(g) of the Act:
N/A
- --------------------------------------------------------------------------------
(Title of class)
Indicated by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the proceeding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No___
---
All of the registrant's common stock outstanding as of November 30, 1995
was held by affiliates of the registrant.
The number of shares outstanding of the registrant's sole class of common
stock as of November 30, 1995 was 10,000.
================================================================================
<PAGE>
TABLE OF CONTENTS
<TABLE>
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PART I
<S> <C>
ITEM 1. BUSINESS ...................................................................1
General .........................................................................1
Regulation .......................................................................1
Federal Home Loan Bank System .................................................1
Liquidity Requirements. .......................................................2
Deposit Insurance Premiums. ...................................................2
Regulatory Capital. ...........................................................3
Prompt Correction Action. .....................................................5
Regulatory Agreement ..........................................................6
Growth Restrictions. ..........................................................6
Qualified Thrift Lender ("QTL") Test. .........................................7
Dividends and Other Capital Distributions. ....................................8
Lending Limits. ..............................................................10
Safety and Soundness Standards. ..............................................10
Regulatory Assessments. ......................................................10
Other Regulations and Legislation. ...........................................10
Pending Legislation ............................................................11
Balanced Budget Act of 1995 ..................................................11
Thrift Charter Legislation ...................................................12
Federal Reserve System .........................................................13
Community Reinvestment Act .....................................................13
Other Aspects of Federal Law ...................................................14
Holding Company Regulation .....................................................14
The Trust and B. F. Saul Company. ............................................14
Recent Accounting Pronouncements ...............................................15
Market Area ....................................................................16
Investment and Other Securities ................................................16
Lending Activities .............................................................17
Loan Portfolio Composition. ..................................................17
Contractual Principal Repayments of Loans. ...................................19
Origination, Purchase and Sale of Real Estate Loans. .........................21
Sales of Mortgage-Backed Securities. .........................................23
Single-Family Residential Real Estate Lending. ...............................24
Commercial Real Estate and Construction Lending. .............................25
Credit Card Lending. .........................................................25
Consumer and Other Lending. ..................................................27
Real Estate Loan Underwriting. ...............................................27
Credit Card Loan Underwriting. ...............................................28
Other Consumer Loan Underwriting .............................................29
Loan Servicing. ..............................................................29
</TABLE>
(i)
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<TABLE>
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Page
<S> <C>
Delinquencies, Foreclosures and Allowances for Losses....................31
Delinquencies and Foreclosures........................................31
Allowances for Losses.................................................32
Deposits and Other Sources of Funds......................................33
General...............................................................33
Deposits..............................................................34
Borrowings............................................................40
Subsidiaries.............................................................41
Real Estate Development Activities....................................42
Securities Brokerage Services.........................................42
Insurance Services....................................................42
Special Purpose Subsidiaries..........................................42
Operating Subsidiaries................................................42
Employees................................................................42
Competition..............................................................43
Federal Taxation.........................................................43
General...............................................................43
Bad Debt Reserve......................................................44
Consolidated Tax Returns; Tax Sharing Payments........................44
State Taxation...........................................................45
ITEM 2. PROPERTIES............................................................46
ITEM 3. LEGAL PROCEEDINGS.....................................................49
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................49
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS...................................................49
ITEM 6. SELECTED FINANCIAL DATA...............................................50
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.............................................53
Financial Condition......................................................53
General...............................................................53
Asset Quality.........................................................53
Asset and Liability Management........................................70
Inflation.............................................................73
Deferred Tax Asset....................................................73
Tax Sharing Payments..................................................73
Capital...............................................................73
Liquidity.............................................................77
Results of Operations....................................................80
Fiscal 1995 Compared to Fiscal 1994......................................80
Overview..............................................................80
Net Interest Income...................................................80
</TABLE>
(ii)
<PAGE>
<TABLE>
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Page
<S> <C>
Provision for Loan Losses.................................................................... 85
Other Income................................................................................. 85
Operating Expenses........................................................................... 86
Fiscal 1994 Compared to Fiscal 1993............................................................. 86
Overview..................................................................................... 86
Net Interest Income.......................................................................... 86
Provision for Loan Losses.................................................................... 88
Other Income................................................................................. 88
Operating Expenses........................................................................... 89
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION........................................F-1
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.................................................................. 90
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS......................................................... 90
Directors....................................................................................... 90
Board Meetings and Committees................................................................... 93
Executive Officers Who Are Not Directors........................................................ 93
ITEM 11. EXECUTIVE COMPENSATION................................................................... 94
Summary of Cash and Certain Other Compensation.................................................. 94
General...................................................................................... 94
Long-Term Incentive Plan Awards.............................................................. 96
Compensation Committee Interlocks and Insider Participation.................................. 97
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICAL OWNERS AND
MANAGEMENT............................................................................... 98
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................... 99
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K...................................................................................... 99
</TABLE>
(iii)
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
Chevy Chase Bank, F.S.B., ("Chevy Chase" or the "Bank"), is a federally
chartered and federally insured stock savings bank which at September 30, 1995
was conducting business from 88 full-service offices and 439 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 18 mortgage loan production offices in
Maryland, Virginia and the District of Columbia, 17 of which are operated by a
wholly-owned mortgage banking subsidiary. At September 30, 1995, the Bank had
total assets of $4.9 billion, total deposits of $4.2 billion and total
stockholders' equity of $328.5 million. Based on total consolidated assets at
September 30, 1995, Chevy Chase is the largest bank headquartered in the
Washington, D.C. metropolitan area.
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 income before income taxes, extraordinary item and
cumulative effect of change in accounting principle of $54.7 million and net
income of $37.3 million for the year ended September 30, 1995, compared to
income before income taxes, extraordinary item and cumulative effect of change
in accounting principle of $52.7 million and net income of $29.0 million for the
year ended September 30, 1994. At September 30, 1995, the Bank's tangible,
core, tier 1 risk-based and total risk-based regulatory capital ratios were
5.77%, 5.77%, 6.65% and 11.63%, respectively. The Bank's capital ratios
exceeded the requirements under the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 ("FIRREA") as well as the standards established for
"well capitalized" institutions under the prompt corrective action regulations
established pursuant to the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA"). On the basis of its balance sheet at September 30,
1995, the Bank met the FIRREA-mandated fully phased-in capital requirements and,
on a fully phased-in basis, met the capital standards established for "well
capitalized" institutions under the prompt corrective action regulations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Capital."
Chevy Chase is subject to comprehensive regulation, examination and
supervision by the Office of Thrift Supervision ("OTS") and, to a lesser extent
by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank's deposit
accounts are fully insured up to $100,000 per insured depositor by the Savings
Association Insurance Fund (the "SAIF"), which is administered by the FDIC.
REGULATION
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, 1995, the Bank had outstanding
<PAGE>
$155.1 million of advances from the FHLB of Atlanta. See Note 16 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, 1995. The Bank earned
dividends of $2.3 million during each of the years ended September 30, 1995 and
1994, at weighted average annual rates of 7.19% and 5.65%, 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, 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,
1995, the Bank was in compliance with both requirements, with a liquid assets
ratio of 17.5% and a short-term liquid assets ratio of 5.8%.
DEPOSIT INSURANCE PREMIUMS. Under FDIC insurance regulations, the Bank is
required to pay premiums to SAIF for insurance of its accounts. The FDIC
utilizes a risk-based premium system in which an institution pays premiums for
deposit insurance on its SAIF-insured deposits 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 reserve levels of both the BIF and the SAIF to 1.25% of
insured deposits over a reasonable period of time and thereafter to maintain
such valuation allowances at not less than that level. During fiscal 1995, the
BIF reserve reached the mandated 1.25% of insured deposits. Accordingly,
although the FDIC previously had applied the same premium rates to BIF and SAIF
deposits, the FDIC board, in August 1995, approved lower BIF premium rates for
all but the riskiest institutions. 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 to
merge the BIF and SAIF. The 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.
Congress is considering legislation that would either reduce or eliminate
the anticipated disparity between BIF and SAIF insurance premiums. See "Pending
Legislation - Balanced Budget Act of 1995."
-2-
<PAGE>
SAIF insurance may be terminated by the FDIC, after notice and a 30-day
corrective period, upon a finding by the FDIC that the institution has engaged
in unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC. The 30-day period may be eliminated by the FDIC
with the approval of the OTS.
REGULATORY CAPITAL. 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, 1995, the Bank's tangible, core
and total risk-based regulatory capital ratios were 5.77%, 5.77% and 11.63%,
respectively, compared to the minimum requirements under FIRREA of 1.50%, 3.00%
and 8.00%, respectively, in effect at that date.
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 and originated mortgage servicing rights (collectively
"MSRs") 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, MSRs and PCCRs are valued
at the lesser of 90% of fair market value or 100% of the current unamortized
book value. At September 30, 1995, the Bank had qualifying MSRs of $27.2
million, which constituted 9.6% of core capital at that date, and had no PCCRs.
The amount of qualifying supervisory goodwill includable as core capital
decreased from 0.375% to 0% effective January 1, 1995. Deductions or 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 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 MSRs 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,
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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 allowances for loan and lease
losses (up to a maximum of 1.25% of risk-weighted assets). At September 30,
1995, the Bank had $53.3 million in allowances for loan and lease losses, of
which $53.1 million was includable as supplementary capital.
Subordinated debt may be included in supplementary capital with OTS
approval subject to a phase-out based on its term to maturity. The phase-out
established for such maturing capital instruments by the OTS permits an
institution to include such instruments in supplementary capital under one of
two phase-out options: (i) at the beginning of each of the last five years
prior to the maturity date of the instrument, the institution may reduce the
amount eligible to be included by 20% of the original amount or (ii) the
institution may include only the aggregate amount of maturing capital
instruments that mature in any one year during the seven years immediately prior
to an instrument's maturity that does not exceed 20% of the institution's
capital. Once an institution selects either the first or second option, it must
continue to select the same option for all subsequent issuances of maturing
capital instruments as long as there is any outstanding balance of such
instruments for which an option has been selected. 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, 1995, the Bank had $160.0 million in maturing subordinated capital
instruments, of which $151.4 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 to incorporate interest-rate risk measures to
complement measures already 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 would be required to maintain
additional amounts of risk-based capital based on the lowest interest rate
exposure at the end of the three previous quarters. In August 1995, the OTS
indefinitely delayed implementation of its interest-rate risk regulation pending
the testing of an OTS appeals process. At September 30, 1995, the Bank would
not have been required to maintain additional amounts of risk-based capital had
the interest-rate risk component of the capital regulations been in effect.
Under regulations effective January 17, 1995, the OTS must consider
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.
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
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permissible for a national bank ("non-includable subsidiaries") are, with
certain exceptions, deducted from the savings institution's capital. At
September 30, 1995, investments in non-includable subsidiaries were subject to a
60% phase-out from all three FIRREA capital requirements. This phase-out will
increase to 100% on July 1, 1996. 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, 1995, the Bank's investments in, and
extensions of credit to, its non-includable subsidiaries had been reduced to
approximately $3.9 million, of which $2.1 million constituted a deduction from
tangible capital.
OTS capital regulations also require the 100% 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 Bank's only equity investments at September 30, 1995
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, 1995, the book value of these properties after subsequent
valuation allowances was $29.2 million, of which $25.7 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,
1995.
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. Accordingly, if the Bank is unable to dispose of any REO property
(through bulk sales or otherwise) prior to the end of its applicable five-year
holding period and is unable to obtain an extension of such five-year holding
period from the OTS, the Bank could be required to deduct the then-current book
value of such REO property from risk-based capital. In September 1995, the Bank
received from the OTS an extension through September 29, 1996 of the five-year
holding period for certain of its REO properties acquired through foreclosure in
fiscal 1990 and 1991. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Capital - Regulatory
Action and Requirements."
The Bank in recent periods has actively managed its levels of investments
in, and loans to, non-includable subsidiaries and equity investments to minimize
the impact of the deductions from capital for these investments. The Bank's
ability to maintain capital compliance is dependent on a number of factors,
including, for example, general economic conditions and the condition of local
real estate markets. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Capital - Regulatory
Action and Requirements."
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
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become more severe as the capital levels of an individual institution decline.
The regulations establish five capital categories to which institutions are
assigned for purposes of determining their treatment under these prompt
corrective action provisions. An institution is categorized as "well
capitalized" under the regulations if (i) it has a leverage ratio of at least
5.0%, a tier 1 risk-based capital ratio of at least 6.0% and a total risk-based
capital ratio of at least 10.0%, and (ii) is not subject to any written
agreement, order, capital directive or prompt corrective action directive issued
by 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, 1995, the Bank's leverage, tier 1 risk-based and total
risk-based regulatory capital ratios were 5.77%, 6.65% and 11.63%, 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 maintain a specific capital level. On a fully phased-in basis, at September
30, 1995, the Bank would also exceed the capital standards established for "well
capitalized" institutiions.
REGULATORY AGREEMENT. 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.
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
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OTS. On December 29, 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
period October 1, 1994 through December 31, 1994. In addition, the OTS notified
the Bank on March 21, 1995 that it would waive the growth restriction for the
period from January 1, 1995 through March 31, 1995 to allow for an increase in
total assets of up to $125 million. On December 21, 1995, the OTS notified the
Bank that it would waive the growth restriction for the quarter ending March 31,
1996 to allow for an increase in total assets of up to $200 million, subject to
the conditions that the Bank maintain sufficient capital to meet the "well
capitalized" ratios under the OTS's prompt corrective action regulations as well
as all fully phased-in regulatory capital requirements.
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. the QTL test must be met on a
monthly average basis in nine out of every 12 months.
At September 30, 1995, the Bank had 74.6% 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. 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, such as investing in subsidiaries that engage in
real estate development activities, failure to satisfy the QTL test would
require Chevy Chase to terminate these activities and divest itself of any
prohibited assets held at such time. Based on a review of the Bank's current
activities, management of the Bank believes that compliance with these
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restrictions would not 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 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
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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, 1995, 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 undercapitalized or that would be
undercapitalized following a capital distribution, or that are not
undercapitalized but are in "troubled condition "(defined generally to include
institutions subject to a formal written agreement relating to safety and
soundness), could make a capital distribution only upon application to and
approval by the OTS. The proposal would delete from the OTS regulations 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 both the current and the proposed OTS capital
distribution rule, with the approval of the OTS, the Bank could substitute the
requirements of the OTS capital distribution rule for any more stringent
requirements imposed on it by a previous written agreement.
The Bank is subject to other limitations on its ability to pay dividends.
The indenture pursuant to which $150 million principal amount of the Bank's 9
1/4% Subordinated Debentures due 2005 was issued in 1993 (the "Indenture")
provides that the Bank may not pay dividends on its capital stock unless, after
giving effect to the dividend, no event of a continuing default shall have
occurred and the Bank is in compliance with its regulatory capital requirements.
In addition, the amount of the proposed dividend may not exceed the sum of (i)
$15 million, (ii) 66 2/3% of the Bank's consolidated net income (as defined)
accrued on a cumulative basis commencing on October 1, 1993 and (iii) the
aggregate net cash proceeds received by the Bank after October 1, 1993 from the
sale of qualified capital stock or certain debt securities, 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. See "Security Ownership of Certain Beneficial
Owners and Management - Preferred Stock."
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
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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 $73.4 million at September
30, 1995, and no group relationships exceeded this limit at that date.
SAFETY AND SOUNDNESS STANDARDS. FDICIA 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. In July 1995, the OTS and the federal bank
regulatory agencies jointly issued final safety and soundness standards. The
operational standards adopted cover internal controls and audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth and
employee compensation. An institution that fails to meet a standard that is
imposed through regulation may be required to submit a plan for corrective
action within 30 days. If a savings association fails to submit or implement an
acceptable plan, the OTS must order it to correct the deficiency, and may
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 addition, the OTS and the federal bank regulators also published
proposed safety and soundness standards for asset quality and earnings. The
asset quality standards would require that an insured depository institution
establish and maintain a system to identify problem assets and prevent
deterioration in those assets. The earnings standards would require that an
insured depository institution establish and maintain a system to evaluate and
monitor earnings and ensure that earnings are sufficient to maintain adequate
capital and reserves. 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.
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 semi-annual asset-based assessments
(which totaled $352,000 for the six-month period ending December 31, 1995) are
the most significant.
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
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with, a BIF-insured institution. Despite these restrictions, SAIF-insured
thrifts may be acquired by banks or by Bank holding companies under certain
circumstances.
The federal agencies regulating financial institutions possess broad
enforcement authority over the institutions they regulate, including the
authority to impose civil money penalties of up to $1 million per day for
violations of laws and regulations.
Federally chartered thrifts like Chevy Chase generally are permitted to
establish new branches anywhere in the United States, provided that they (i)
meet their regulatory capital requirements; (ii) either have a satisfactory
record under the OTS's regulations implementing the Community Reinvestment Act
("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.
PENDING LEGISLATION
BALANCED BUDGET ACT OF 1995. In November 1995, Congress passed and
presented to President Clinton the Balanced Budget Act of 1995 (the "Budget
Act"), which would, among other things, capitalize the SAIF and either reduce or
eliminate the disparity between the BIF and SAIF insurance rates. Under the
Budget Act: (i) thrift institutions would pay a one-time assessment estimated to
be up to 85 basis points on their SAIF-insured deposits, as measured on March
31, 1995, to increase the SAIF's reserve ratio to 1.25%; and (ii) effective
January 1, 1996, the assessment base for interest on Financing Corporation
bonds, which were issued in the late 1980's to resolve troubled thrifts, would
be expanded to cover all FDIC-insured institutions, including members of both
BIF and SAIF. If the legislation is enacted in its current form, the Bank would
be required to pay a one-time assessment of up to $35 million in the first
quarter of calendar year 1996; however, the Bank's semi-annual risk-based
deposit insurance premiums should be reduced in future years.
The Budget Act also would repeal the thrift bad debt reserve provisions of
the Internal Revenue Code. See "Federal Taxation - Bad Debt Reserve." In
addition, although the Budget Act does not require savings associations to
convert to bank charters, it does provide for a merger of the BIF and the SAIF
on January 1, 1998, if no insured depository institution remains chartered as a
savings association on that date.
On December 6, 1995, President Clinton vetoed the Budget Act for reasons
that are unrelated to the above-described provisions, and it cannot be
determined whether, or in what form, the Budget Act will eventually be enacted.
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THRIFT CHARTER LEGISLATION. In September 1995, the Financial Institutions
Subcommittee of the House Banking Committee approved the Thrift Charter
Conversion Act of 1995 (the "Conversion Act"). The Conversion Act would, among
other things, eliminate the federal thrift charter by requiring all federally
chartered thrifts, including the Bank, to convert to national bank, state bank,
or state thrift charters by January 1, 1998. Any institution with a federal
thrift charter on January 1, 1998, would be converted to a national bank by
operation of law. Effective January 1, 1998, the Conversion Act also would,
among other things: (i) abolish the OTS and transfer its functions to other
agencies; (ii) repeal the Home Owners Loan Act, the federal statute governing
the operations of thrift institutions and their holding companies; and (iii)
merge the SAIF and BIF.
Following conversion, a federal thrift generally would be required to
conform its activities to those permissible under its new charter. However,
existing non-conforming activities could be continued for up to four years (two
years, with two possible one year extensions) from the date that the thrift
converts to a new charter. Accordingly, if the Conversion Act were enacted in
its current form and Chevy Chase were to become a national bank, the Bank could
be required, within as little as two years after its conversion date, to
restrict its sales of non-credit-related insurance and to divest itself of
certain limited real estate investments.
The Conversion Act would permanently grandfather the existing interstate
branches of a converted thrift, but the converted thrift could establish
additional interstate branches only in conformity with federal and state law
applicable to national and state-chartered commercial banks without regard to
any grandfathered interstate branches. Because Maryland and Virginia have
enacted interstate banking laws, the principal impact on the Bank of this
provision of the Conversion Act would be to eliminate the flexibility the Bank
now has under federal law to open interstate branches in any state, regardless
of state law. Conversion of the Bank to a commercial bank charter also would
change (i) the primary federal regulator of the Bank and (ii) certain of the
regulatory capital and accounting policies and rules applicable to the Bank.
Application of different capital and accounting policies and rules without an
appropriate transition period could have an adverse effect on the Bank's
earnings and regulatory capital ratios.
Finally, upon the Bank's conversion to a commercial bank, the Bank's four
registered savings and loan holding companies would become bank holding
companies regulated at the holding company level by the Federal Reserve Board
("FRB"). Current rules and regulations of the FRB subject bank holding
companies to capital requirements and activities restrictions that are not
currently generally applicable to savings and loan holding companies under OTS
regulations. The Conversion Act would permit holding companies of converted
thrifts that meet certain requirements ("Qualified Bank Holding Companies" or
"QBHCs") to continue to engage in nonconforming activities so long as their
subsidiary converted thrift continued to satisfy the qualified thrift lender
test and continued to comply with all limitations and restrictions on the types
and amounts of loans and investments (such as the 10% of assets limitation on
commercial loans) that were applicable to such institutions on the Conversion
Act's enactment date. However, QBHC status would be lost if (i) the QBHC
underwent a change in control, or were the subject of any merger or
consolidation with a company not under common control with the QBHC or (ii)
either the QBHC or its subsidiary converted thrift acquired more than 5% of the
shares or assets of any insured depository institution. Under the Conversion
Act, QBHCs generally would not be subject to the FRB's bank holding company
capital requirements.
In November 1995, legislation identical to the Conversion Act was
introduced in the Senate, and the Senate Banking Committee has announced plans
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to hold hearings on the bill and to approve its version of a bill by April 1996.
Chevy Chase cannot determine whether, or in what form, such legislation will
eventually be enacted.
FEDERAL RESERVE SYSTEM
The FRB requires depository institutions, including federal savings banks,
to maintain valuation allowances against their transaction accounts and certain
non-personal deposit accounts. Because valuation allowances 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 valuation allowances be maintained against net
transaction accounts. Prior to December 19, 1995, the first $4.2 million of a
depository institution's transaction accounts were subject to a 0% reserve
requirement. The next $49.8 million in net transaction accounts were subject to
a 3.0% reserve requirement and any net transaction accounts over $54.0 million
were subject to a 10.0% reserve requirement. Effective December 19, 1995, the
FRB increased the amount of transaction accounts subject to a 0% reserve
requirement from $4.2 million to $4.3 million and decreased the "low reserve
tranche" from $49.8 million to $47.7 million. The Bank met its reserve
requirements for each period during the year ended September 30, 1995. 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.
The FRB also has a clearing balance requirement which may be established at
a depository institution's request in order to, among other things, generate
earnings credits at market rates which are used to offset service charges
resulting from the use of FRB services. An institution that has a reserve
account with the FRB may also elect to maintain a clearing balance requirement
with its reserve requirement in a single account. The maintenance period for
the clearing balance requirement is the same as that for the reserve maintenance
period. Therefore, an institution is expected to maintain a daily average
balance equal to the sum of its reserve balance and clearing balance
requirements. In order to take advantage of being able to use earnings credits
to offset FRB service charges, the Bank began to participate in the clearing
balance requirement program, in the maintenance period beginning November 9,
1995. These additional balances may also be used to satisfy the liquidity
requirements imposed by the OTS.
Savings institutions may borrow from the FRB "discount window," although
FRB regulations require these institutions to exhaust all reasonable alternate
sources of funds, including FHLB sources, before borrowing from the FRB. FDICIA
imposes additional limitations on the ability of the FRB to lend to
undercapitalized institutions through the discount window.
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. In April 1995, the OTS issued a final CRA evaluation, based
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on an examination dated January 9, 1995, and assigned the Bank a "satisfactory"
rating.
In April 1995, the federal bank regulatory agencies issued amendments 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, institutions like the Bank, with more than $250 million in assets,
will be evaluated on the basis of their lending and investment in, and provision
of services, to low- and moderate-income areas unless they request designation
and receive approval as wholesale or limited purpose institutions or have been
approved for evaluation under a strategic plan. The Bank does not contemplate
employing any of these options. Additionally, large retail banks will be
required to collect and report additional data concerning small business loans.
Data collection will become effective January 1, 1996 and reporting
requirements will become effective on January 1, 1997. Beginning on January
1, 1996, the Bank could be evaluated under the new examination procedures if it
provided the necessary data; however, the new procedures are not required to be
applied until July 1, 1997.
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.
HOLDING COMPANY REGULATION
THE TRUST AND B. F. SAUL COMPANY. The Trust and B. F. Saul Company (the
"Saul Company"), by virtue of their direct and indirect control of the Bank (see
"Security Ownership of Certain Beneficial Owners and Management"), and Chevy
Chase Property Company ("CCPC") and CCPC's wholly-owned subsidiary Westminster
Investing Corporation ("Westminster"), by virtue of Westminster's direct and
indirect ownership of 24.9% of the common stock of the Trust (collectively the
"Holding Companies"), are "savings and loan holding companies" subject to
regulation, examination and supervision by the OTS. The Bank is prohibited from
making or guaranteeing loans or advances to or for the benefit of the Holding
Companies or other affiliates engaged in activities beyond those permissible for
bank holding companies and from investing in the securities of the Holding
Companies or other affiliates. Further, transactions between the Bank and the
Holding Companies must be on terms substantially the same, or at least as
favorable to the Bank, as those that would be available to non-affiliates.
The Holding Companies must obtain the prior approval of the OTS before
acquiring by merger, consolidation or purchase of assets any federally insured
savings institution or any savings and loan holding company. As unitary savings
and loan holding companies, the Holding Companies are virtually unrestricted in
the types of business activities in which they may engage, provided the Bank
continues to meet the qualified thrift lender test. See "Qualified Thrift
Lender ("QTL") Test." If the Holding Companies were to acquire one or more
federally insured institutions and operate them as separate subsidiaries rather
than merging them into the Bank, the Holding Companies would become "multiple"
savings and loan holding companies. As multiple savings and loan holding
companies, the Holding Companies would be subject to limitations on the types of
business activities in which they would be permitted to engage, unless the
additional thrifts were troubled institutions acquired pursuant to certain
emergency acquisition provisions and all subsidiary thrifts met the QTL test.
The Holding Companies may acquire and operate additional savings institution
subsidiaries outside of Maryland and
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<PAGE>
Virginia only if the laws of the target institution's state specifically permit
such acquisitions or if the acquisitions are made pursuant to emergency
acquisition provisions.
The Trust and the Saul Company entered into an agreement with OTS's
predecessor, the Federal Savings and Loan Insurance Corporation, to maintain the
Bank's regulatory capital at the required levels, and, if necessary, to infuse
additional capital to enable the Bank to meet those requirements. Since the
execution of this agreement, the OTS has changed its policy and now accepts more
limited agreements from those acquiring thrift institutions. In addition, the
regulatory capital requirements applicable to the Bank have changed
significantly as a result of FIRREA. The OTS has stated that capital
maintenance agreements entered into prior to 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. To the extent the
Bank is unable to meet regulatory capital requirements in the future, the OTS
could seek to enforce the obligations of the Trust and the Saul Company under
the agreement. The Bank's business plan does not contemplate any future capital
contributions from the Trust or the Saul Company.
If the Bank were to become "undercapitalized" under the prompt corrective
action regulations, it would be required to file a capital restoration plan with
the OTS setting forth, among other things, the steps the Bank would take to
become "adequately capitalized." The OTS could not accept the plan unless the
Holding Companies guaranteed in writing the Bank's compliance with that plan.
The aggregate liability of the Holding Companies under such a commitment would
be limited to the lesser of (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. See "Prompt Corrective Action."
Congress is considering legislation that would significantly restrict the
operations of unitary thrift holding companies. See "Business - Pending
Legislation - Balanced Budget Act of 1995."
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of" ("SFAS 121"), was issued in March 1995. SFAS 121 establishes accounting
standards for the impairment of long-lived assets, certain identifiable
intangibles, and goodwill related to those assets, to be held and used and for
long-lived assets and certain identifiable intangibles to be disposed of. It
addresses how impairment losses should be measured and when such losses should
be recognized. Under SFAS 121, long-lived assets and certain identifiable
intangibles to be held and used shall be reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. If the sum of the expected cash flows (undiscounted and
without interest charges) is less than the carrying amount of the asset, the
entity shall recognize an impairment loss. Measurement of an impairment loss
for long-lived assets and identifiable intangibles that an entity expects to
hold and use should be based on the fair value of the asset. Long-lived assets
and certain identifiable intangibles to be disposed of should generally be
reported at the lower of carrying amount or fair value less the cost to sell.
SFAS 121 is effective for financial statements for fiscal years beginning after
December 15, 1995. The adoption of SFAS 121 is not anticipated to have a
material impact on the Bank's financial condition on
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<PAGE>
the results of operations. See Note 1 to the Consolidated Financial Statements
in this report.
Statement of Position 94-6, "Disclosures of Significant Risks and
Uncertainties" ("SOP 94-6"), was issued in January 1995. SOP 94-6 requires an
entity to disclose certain information about the nature of its operations and
use of estimates in the preparation of its financial statements. In addition,
if specified criteria are met, it requires an entity to disclose certain
information about certain significant estimates and current vulnerability to
risk due to certain concentrations. SOP 94-6 is effective for financial
statements for fiscal years ending after December 15, 1995, and for financial
statements for interim periods in fiscal years subsequent to the year for which
SOP 94-6 is first applied. See Note 1 to the Consolidated Financial Statements
in this report.
MARKET AREA
The Bank's principal deposit and lending markets are located in the
Washington, D.C. metropolitan area. Service industries and federal, state and
local governments employ a significant portion of the Washington, D.C. area
labor force, while a substantial number of the nation's 500 largest corporations
have some presence in the area. The Washington, D.C. area's seasonally
unadjusted unemployment rate is generally below the national rate and was 4.1%
in September 1995, compared to the national rate of 5.4%.
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 27.4% of the Bank's deposits at September 30, 1995
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, 1995, according to preliminary 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 Montgomery
and Fairfax Counties in September 1995 (2.8% and 2.9%, respectively) was below
the national rate (5.4%) and state rates (5.0% for Maryland and 4.5% for
Virginia) for the same month.
The Bank historically has concentrated its lending activities in the
Washington, D.C. metropolitan area. See "Lending Activities."
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.
During fiscal 1995, the Bank transferred at fair value all of its
investment securities and mortgage-backed securities previously classified as
available-for-sale to held-to-maturity and, as a result, all such securities are
classified as held-to-maturity at September 30, 1995. Net unrealized
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<PAGE>
holding losses, net of the related income tax effect, continue to be reported as
a separate component of stockholders' equity and are being amortized to income
over the remaining lives of the securities.
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, 1995, the Bank's loan
portfolio totaled $2.9 billion, which represented 59.5% 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 48.3% 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.
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<PAGE>
LOAN PORTFOLIO
--------------
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30,
--------------------------------------------------------------------------
1995 1994 1993
----------------------- ----------------------- -----------------------
% of % of % of
Balance Total Balance Total Balance Total
------------ -------- ------------ -------- ------------ --------
<S> <C> <C> <C> <C> <C> <C>
Residential (1) $ 1,391,694 47.3 % $ 1,369,571 53.8 % $ 1,287,333 53.6 %
Home equity (1) 29,024 1.0 34,708 1.4 60,549 2.5
Commercial and multifamily 85,781 2.9 84,210 3.3 94,079 3.9
Real estate construction
and ground 32,652 1.1 52,350 2.0 62,637 2.6
Credit card (1) 1,012,548 34.4 650,199 25.5 754,520 31.4
Automobile (1) 239,217 8.1 289,346 11.4 106,725 4.4
Other 152,897 5.2 66,851 2.6 38,048 1.6
------------ -------- ------------ -------- ------------ --------
2,943,813 100.0 % 2,547,235 100.0 % 2,403,891 100.0 %
------------ ======== ------------ ======== ------------ ========
Less:
Unearned premiums and discounts 872 1,108 1,484
Deferred loan origination
fees (costs) (13,520) (10,397) (3,265)
Reserve for loan losses 60,496 50,205 68,040
47,848 40,916 66,259
------------ ------------ ------------
Total loans receivable $ 2,895,965 $ 2,506,319 $ 2,337,632
============ ============ ============
-------------------------------------------------
1992 1991
----------------------- -----------------------
% of % of
Balance Total Balance Total
------------ -------- ------------ --------
<S> <C> <C> <C> <C>
Residential (1) $ 933,867 41.6 % $ 1,345,409 41.7 %
Home equity (1) 223,148 9.9 289,976 9.0
Commercial and multifamily 61,522 2.7 69,097 2.1
Real estate construction
and ground 92,215 4.1 133,852 4.2
Credit card (1) 872,672 38.9 1,302,008 40.4
Automobile (1) 19,910 0.9 16,924 0.5
Other 42,019 1.9 67,659 2.1
------------ -------- ------------ --------
2,245,353 100.0 % 3,224,925 100.0 %
------------ -------- ------------ --------
Less:
Unearned premiums and discounts 3,260 3,945
Deferred loan origination
fees (costs) 2,359 8,438
Reserve for loan losses 78,818 89,745
------------ ------------
84,437 102,128
------------ ------------
Total loans receivable $ 2,160,916 $ 3,122,797
============ ============
</TABLE>
- --------------------------------------------------------------------------------
(1) Includes loans held for sale and/or securitization, if any.
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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",
"- Qualified Thrift Lender ("QTL") Test" and "- Federal Taxation - Bad Debt
Reserve" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - 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,
1995. The entire balance of loans held for sale and/or securitization is shown
in the year ending September 30, 1996, because such loans are expected to be
sold in less than one year.
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<PAGE>
CONTRACTUAL PRINCIPAL REPAYMENTS
(In thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Balance Approximate Principal Repayments
Outstanding at Due in Years Ending September 30,
September 30, -------------------------------------------------------------
1995 (1) 1996 1997 1998 1999-2000
-------------- ------------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
Residential $ 1,323,013 $ 26,421 $ 24,059 $ 25,926 $ 81,108
Home equity 29,024 2,013 - - -
Commercial and multifamily 85,781 7,197 1,506 680 15,723
Real estate construction and ground 32,652 13,993 17,479 1,180 0
Credit card (2) 712,548 41,872 39,411 37,095 70,429
Automobile 39,217 8,178 8,909 9,705 12,425
Other 152,897 21,880 23,169 23,068 29,431
Loans held for sale 68,679 68,679 - - -
Loans held for securitization and sale 500,000 500,000 - - -
-------------- ------------- ------------ ------------ -----------
Total loans receivable (3) $ 2,943,813 $ 690,233 $ 114,533 $ 97,654 $ 209,116
============== ============= ============ ============ ===========
Fixed-rate loans $ 366,988 $ 33,756 $ 35,100 $ 37,750 $ 91,332
Adjustable-rate loans 2,008,146 87,798 79,433 59,904 117,784
Loans held for sale 68,679 68,679 - - -
Loans held for securitization and sale 500,000 500,000 - - -
-------------- ------------- ------------ ------------ -----------
Total loans receivable (3) $ 2,943,813 $ 690,233 $ 114,533 $ 97,654 $ 209,116
============== ============= ============ ============ ===========
<CAPTION>
Approximate Principal Repayments
Due in Years Ending September 30,
-------------------------------------------------
2011 and
2001-2005 2006-2010 Thereafter
-------------- ------------- -------------
<S> <C> <C> <C>
Residential $ 195,282 $ 174,353 $ 795,866
Home equity - - 27,011
Commercial and multifamily 48,060 12,615 -
Real estate construction and ground - - -
Credit card (2) 137,522 101,594 284,625
Automobile - - -
Other 55,349 - -
Loans held for sale - - -
Loans held for securitization and sale - - -
-------------- ------------- -------------
Total loans receivable (3) $ 436,213 $ 288,562 $ 1,107,502
============== ============= =============
Fixed-rate loans $ 144,675 $ 6,356 $ 18,019
Adjustable-rate loans 291,538 282,206 1,089,483
Loans held for sale 0 0 0
Loans held for securitization and sale 0 0 0
-------------- ------------- -------------
Total loans receivable (3) $ 436,213 $ 288,562 $ 1,107,502
============== ============= =============
</TABLE>
________________________________________________________________________________
(1) Of the total amount of loans outstanding at September 30, 1995 which were
due after one year, an aggregate principal balance of approximately $333.2
million had fixed interest rates and an aggregate principal balance of
approximately $1.9 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).
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<PAGE>
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, 1995,
principal repayments of $121.6 million are contractually due to the Bank within
the next year. Of the $121.6 million, $33.8 million is contractually due on
fixed-rate loans and $87.8 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.
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<PAGE>
ORIGINATION, PURCHASE AND SALE OF REAL ESTATE LOANS
---------------------------------------------------
(In thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Year Ended September 30,
------------------------------------------------------------------------
1995 1994 1993
----------------- ----------------- -----------------
<S> <C> <C> <C>
Real estate loan originations and purchases: (1)
Residential and home equity $ 742,560 $ 1,570,155 $ 1,758,484
Commercial and multifamily 4,023 9,582 42,718
Real estate construction and ground 37,510 47,693 41,675
----------------- ----------------- -----------------
Total originations and purchases 784,093 1,627,430 1,842,877
----------------- ----------------- -----------------
Principal repayments (245,376) (389,847) (346,645)
Sales (2) (374,414) (800,506) (785,255)
Loans transferred to real estate acquired
in settlement of loans (9,822) (4,106) (23,158)
Other - (869) -
----------------- ----------------- -----------------
(629,612) (1,195,328) (1,155,058)
Transfers to mortgage-backed securities (3) (156,169) (396,189) (493,973)
----------------- ----------------- -----------------
Increase (decrease) in real estate loans $ (1,688) $ 35,913 $ 193,846
================= ================= =================
</TABLE>
________________________________________________________________________________
(1) Excludes unfunded commitments.
(2) Includes securitization and sale of home equity credit line receivables of
$150.5 millon, $181.9 million and $340.4 million for the years ended
September 30, 1995, 1994 and 1993, respectively.
(3) Represents real estate loans which were pooled and exchanged for FHLMC and
FNMA mortgage-backed securities.
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<PAGE>
As a federally chartered savings institution, the Bank has general
authority to make loans secured by real estate located throughout the United
States. Approximately 96.0% of the Bank's real estate loans at September 30,
1995 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, 1995, approximately $88.5 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 1995, sales of mortgage loans originated or purchased for sale by the
Bank totaled $223.9 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
salability 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, 1995, the Bank had $68.7 million of
single-family residential loans held for sale to investors.
When the Bank sells a whole loan or loan participation and retains
servicing, or purchases mortgage servicing rights from third parties, it
continues to collect and remit loan payments, inspect the properties, make
certain insurance and tax payments on behalf of borrowers and otherwise service
the loans. The normal servicing fee, generally ranging from 0.25% to 0.50% of
the outstanding loan principal amount per annum, is recognized as income over
the life of the loans. The Bank also typically derives income from temporary
investment for its own account of loan collections pending remittance to the
participation or whole loan purchaser. At September 30, 1995, the Bank was
servicing residential permanent loans totaling $1.4 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
-23-
<PAGE>
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, 1995. Fixed-rate loans are designated as held for sale in the Consolidated
Statements of Financial Condition 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, 1995, $1.4 billion (or 48.3%) of the Bank's loan portfolio consisted of
loans secured by first or second mortgages on such properties, including $36.1
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, 1995, 39.3% of the Bank's loans
consisted of ARMs scheduled to have interest rate adjustments within five years.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - 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 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%.
During the current fiscal year, the Bank continued to fulfill its 1994
five-year commitment of $1.0 billion to meet the credit needs of low- and
moderate-income borrowers in the various communities which it serves. As part
of this commitment, the Community Development Mortgage Program is providing
$140.0 million of mortgage financing over a five-year period, with $7.0 million
in subsidies for below-market mortgage loans, to families in minority
neighborhoods in the District of Columbia and Prince George's County, Maryland.
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." The Bank transferred $150.5 million, $181.9 million and $340.4
million of home equity credit line receivables in fiscal 1995, fiscal 1994 and
fiscal 1993, respectively, to trusts for securitization and sale to investors.
Gains of $7.6 million, $9.5 million and $16.8 million were recognized by the
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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 13.3% in fiscal 1995 to $118.4 million at September
30, 1995 from $136.6 million at September 30, 1994. In the past three fiscal
years, the Bank has provided financing, generally at market rates, to certain
purchasers of its commercial REO. Additionally, the Bank finances the
construction of residential real estate, principally single-family detached
homes and townhouses, but generally only when a home is under contract for sale
by the builder to a consumer.
CREDIT CARD LENDING. Chevy Chase provides consumer credit through its
credit card program, which offers VISA(R) and MASTERCARD(R) credit cards and
includes gold and Classic 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 34.4% of Chevy Chase's total loans at September 30, 1995.
according to statistics published in Sheshunoff S&L Quarterly, Chevy Chase is
the second largest issuer of credit cards among thrift institutions, based on
total credit card loans outstanding at March 31, 1995. at September 30, 1995,
credit card loans outstanding totaled $1.0 billion and managed credit card
receivables, including receivables owned by the Bank and receivables
securitized, sold and serviced by the Bank, totaled $4.2 billion.
The Bank emphasizes credit card lending in recent years because the
shorter term and normally higher interest rates on such loans help it maintain a
profitable spread between its average loan yield and its cost of funds. In
addition, credit card accounts typically may be sold at a premium over their
receivables balances, thus further enhancing their potential value to the Bank.
Chevy Chase also believes its credit card program contributes to market share
growth in its local markets by attracting new depositors, promoting a high
degree of customer loyalty and providing opportunities to cross-market other
products of the Bank. For this reason, the Bank has not sold any credit card
accounts maintained by cardholders having addresses in Maryland, Virginia or the
District of Columbia, the Bank's primary market area.
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.
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<PAGE>
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Asset Quality - Delinquent Loans" and "-
Allowances 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.
Certain jurisdictions and their residents may attempt to require out-of-
state credit card issuers to comply with such jurisdictions' consumer protection
laws (including laws limiting the charges imposed by such credit card issuers)
in connection with their operations in such jurisdictions. For example, in
recent years a number of lawsuits and administrative actions have been filed in
several states against out-of-state credit card issuers (including both
federally chartered and state chartered insured depository institutions)
challenging various fees and charges (such as late fees, over-the-limit fees,
returned check fees and annual membership fees) assessed against residents of
the states in which such lawsuits were filed, based on restrictions or
prohibitions under the laws of such states. Several state and federal courts
that have considered this issue have ruled in favor of the issuing institutions;
however, courts in some states, notably Pennsylvania and New Jersey, have
determined that certain laws of those states that prohibit certain fees and
charges are applicable to out-of-state credit card issuers. If it were
determined that out-of-state credit card issuers must comply with a
jurisdiction's laws limiting the charges imposed by credit card issuers, such
action could have an adverse impact on the Bank's credit card operations.
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 and 1991, the Bank sold approximately 150,000 credit card
relationships at a premium over their receivables balances of $96.5 million,
$14.9 million and $273.4 million, respectively. No such sales occurred during
fiscal 1995 and fiscal 1993. The Bank transferred $1.6 billion, $1.4 billion,
$350.0 million and $280.0 million of credit card receivables in fiscal 1995,
fiscal 1994, fiscal 1993 and fiscal 1992, 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.
Chevy Chase plans to securitize an additional $750.0 million of credit card
receivables during the first and second quarters of fiscal 1996. Certain of
these receivables at September 30, 1995 were classified as loans held for
securitization and sale in the Consolidated Statements of Financial Condition 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.
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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, home improvement loans and other unsecured loans for
traditional consumer purchases and needs. The largest areas of recent growth
have been in automobile loans and home improvement loans. During fiscal 1995,
the Bank purchased or originated $256.7 million of automobile loans, which was
offset in part by the transfer of $252.2 million of receivables to a trust for
securitization and sale to investors. Home improvement loans increased $75.2
million during fiscal 1995 as a result of an increase in the number of dealers
selling such loans to the Bank. The Bank's portfolio of automobile loans, home
improvement loans and other consumer loans totaled $239.2 million, $112.7
million and $40.2 million, respectively, at September 30, 1995. Automobile
loans, home improvement loans and other consumer loans (other than credit card
loans) accounted for 13.3% 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
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
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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.
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
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 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. The bank generates new credit card 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 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.
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<PAGE>
OTHER CONSUMER LOAN UNDERWRITING. Other consumer loans (which include
automobile loans and home improvement loans) are originated or purchased by the
Bank after a review by the Bank in accordance with its established underwriting
procedures.
The underwriting procedures are designed to provide a basis for assessing
the borrower's ability and willingness to repay the loan. In conducting this
assessment, the Bank considers the borrower's ratio of debt to income and
evaluates the borrower's credit history through a review of a written credit
report compiled by a recognized consumer credit reporting bureau. The
borrower's equity in the collateral and the terms of the loan are also
considered. The Bank's guidelines are intended only to provide a basis for
lending decisions, and exceptions to such guidelines may, within certain limits,
be made based upon the credit judgment of the Bank's lending officer. The Bank
periodically conducts quality audits to ensure compliance with its established
policies and procedures.
The Bank also makes automobile loans through one of its operating
subsidiaries. The underwriting guidelines for this subsidiary apply to a
category of lending in which loans may be made to applicants who have
experienced certain adverse credit events (and therefore would not necessarily
meet all of the Bank's guidelines for its traditional loan program), but who
meet certain other creditworthiness tests. Such loans may experience higher
rates of delinquencies, repossessions and losses, especially under adverse
economic conditions, compared with loans originated pursuant to the Bank's
traditional lending program. See "Subsidiaries - Operating Subsidiaries."
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 automobile 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.
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The following table sets forth certain information relating to the Bank's
servicing income as of or for the years indicated.
<TABLE>
<CAPTION>
As of or For the Year Ended September 30,
--------------------------------------------------
1995 1994 1993
------------- -------------- --------------
<S> <C> <C> <C>
(In thousands)
Residential ..........................$ 1,350,423 $ 1,495,120 $ 2,022,033
Credit Card .......................... 3,226,316 1,953,792 841,828
Home Equity .......................... 455,791 485,428 530,092
Automobile .......................... 218,287 9,506 29,625
Total amount of loans ------------- --------------- --------------
serviced for others (1) .......... $ 5,250,817 $ 3,943,846 $ 3,423,578
============= =============== ==============
Loan servicing fee
income (2) ..........................$ 184,275 $ 69,878 $ 46,631
============= =============== ==============
</TABLE>
_____________________
(1) The Bank's basis in its servicing rights at September 30, 1995, 1994 and
1993 was $53.3 million, $40.3 million and $47.9 million, respectively.
(2) In each of the years ended September 30, 1995, 1994 and 1993, loan
servicing fee income as a percentage of net interest income before
provision for loan losses was 104.6%, 41.4% and 25.6%, respectively.
The Bank earns fees in connection with the servicing of home equity credit
line loans, credit card loans, automobile loans and single-family residential
mortgage loans. The Bank's level of servicing fee income increases or decreases
with increases or decreases in securitized balances of these loan types. The
substantial increase in loan servicing fee income in fiscal 1995 from the level
achieved in fiscal 1994 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, acquires
mortgage servicing rights either through purchase or origination, or sells
mortgage loans and retains the servicing rights on those loans, the level of
servicing fee income increases. During fiscal 1995, the Bank securitized and
sold $1.6 billion of credit card receivables, $150.5 million of home equity
credit line receivables and $252.2 million of automobile loan receivables. In
fiscal 1995, the Bank also sold the rights to service mortgage loans with an
aggregate principal balance of $148.1 million, which were originated by the Bank
in connection with its mortgage banking activities.
The Bank's investment in loan servicing rights (including purchased and
originated mortgage servicing rights (collectively "mortgage servicing rights")
and excess loan servicing assets), and the amortization of such rights, are
evaluated for impairment. Excess loan servicing assets 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 of these assets are
recorded as a reduction of fee income 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.
In accordance with Statement of Financial Accounting Standards No. 122,
"Accounting for Mortgage Servicing Rights" ("SFAS 122"), the Bank evaluates its
mortgage servicing rights for impairment
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<PAGE>
based on fair value. To measure fair value of its mortgage servicing rights, the
Bank uses either quoted market prices or discounted cash flow analyses using
appropriate assumptions for servicing fee income, servicing fee costs,
prepayment rates and discount rates. Additionally, the Bank stratifies its
capitalized mortgage servicing rights for purposes of evaluating impairment by
taking into consideration relevant risk characteristics, including loan type,
note rate and date of acquisition. See Note 1 to the Consolidated Financial
Statements in this report.
The Bank's current origination fees on its single-family mortgage loans
generally range from 1.0% to 3.0% of the principal amount of the loan. Its
current origination fees on construction and multifamily residential and
commercial real estate loans generally range from 0.5% to 2.0% of the principal
amount of the loan.
Loan origination and commitment fees, and the related costs associated with
making the loans, are deferred in accordance with Statement of Financial
Accounting Standards No. 91, "Accounting for Nonrefundable Fees Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases." For fully
amortizing loans originated for the Bank's portfolio, the net deferred fees are
accreted to interest income over the estimated life of the loans using the
level-yield method. Fees deferred on revolving credit lines or loans which have
no scheduled amortization originated for the Bank's portfolio are accreted to
income over the estimated lives of the underlying loans using the straight-line
method.
Fees deferred on loans originated and held for sale are not accreted to
income but instead are used in determining the gain or loss on the sale of the
loans.
DELINQUENCIES, FORECLOSURES AND ALLOWANCES FOR LOSSES
DELINQUENCIES AND FORECLOSURES. When a borrower fails to make a required
payment on a mortgage loan, the loan is considered delinquent and, after
expiration of the applicable cure period, the borrower is charged a late fee.
the bank follows practices customary in the banking industry in attempting to
cure delinquencies and in pursuing remedies upon default. Generally, if the
borrower does not cure the delinquency within 90 days, the bank initiates
foreclosure action. If the loan is not reinstated, paid in full or refinanced,
the security property is sold. In some instances, the bank may be the
purchaser. Thereafter, 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.
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<PAGE>
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Asset Quality - Delinquent Loans"
for a discussion of the Bank's delinquent loan portfolio at September 30, 1995.
ALLOWANCES FOR LOSSES. It is the Bank's policy to maintain adequate
allowances for estimated losses on loans and real estate. Generally, the
allowances 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. Allowances 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 - Asset Quality - Allowances for Losses."
The Bank's specific methods for establishing the appropriate levels of
allowances vary depending upon the assets involved. The Bank's allowance on
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 allowance 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 allowances
are adjusted accordingly. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition - Asset
Quality - Allowances for Losses."
The Bank's methods for determining the allowance on loans secured by real
estate vary depending on whether the loans are secured by residential homes or
by other real estate. For residential mortgage loans, management computes the
allowance 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 allowances, 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 valuation allowances on 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
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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 allowances for losses.
In addition to the general valuation allowances 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.
Beginning October 1, 1994, the Bank has been providing additional general
valuation allowances, which are equal to, or exceed, the net earnings generated
by the development and sale of land in the Communities. See "Managements'
Discussion and Analyses of Financial Condition and Results of Operations -
Financial Condition - Asset Quality - Allowances for Losses."
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
allowances.
The Bank's individualized asset review takes place within its Asset Review
Committee and the Asset Classification Committee (the "Committee"). The Asset
Review Committee accumulates and analyzes data relating to classified and
potential problem assets of $5.0 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 allowances 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.
The Federal Financial Institution Examination Council, which is composed of
the OTS and the other federal banking agencies, has issued guidelines regarding
the appropriate levels of general valuation allowances that should be maintained
by insured institutions. The Bank believes that its levels of general valuation
allowances at September 30, 1995 comply with the guidelines.
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 valuation allowances or incur additional
charge-offs.
DEPOSITS AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the primary source of the bank's funds for use in
lending and for other general business purposes. In addition to deposits, chevy
chase receives funds from loan repayments and loan sales. Loan repayments are a
relatively stable source of funds, while deposit inflows and
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<PAGE>
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, 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 439 ATMs,
including 129 ATMs located in Safeway Inc. stores and 48 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. These ATMs and installation rights significantly
enhance the Bank's position as a leading provider of convenient ATM service in
its primary market area. The Bank is a member of the 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 213,000
locations worldwide.
The Bank obtains deposits primarily from customers residing in Montgomery
and Prince George's Counties in Maryland and Northern Virginia. Approximately
27.4% of the Bank's deposits at September 30, 1995 were obtained from
depositors residing outside of Maryland, with approximately 12.6% 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.
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<PAGE>
<TABLE>
<CAPTION>
DEPOSIT ANALYSIS
----------------
(DOLLARS IN THOUSANDS)
- -----------------------------------------------------------------------------------------------------------------------------------
September 30,
-----------------------------------------------------------------------------------------------------
1995 1994 1993
----------------------------- ------------------------------- -----------------------------------
% of % of % of
Balance Total Balance Total Balance Total
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Demand and NOW accounts $ 950,118 22.8% $ 918,227 22.9% $ 835,084 21.6%
Money market deposit
accounts 984,257 23.7 1,104,730 27.6 1,196,690 30.9
Statement savings accounts 872,366 21.0 1,201,141 30.0 941,289 24.3
Jumbo certificate accounts 219,304 5.3 85,110 2.1 56,218 1.5
Other certificate accounts 1,072,196 25.8 641,857 16.0 790,465 20.4
Other deposit accounts 61,011 1.4 57,696 1.4 50,277 1.3
------------ -------- -------------- ------- --------------- -------
Total deposits 4,159,252 100.0% 4,008,761 100.0% 3,870,023 100.0%
======== ======= =======
Deferred premium on
certificate accounts - - -
------------ -------------- ---------------
Total $ 4,159,252 $ 4,008,761 $ 3,870,023
============ ============== ===============
<CAPTION>
September 30
----------------------------------------------------------------
1992 1991
------------------------------ -------------------------------
% of % of
Balance Total Balance Total
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Demand and NOW accounts $ 743,214 19.0% $ 729,559 17.1%
Money market deposit
accounts 1,292,779 33.0 1,364,390 32.0
Statement savings accounts 690,328 17.6 595,181 14.0
Jumbo certificate accounts 42,423 1.1 128,288 3.0
Other certificate accounts 1,099,833 28.1 1,400,853 32.9
Other deposit accounts 47,381 1.2 44,759 1.0
------------- ------- ------------- -------
Total deposits 3,915,958 100.0% 4,263,030 100.0%
======= =======
Deferred premium on
certificate accounts - 3
------------- -------------
Total $ 3,915,958 $ 4,263,033
============= =============
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
AVERAGE COST OF DEPOSITS
- -----------------------------------------------------------------------------------------------------------------------------------
Year Ended September 30,
------------------------------------------------------------------------
1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Demand and NOW accounts 2.71% 2.74% 2.47%
Money market accounts 3.96% 3.24% 3.17%
Statement savings and
other deposit accounts 3.35% 3.37% 3.25%
Certificate accounts 5.17% 3.96% 4.33%
Total deposit accounts 3.84% 3.31% 3.35%
======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE>
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. During
fiscal 1995, the Bank periodically solicited brokered deposits through entities
registered with the FDIC as deposit brokers. Under FDIC regulations, the Bank
is permitted to accept brokered deposits as long as it remains well capitalized
or (with FDIC approval) adequately capitalized under the prompt correction
action regulations.
The following table sets forth Chevy Chase's deposit flows during the
periods indicated.
<TABLE>
<CAPTION>
Deposit Flows
Year Ended September 30,
-------------------------------------------------------
(In thousands)
1995 1994 1993
------------------ --------------- -------------
<S> <C> <C> <C>
Deposits ................... $ 14,086,575 $ 12,308,342 $ 10,801,085
Withdrawals from
accounts .................. (14,089,444) (12,305,196) (10,985,541)
------------ --------------- ---------------
Net cash from
accounts .................. (2,869) 3,146 (184,456)
Interest credited to
accounts ................... 153,360 135,592 138,521
------------ --------------- ---------------
Net increase (decrease)
in deposit balances ........ $ 150,491 $ 138,738 $ (45,935)
============ =============== ===============
</TABLE>
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, 1995 which will mature during
the fiscal years indicated.
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<PAGE>
WEIGHTED AVERAGE INTEREST RATES OF DEPOSITS
---------------------------------------------
AS OF SEPTEMBER 30, 1995
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
DEMAND, NOW
AND MONEY MARKET STATEMENT PASSBOOK AND OTHER CERTIFICATE
DEPOSIT ACCOUNTS SAVINGS ACCOUNTS CORE ACCOUNTS ACCOUNTS
------------------------ ------------------------ ------------------------ -----------------------
MATURING DURING WEIGHTED WEIGHTED WEIGHTED WEIGHTED
YEAR ENDING AVERAGE AVERAGE AVERAGE AVERAGE
SEPTEMBER 30, AMOUNT RATE AMOUNT RATE AMOUNT RATE AMOUNT RATE
- ------------- ------------ ---------- ----------- ---------- ------------ --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1996 $ 1,934,375 3.29 % $ 872,366 3.48 % $ 61,011 2.98 % $ 885,430 5.68
1997 - - - - - - 224,455 6.09
1998 - - - - - - 66,429 5.97
1999 - - - - - - 29,078 5.43
2000 - - - - - - 86,108 6.71
------------ ----------- ------------ ------------
Total $ 1,934,375 3.29 % $ 872,366 3.48 % $ 61,011 2.98 % $ 1,291,500 5.83%
============ =========== ============ ============
<CAPTION>
TOTAL
------------------------------
MATURING DURING WEIGHTED
YEAR ENDING AVERAGE
SEPTEMBER 30, AMOUNT RATE
- ------------- ------------ ----------
<S> <C> <C>
1996 $ 3,753,182 3.89 %
1997 224,455 6.09
1998 66,429 5.97
1999 29,078 5.43
2000 86,108 6.71
------------
$ 4,159,252 4.11 %
============
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE>
The following table summarizes maturities of certificate accounts in
amounts of $100,000 or greater as of September 30, 1995.
<TABLE>
<CAPTION>
Year Ending September 30, Amount Weighted Average Rate
- -------------------------- ------ ---------------------
(Dollars in thousands)
<S> <C> <C>
1996 ....................... $ 143,572 5.89%
1997 ....................... 20,397 6.55%
1998 ....................... 4,194 5.73%
1999 ....................... 3,500 5.30%
2000 ....................... 7,020 6.81%
----------
Total $ 178,683 5.99%
========== =====
</TABLE>
The following table represents the amounts of deposits by various interest
rate categories as of September 30, 1995 maturing during the fiscal years
indicated.
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<PAGE>
MATURITIES OF DEPOSITS BY INTEREST RATES
----------------------------------------
AS OF SEPTEMBER 30, 1995
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ACCOUNTS MATURING DURING YEAR ENDING SEPTEMBER 30,
--------------------------------------------------------------------------------------------------------
INTEREST RATE 1996 1997 1998 1999 2000
---------------- ---------------- ---------------- ----------------- --------------
<S> <C> <C> <C> <C> <C>
Demand deposits (0%) $ 123,141 $ - $ - $ - $ -
0.00% to 1.99% 413 - - - -
2.00% to 2.99% 30,304 - - - -
3.00% to 3.99% 2,101,543 - - - -
4.00% to 4.99% 733,662 17,383 1,351 - -
5.00% to 5.99% 368,320 52,839 27,490 25,102 1,212
6.00% to 7.99% 395,766 154,233 37,560 3,976 84,896
8.00% to 9.99% 33 - 28 - -
---------------- ---------------- ---------------- ---------------- --------------
Total $ 3,753,182 $ 224,455 $ 66,429 $ 20,078 $ 86,108
================ ================ ================ ================ ==============
<CAPTION>
ACCOUNTS MATURING DURING YEAR ENDING SEPTEMBER 30,
- -------------------------------------------------------------------------------
INTEREST RATE TOTAL
---------------
Demand deposits (0%) $ 123,141
0.00% to 1.99% 413
2.00% to 2.99% 30,304
3.00% to 3.99% 2,101,543
4.00% to 4.99% 752,396
5.00% to 5.99% 474,963
6.00% to 7.99% 676,431
8.00% to 9.99% 61
---------------
Total $ 4,159,252
===============
</TABLE>
- ------------------------------------------------------------------------------
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<PAGE>
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, credit may be extended to
creditworthy institutions based upon the financial condition, and the adequacy
of collateral pledged to secure the extension of credit. Such extensions of
credit or 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 outstanding FHLB advances of $155.1 million
at September 30, 1995.
From time to time, the Bank enters into repurchase agreements, which are
treated as financings. The Bank sells securities (usually 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, 1995.
-40-
<PAGE>
The following table sets forth a summary of the repurchase agreements of
the Bank as of the dates and for the years indicated.
<TABLE>
<CAPTION>
September 30,
----------------------------------
1995 1994
------------- ------------
Securities sold under repurchase (Dollars in thousands)
agreements:
<S> <C> <C>
Balance at year-end............................ $ - $ -
Average amount outstanding during
the year...................................... 159,044 103,299
Maximum amount outstanding at any
month-end..................................... 353,615 202,256
Weighted average interest rate
during year................................... 6.02% 3.78%
Weighted average interest rate on
year - end balance.......................... - % - %
</TABLE>
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 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
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, 1995, 2.0% and 3.0% of the Bank's assets was equal to $98.9
million and $148.4 million, respectively, and the Bank had $22.8 million
invested in its service corporation subsidiaries, $5.1 million of which was in
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<PAGE>
the form of conforming loans. The Bank is required to provide 30 days advance
notice to the OTS and to the FDIC before establishing a new subsidiary or
conducting a new activity in an existing subsidiary. 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")
previously engaged in certain real estate development activities as the result
of activities commenced prior to the enactment of FIERRA and continues to manage
the two remaining assets it holds. As a result of the stringent capital
requirements that FIERRA 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. In fiscal 1995, Manor sold two of its largest projects. See
"Management's Discussion And Analysis of Financial Condition and Results of
Operations - Financial Condition - Asset Quality."
SECURITIES BROKERAGE SERVICES. Chevy Chase Securities, Inc., a licensed
broker-dealer, sells 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, 1995, Chevy Chase owned 20
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 $252.2
million at September 30, 1995. The Bank's investments in these subsidiaries
are not subject to the 3.0% service corporation investment limit discussed
above. See "Regulation - Regulatory Capital."
OPERATING SUBSIDIARIES. 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 two credit card trusts formed by the Bank and certain
other related assets. Consumer Finance Corporation was formed as an operating
subsidiary in December 1994 to engage in automobile lending.
EMPLOYEES
The Bank and its subsidiaries had 2,905 full-time and 687 part-time
employees at September 30, 1995. 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.
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<PAGE>
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 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 three
depository institutions in the origination of home equity credit line loans. At
June 30, 1995, according to preliminary published industry statistics, Chevy
Chase had the largest market share (approximately 19.6%) 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.
FEDERAL TAXATION
Savings institutions, such as the Bank, generally are taxed in the same
manner as other corporations. There are, however, several special rules that
apply principally to savings institutions (and, in some cases, other financial
institutions). Certain significant aspects of the federal income taxation of
the Bank are discussed below.
GENERAL. 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. Each member of an affiliated group of corporations which files
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<PAGE>
consolidated income tax returns is liable for the group's federal income tax
liability.
The Internal Revenue Service ("IRS") is currently conducting audits of the
federal income tax returns of the Trust for the taxable years ended September
30, 1992 and September 30, 1993.
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," including cash, certain U.S. and state government securities,
obligations of certain deposit insurance corporations, loans secured by
interests in residential real property and loans made for the improvement of
residential real property.
A qualifying thrift generally may compute the amount of the addition to the
reserve for losses on qualifying real property loans under the more favorable of
either 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., 8.0%) 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 fiscal 1995, approximately $81.7 million) into taxable
income. In addition, the Bank would be allowed to deduct only those bad debts
that actually were incurred 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 ("GAAP").
The Balanced Budget Act of 1995, which was passed by Congress but vetoed by
President Clinton on December 6, 1995, contained provisions that would have
repealed the special bad debt reserve methods used by thrift institutions so
that in future taxable years thrifts (like banks) generally would be able to
deduct only those bad debts actually incurred during the taxable year. This
legislation also would have required thrifts to recapture and pay tax on bad
debt reserves accumulated since 1987 ("excess base year reserves") over a six
year period, beginning with a thrift's first taxable year starting after
December 31, 1995 (or, if the thrift meets a mortgage origination test,
beginning up to two years later. Reserves accumulated prior to 1988 would not
have been recaptured under this legislation. Should this legislation ultimately
be enacted into law in its current form, it would not have a material impact on
the Bank's financial statements.
CONSOLIDATED TAX RETURNS; TAX SHARING PAYMENTS. In recent years, the
operations of the Trust have generated significant net operating losses. The
Bank's taxable income in the current year was sufficient to fully utilize all
net operating loss carryforwards and current year losses of the Trust. under
the terms of a tax sharing agreement dated June 28, 1990 (the "Tax Sharing
Agreement"), the Bank is obligated to make payments to the Trust based on its
taxable income, as explained more fully below. However, the terms of the Bank's
written agreement with the OTS reflect the Bank's agreement 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
-44-
<PAGE>
generally must be paid even if the affiliated group has no tax liability or the
group's tax liability is less than the sum of such amounts. Under the Tax
Sharing Agreement, the Trust, in turn, is obligated to pay to the applicable
taxing authorities the overall tax liability, if any, of the group. In addition,
to the extent the net operating losses or tax credits of a particular member
reduce the overall tax liability of the group, the Trust is required to
reimburse such member on a dollar-for-dollar basis, thereby compensating the
member for the group's use of its net operating losses or tax credits.
The Bank made tax sharing payments of $20.5 million in fiscal 1995. OTS
approval of the tax sharing payments 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. At September 30, 1995, the amount of tax sharing
payments due from the Bank to the Trust, but unpaid at that date, was $17.7
million. Subsequent to September 30, 1995, with OTS approval, the Bank made a
tax sharing payment of $10.0 million to the Trust. It is expected that the Bank
will have taxable income in future years and that the Trust's NOLs and
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).
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 extension of credit by the
Bank to the Trust which, as described above under "Regulation - 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, 1995, $17.7 million of
tax sharing payments was due from the Bank to the Trust (of which $10.0 million
was subsequently paid to the Trust). Any reimbursement obligation of the Trust
should be available to be offset against any obligation of the Bank to the Trust
under the Tax Sharing Agreement that is unpaid at the time the reimbursement
obligation arises.
The Bank, as a member of an affiliated group of corporations filing
consolidated income tax returns, is liable under the Internal Revenue Code for
the group's tax liability. Although the Bank would be entitled to reimbursement
under the Tax Sharing Agreement for tax paid with respect to the income of other
members of the affiliated group, there can be no assurance that the Trust or
other members would be able to fulfill this obligation.
STATE TAXATION
Maryland law does not allow the filing of consolidated income tax returns,
and thus the Trust and its subsidiaries, which includes the Bank, subject to
Maryland income tax are required to file separately in Maryland. The Trust and
its subsidiaries are also subject to income taxes in other states, some of which
allow or require combined or consolidated filing. The Commonwealth of Virginia
is currently conducting audits of the consolidated state income tax returns of
the Trust for the taxable years ended September 30, 1991, September 30, 1992 and
September 30, 1993.
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<PAGE>
ITEM 2. PROPERTIES
At September 30, 1995, 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, 5310 and 5340 Spectrum Drive, Frederick, Maryland and
7430 New Technology Way, Frederick, Maryland; its office facilities at 7700 Old
Georgetown Road, Bethesda, Maryland; 7926 Jones Branch Drive, McLean, Virginia
and 88 full-service offices located in Maryland, Virginia and the District of
Columbia. On that date, the Bank owned the building and land for 16 of its
branch offices and leased its remaining 72 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 1996 to 2019 and the ground leases have terms
expiring from 2029 to 2080. See Note 11 to the Consolidated Financial
Statements in this report for lease expense and commitments.
At November 30, 1995, the Bank had received OTS approval to open six
additional branches. The branches, two in Virginia and four in Maryland, are
scheduled to open during fiscal 1996.
The following table sets forth the location of the Bank's 88 full-service
offices at September 30, 1995.
8401 Connecticut Avenue 7340 Westlake Terrace
Chevy Chase, MD 20815 Bethesda, MD 20817
5424 Western Avenue 11261 New Hampshire Avenue
Chevy Chase, MD 20815 Silver Spring, MD 20904
13641 Connecticut Avenue 1327 Lamberton Drive
Wheaton, MD 20906 Silver Spring, MD 20902
8401 Georgia Avenue 1661 Rockville Pike
Silver Spring, MD 20910 Rockville, MD 20852
4701 Sangamore Road 2215 Bel Pre Road
Bethesda, MD 20816 Wheaton, MD 20906
Landover Mall 2807 University Blvd. West
Landover, MD 20785 Kensington, MD 20895
11325 Seven Locks Road 11305 Rockville Pike
Potomac, MD 20854 Kensington, MD 20895
6200 Annapolis Road 7500 Old Georgetown Road
Landover Hills, MD 20784 Bethesda, MD 20814
33 West Franklin Street 26001 Ridge Road
Hagerstown, MD 21740 Damascus, MD 20872
6400 Belcrest Road 5370 Westbard Avenue
Hyattsville, MD 20782 Bethesda, MD 20816
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<PAGE>
8740 Arliss Street 3601 St. Barnabas Road
Silver Spring, MD 20901 Silver Hill, MD 20746
2409 Wootton Parkway 17831 Georgia Avenue
Rockville, MD 20850 Olney, MD 20832
8889 Woodyard Road 6107 Greenbelt Road
Clinton, MD 20735 Berwyn Heights, MD 20740
1181 University Boulevard 4 Bureau Drive
Langley Park, MD 20783 Gaithersburg, MD 20878
12921 Wisteria Drive 19610 Club House Road
Germantown, MD 20874 Gaithersburg, MD 20879
1009 West Patrick Street 812 Muddy Branch Road
Frederick, MD 21701 Gaithersburg, MD 20878
7937 Ritchie Hwy. 10211 River Road
Glen Burnie, MD 21061 Potomac, MD 20854
19781 Frederick Road 12331-C Georgia Avenue
Germantown, MD 20874 Wheaton, MD 20906
16823 Crabbs Branch Way 14113 Baltimore Avenue
Rockville, MD 20855 Laurel, MD 20707
2331-A Forest Drive 7290-A Cradlerock Way
Annapolis, MD 21401 Columbia, MD 21045
3244 Superior Lane 1151 Maryland Route 3 North
Bowie, MD 20716 Gambrills, MD 21054
20000 Goshen Road 12228 Viers Mill Road
Gaithersburg, MD 20879 Silver Spring, MD 20906
12097 Rockville Pike 317 Kentlands Blvd.
Rockville, MD 20852 Gaithersburg, MD 20878
10159 New Hampshire Avenue 215 N. Washington Street
Hillandale, MD 20903 Rockville, MD 20850
6264 Central Avenue 1336 Crain Highway South
Seat Pleasant, MD 20743 Mitchellville, MD 20716
7700 Old Georgetown Road 543 Ritchie Highway
Bethesda, MD 20814 Severna Park, MD 21146
15777 Columbia Pike 4745 Dorsey Hall Drive
Burtonsville, MD 20866 Ellicott City, MD 21043
18104 Town Center Drive 1130 Smallwood Drive
Olney, MD 20832 Waldorf, MD 20603
6197 Oxon Hill Road 10985 Baltimore Avenue
Oxon Hill, MD 20745 Beltsville, MD 20705
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<PAGE>
980 E. SwanCreek Road 1040 Largo Center Drive
Fort Washington, MD 20744 Landover, MD 20785
1 Catoctin Circle 14245-R Lee Highway
Leesburg, VA 22075 Centreville, VA 22020
8251 Greensboro Drive 1100 W. Broad Street
McLean, VA 22102 Falls Church, VA 22046
234 Maple Avenue East 3941 Pickett Road
Vienna, VA 22180 Fairfax, VA 22031
8436 Old Keene Mill Road 1401 Chain Bridge Road
Springfield, VA 22152 McLean, VA 22101
75 West Lee Highway 12002 N. Shore Drive
Warrenton, VA 22186 Reston, VA 22090
6212 Leesburg Pike 8120 Sudley Road
Falls Church, VA 22044 Manassas, VA 22110
11800 Sunrise Valley Drive 1100 S. Hayes Street
Reston, VA 22091 Arlington, VA 22202
2952-H Chain Bridge Road 13344-A Franklin Farm Road
Oakton, VA 22124 Herndon, VA 22071
6756 Richmond Highway 20970 Southbank Street
Alexandria, VA 22306 Sterling, VA 20165
5613 Stone Road 21800 Town Center Plaza
Centerville, VA 22020 Sterling, VA 22170
44151 Ashburn Village Way 7030 Little River Turnpike
Ashburn, VA 22011 Annandale, VA 22003
3537 S. Jefferson Street 210 Michigan Avenue, N.E.
Bailey's Crossroads, VA 22041 Washington, DC 20017
2626-T Naylor Road 4455 Connecticut Avenue, N.W.
Washington, D.C. 20020 Washington, D.C. 20008
4860 Massachusetts Avenue, N.W. 318A Riggs Road, N.E.
Washington, D.C. 20016 Washington, D.C. 20011
At September 30, 1995, the net book value of the Bank's office facilities
(including leasehold improvements) was $115.0 million. See Note 10 to the
Consolidated Financial Statements in this report.
The Bank currently plans to build facilities in Frederick, Maryland and in
Laurel, Maryland to consolidate the Bank's employees and operations in those
areas. At September 30, 1995, the Bank had invested $4.8 million in the land
and $3.2 million for capital expenditures relating to these facilities.
During fiscal 1995, the Bank transferred an office building, which was
previously classified as real estate held for investment, to property and
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<PAGE>
equipment. Management plans to use a significant portion of the building to
satisfy the Bank's current and anticipated need for additional office space.
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 and data processing
equipment. At September 30, 1995, these other assets had a net book value of
$59.7 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.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Bank 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,
and certain employment claims. In the opinion of management, litigation which
is currently pending will not have a material impact on the financial condition
or future operations of the Bank.
In August 1994, Chevy Chase and its subsidiary, B. F. Saul Mortgage Company
(together, the "Companies"), entered into an agreement with the United States
Department of Justice (the "Department") 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
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders of the Bank during
the fourth quarter of the fiscal year ended September 30, 1995.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
There is no public market in the Bank's common stock. The common stock is
held of record by three stockholders. See "Security Ownership of Certain
Beneficial Owners and Management - Common Stock."
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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data of the Bank herein have been derived from the
Consolidated Financial Statements of the Bank, which statements have been
audited by Arthur Andersen LLP, independent public accountants, as indicated by
their report with respect thereto included elsewhere in this report. 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 herein.
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<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
----------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
AS OF OR FOR THE YEAR ENDED SEPTEMBER 30,
---------------------------------------------------------------------------
1995 1994 1993 1992 1991
------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance sheet data:
Total assets $ 4,947,995 $ 4,703,788 $ 4,918,795 $ 5,062,619 $ 4,904,104
Mortgage-backed securities 880,208 1,025,525 1,501,192 1,599,959 443,714
Loans receivable, net 2,327,286 2,357,721 1,861,128 1,635,218 2,537,435
Loans held for sale 68,679 33,598 176,504 175,698 51,734
Loans held for securitization and sale 500,000 115,000 300,000 350,000 533,628
Reserve for losses on loans 60,496 50,205 68,040 78,818 89,745
Real estate held for investment or sale, net 222,860 330,002 387,583 521,051 563,261
Reserve for losses on real estate held for
investment or sale 135,236 118,973 111,644 109,044 57,498
Cost in excess of net assets acquired, net 44,528 48,637 52,650 56,348 60,045
Mortgage servicing rights, net 28,369 15,075 20,288 12,787 13,962
Deposit accounts 4,159,252 4,008,761 3,870,023 3,915,958 4,263,033
Securities sold under repurchase
agreements and other short - term borrowings 10,435 8,907 88,266 450,321 3,459
Bonds payable - 24,030 24,605 25,130 25,605
Notes payable 7,514 7,729 7,925 8,640 10,354
Federal Home Loan Bank advances 155,052 100,000 412,000 275,000 200,000
Capital notes-subordinated 160,000 160,000 138,500 138,500 138,500
Stockholders' equity 328,544 289,956 284,794 177,430 156,389
Non-performing assets 247,185 311,898 372,031 517,639 594,069
Selected ratios:
Earnings (loss) per common share $ 2,757.20 $ 1,929.00 $ 3,549.50 $ 2,104.10 $ (1,028.50)
Return on average assets 0.76% 0.58% 0.77% 0.44% -0.20%
Return on average stockholders' equity 12.66% 9.62% 16.20% 11.87% -5.64%
Average stockholders' equity to average assets 5.98% 6.07% 4.72% 3.67% 3.49%
Net loan charge-offs to average loans 1.51% 1.74% 3.33% 4.04% 3.60%
Non-performing assets, net to total assets 3.77% 5.35% 5.97% 8.37% 10.20%
Net yield on interest earning assets 4.24% 4.06% 4.60% 4.99% 3.80%
Average interest-earning assets to
average interest-bearing liabilities 91.91% 90.81% 86.43% 82.81% 85.73%
Regulatory capital ratios:
Tangible 5.77% 4.96% 4.60% 2.22% 1.58%
Core (or leverage) 5.77% 5.34% 5.35% 3.22% 2.82%
Tier 1 risk-based 6.65% 6.95% 7.29% N/A N/A
Total risk-based 11.63% 12.19% 11.70% 7.72% 5.51%
Full service banking facilities 88 81 74 73 74
Full service mortgage banking facilities 18 17 17 13 12
</TABLE>
- --------------------------------------------------------------------------------
-51-
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
----------------------------------------
(In thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------------------------------------------
1995 1994 1993 1992 1991
------------- ------------- ------------- ------------- -------------------
<S> <C> <C> <C> <C> <C>
Interest income $ 365,336 $ 334,460 $ 349,537 $ 403,559 $ 487,221
Interest expense 189,114 165,544 167,518 214,761 325,711
------------ ----------- ------------ ---------- -----------------
Net interest income 176,222 168,916 182,019 188,798 161,510
Provision for loan losses 54,979 29,222 60,372 86,453 143,544
Net interest income after ------------ ----------- ----------- ---------- -----------------
provision for loan losses 121,243 139,694 121,647 102,345 17,966
------------ ----------- ----------- ---------- -----------------
Non-interest income:
Credit card fees, loan servicing
fees and deposit servicing fees 218,572 111,279 91,216 92,291 105,441
Gain on sales of investment securities,net - - 8,895 - 1,159
Gain (loss) on sales of trading (600) 1,695 - - 11,651
securities, net
Earnings (loss) on real estate held
for investment or sale, net (4,672) 1,326 (12,722) (50,649) (47,339)
Gain on sales of credit card
relationships, loans and mortgage-
backed securities, net 12,882 30,522 31,338 38,716 69,096
Gain on sales of mortgage servicing
rights, net 1,397 5,833 4,828 3,750 9,633
Other 5,923 9,885 7,161 10,766 12,133
------------ -------------- ------------ ------------ ------------------
Total non-interest income 233,502 160,540 130,716 94,874 161,774
------------ -------------- ------------ ------------ ------------------
Non-interest expense:
Salaries and employee benefits 108,432 87,390 69,739 62,725 78,344
Marketing expenses 46,117 46,441 15,138 4,632 6,831
Other non-interest expense 145,544 113,739 103,492 91,718 100,399
------------ -------------- ------------ ------------ ------------------
Total non-interest expense 300,093 247,570 188,369 159,075 185,574
------------ -------------- ------------ ------------ ------------------
Income (loss) before income taxes,
extraordinary items and cumulative
effect of change in
accounting principle 54,652 52,664 63,994 38,144 (5,834)
Provision for income taxes 17,330 22,394 26,603 17,103 4,451
Extraordinary loss on early - (6,333) - - -
extinguishment of debt
Cumulative effect of change in
accounting for income taxes - 5,103 - - -
------------ ----------- ---------- ---------- ----------------
Net income (loss) $ 37,322 $ 29,040 $ 37,391 $ 21,041 $ (10,285)
============ =========== ========== ========== ================
</TABLE>
- --------------------------------------------------------------------------------
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL CONDITION
GENERAL. The Bank recorded income before income taxes, extraordinary item
and cumulative effect of change in accounting principle of $54.7 million and net
income of $37.3 million during fiscal 1995, compared to income before income
taxes, extraordinary item and cumulative effect of change in accounting
principle of $52.7 million and net income of $29.0 million, respectively, in
fiscal 1994. The increase in income for fiscal 1995 resulted primarily from the
continued expansion of the Bank's credit card program and other loan products
and services, which contributed to the $114.4 million increase in loan servicing
fees over the prior year. The operating results for the current year also
reflected an increase in net interest income. The positive effect of these
items on income was partially offset by a $52.5 million increase in operating
expenses and a $25.8 million increase in the provision for loan losses resulting
from increased consumer and credit card loan originations. See "Results Of
Operations."
At September 30, 1995, the Bank's tangible, core, tier 1 risk-based and
total risk-based regulatory capital ratios were 5.77%, 5.77%, 6.65% and 11.63%,
respectively. The Bank's capital ratios exceeded the requirements under FIRREA
as well as the standards established for "well capitalized" institutions under
the prompt corrective action regulations issued pursuant to FDICIA. On the
basis of its balance sheet at September 30, 1995, the Bank met the FIRREA-
mandated fully phased-in capital requirements and, on a fully phased-in basis,
met the capital standards established for "well capitalized" institutions under
the prompt corrective action regulations. See "Capital."
Effective July 1, 1995, the Bank adopted Statement of Financial Accounting
Standards ("SFAS") No. 122, "Accounting for Mortgage Servicing Rights" ("SFAS
122"), an amendment of SFAS No. 65, "Accounting for Certain Mortgage Banking
Activities." SFAS 122 requires that a mortgage banking enterprise recognize, as
separate assets, rights to service mortgage loans for others, however those
servicing rights are acquired. SFAS 122 also requires that a mortgage banking
enterprise evaluate its mortgage servicing rights for impairment based upon fair
value. See "Summary of Significant Accounting Policies" in the Notes to the
Consolidated Financial Statements in this report.
SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments" ("SFAS 119"), was issued in October 1994. This
new statement requires certain disclosures about financial derivatives,
including amounts, nature and terms of the instruments. Disclosures required by
SFAS 119 are effective for fiscal years ended after December 15, 1994 and are
therefore reflected in the Bank's audited financial statements. See "Summary of
Significant Accounting Policies" and "Financial Instruments" in the Notes to the
Consolidated Financial Statements in this report.
The Bank's assets are subject to review and classification by the OTS upon
examination. The OTS is currently conducting an examination of the Bank.
ASSET QUALITY. Non-Performing Assets. The Bank's level of non-performing
---------------------
assets continued to decline during fiscal 1995. The following table sets forth
information concerning the Bank's non-performing assets at the dates indicated.
The figures shown are after charge-offs and, in the case of real estate acquired
in settlement of loans, after all valuation allowances.
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<PAGE>
NON-PERFORMING ASSETS
---------------------
(Dollars in Thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30,
------------------------------------------------------------------------
1995 1994 1993 1992 1991
------------ ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Non-Peforming assets:
Non-accrual loans:
Residential $ 8,593 $ 8,306 $ 9,108 $ 12,865 $ 17,913
Commercial and multifamily 194 - - 3,694 -
Residential construction and ground - - - 11,196 30,469
Commercial construction and ground - - - 3,413 15,629
------------ ----------- ----------- ----------- -----------
Total non-accrual real estate loans 8,787 8,306 9,108 31,168 64,011
Credit card 18,569 16,229 20,557 26,780 33,682
Consumer and other 595 498 314 3,572 3,331
------------ ----------- ----------- ----------- -----------
Total non-accrual loans (1) 27,951 25,033 29,979 61,520 101,024
------------ ----------- ----------- ----------- -----------
Non-accrual real estate held for investment (1) - 8,915 8,898 8,892 8,892
------------ ----------- ----------- ----------- -----------
Real estate acquired in settlement of loans 354,277 387,024 434,616 541,352 537,490
Reserve for losses on real estate acquired in
settlement of loans (135,043) (109,074) (101,462) (94,125) (53,337)
------------ ----------- ----------- ----------- -----------
Real estate acquired in settlement of loans, net 219,234 277,950 333,154 447,227 484,153
------------ ----------- ----------- ----------- -----------
Total non-performing assets $ 247,185 $ 311,898 $ 372,031 $ 517,639 $ 594,069
============ =========== =========== =========== ===========
Reserve for losses on loans $ 60,496 $ 50,205 $ 68,040 $ 78,818 $ 89,745
Reserve for losses on real estate held for
investment 193 9,899 10,182 14,919 4,161
Reserve for losses on real estate acquired in
settlement of loans 135,043 109,074 101,462 94,125 53,337
------------ ----------- ----------- ----------- -----------
Total reserves for losses $ 195,732 $ 169,178 $ 179,684 $ 187,862 $ 147,243
============ =========== =========== =========== ===========
</TABLE>
________________________________________________________________________________
(1) Before deductions of reserves for losses.
<PAGE>
NON-PERFORMING ASSETS (CONTINUED)
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------------------------------------------------------
1995 1994 1993 1992 1991
--------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C>
RATIOS:
Non-performing assets, net to total assets (1)(4) 3.77% 5.35% 5.97% 8.37% 10.20%
Reserve for losses on real estate loans to
non-accrual real estate loans (2) 123.82% 169.58% 219.29% 53.16% 23.72%
Reserve for losses on credit card loans to
non-accrual credit card loans (2) 249.47% 212.77% 228.08% 214.96% 209.73%
Reserve for losses on consumer and other
loans to non-accrual consumer
and other loans (2) 553.11% 319.28% 376.11% 131.10% 117.68%
Reserve for losses on losses to non-accrual
loans (2) 216.44% 200.56% 226.96% 128.12% 88.84%
Reserve for losses on loans to total loans
receivable (3) 2.05% 1.97% 2.83% 3.52% 2.79%
</TABLE>
- --------------------------------------------------------------------------------
(1) Non-performing assets is presented after all reserves for losses on loans
and real estate held for investment or sale.
(2) Before deduction of reserves for losses.
(3) Includes loans receivable and loans held for sale and/or securitization,
before deduction of reserve for losses.
(4) In November 1995, the Bank sold approximately 2,000 residential lots in the
Communities to a single purchaser. If this sale had occured prior to
September 30, 1995, the ratio of non-performing assets, met to total asssets
would have been 2.77% at September 30, 1995. See "Disposition of REO."
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<PAGE>
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 No. 114, "Accounting by
Creditors for Impairment of a Loan," in fiscal 1994).
Non-performing assets totaled $247.2 million, after valuation allowances on
REO of $135.0 million, at September 30, 1995, compared to $311.9 million, after
valuation allowances on REO of $109.1 million, at September 30, 1994. In
addition to the valuation allowances on REO, the Bank maintained $2.3 million of
valuation allowances on its non-accrual loans at September 30, 1995, compared
to $4.0 million of valuation allowances on its non-accrual loans and non-accrual
real estate held for investment at September 30, 1994. The decrease in non-
performing assets was primarily attributable to a net decrease in REO of $58.7
million. During fiscal 1995, non-accrual REI with a balance of $6.7 million at
September 30, 1995 was transferred to REO. See "Real Estate Held for
Investment."
The Bank's non-performing real estate assets, which include non-accrual
real estate loans, REO and non-accrual REI, totaled $228.0 million at September
30, 1995, or 92.2% 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 $227.6 million at September 30, 1995, reflecting both
additional write-downs on non-performing assets during that period and, in more
recent periods, asset sales.
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<PAGE>
Decline in Non-Performing
-------------------------
Real Estate Assets
------------------
<TABLE>
<CAPTION>
Total
Valuation
Allowances
on Non
Accrual Cumulative
Total Non- Real Estate Total Non- Decline from
Performing Loans and Performing February 29, 1992
-----------------
Real Estate Non-Accrual Real Estate Amount Percent
Assets (1) REI (2) Assets, net ------- -------
---------- ------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
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%
December 31, 1994............ 283,375 2,388 280,987 (286,622) -50.5%
March 31, 1995............... 270,546 2,407 268,139 (299,470) -52.8%
June 30, 1995................ 240,243(3) 348(3) 239,895 (327,714) -57.7%
September 30, 1995........... 228,021(3)(4) 439(3) 227,582 (340,027) -59.9%
</TABLE>
_____________________
(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.
(3) The Bank had no non-accrual REI at these dates.
(4) In November, 1995, the Bank sold approximately 2,000 residential lots in
the Communities to a single purchaser. If this sale had occurred prior to
September 30, 1995, total non-performing assets would have been $178.9
million. See "Disposition of REO."
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<PAGE>
At September 30, 1995, $209.5 million or 91.9% of the Bank's total non-
performing real estate assets related to residential real estate properties,
including the Bank's Communities. The Bank has disposed of the majority of its
commercial REO and is continuing 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 $28.0 million at
-----------------
September 30, 1995, compared to $25.0 million at September 30, 1994. At
September 30, 1995, non-accrual loans consisted primarily of $8.8 million of
non-accrual real estate loans and $18.6 million of non-accrual credit card
loans.
At September 30, 1995, the $18.6 million of non-accrual credit card loans
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 $14.8 million of credit card loans classified for regulatory
purposes as substandard which were not 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 non-performing assets
($14.8 million) primarily related to accounts for which the customers have
agreed to modified payment terms, but which were 30-89 days past due. Of the
$14.8 million, $3.7 million was current, $6.4 million was 30-59 days past due
and $4.7 million was 60-89 days past due at September 30, 1995. All delinquent
amounts are included in the table of delinquent loans under "Delinquent Loans."
Non-accrual REI. At September 30, 1995, the Bank had no non-accrual REI.
---------------
At September 30, 1994, a participating loan to a developer with a balance of
$8.9 million, before valuation allowances of $2.0 million, was non-performing.
During fiscal 1995, this loan with a balance of $6.7 million at September 30,
1995 was transferred to REO. See "Real Estate Held for Investment."
REO. At September 30, 1995, the Bank's REO totaled $219.2 million, after
---
valuation allowances on such assets of $135.0 million. The principal component
of REO consists of the Communities, which had an aggregate book value of $162.0
million at that date. Four of the Communities are under active development.
During fiscal 1995, REO decreased $58.7 million. This decrease was
primarily attributable to the sale of three retail center properties and two
commercial ground properties and sales of residential lots or units in the
Communities and other smaller residential properties. This decrease was
partially offset by the transfer from REI to REO of a participating loan to a
developer referred to above under "Non-accrual REI." The transfer resulted from
the Bank's acquisition of title to the property. 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" and "Allowances for Losses." The Bank capitalized interest
in the amount of $4.5 million in fiscal 1995, of which $4.4 million was related
to the Bank's four active Communities.
Disposition of REO. During fiscal 1995, the Bank received proceeds of
------------------
approximately $90.1 million upon the disposition of REO consisting of three
retail centers ($10.1 million), two commercial ground properties ($1.8 million),
1,347 residential lots or units in the Communities and other smaller residential
properties ($72.1 million), approximately 3.2 acres of land in three of the
Communities ($1.7 million) and various single-family residential properties
($4.4 million).
- 58 -
<PAGE>
The Bank's objective with respect to its REO is to sell such properties as
expeditiously as possible and in a 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.
The following table sets forth information about the Bank's REO at
September 30, 1995.
<TABLE>
<CAPTION>
Balance Before Balance After
Valuation All Valuation Valuation Percent of
Allowances Allowances Allowances Total
---------- ---------- ---------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Communities.............................. $270,630 $108,656 $161,974 73.9%
Residential ground and construction...... 56,187 20,737 35,450 16.2%
Commercial ground........................ 23,742 5,464 18,278 8.3%
Single-family residential properties..... 3,718 186 3,532 1.6%
-------- -------- -------- ------
Total REO.............................. $354,277 $135,043 $219,234 100.0%
======== ======== ======== ======
</TABLE>
On November 13, 1995, the Bank sold its remaining residential lots
(approximately 2,000) in two of its Communities at an amount that approximated
its net carrying value, after utilization of applicable valuation allowances.
The impact of the transaction was to reduce REO, net of all valuation
allowances, by $49.2 million. In connection with this sale, the Bank provided
financing of $33.4 million net of participations.
At September 30, 1995 and before the November sale discussed above, the
four active Communities consisted of 12,928 residential lots or units and 197.6
acres of land designated for retail use. At September 30, 1995, 9,273
residential units (71.7%) had been sold to builders, consisting of 8,170 units
(63.2%) which had been settled and 1,103 units (8.5%) which were under contract
and pending settlement. At the same date, approximately 115.0 acres (58.2%) of
retail land had been sold to developers, including 26.5 acres which were under
contract and pending settlement. In addition, at September 30, 1995, the Bank
was engaged in discussions with potential purchasers regarding the sale of
additional residential units and retail land.
The rate of residential lot sales in the Bank's four active Communities
increased 31.6% to 1,298 lots during fiscal 1995 from 986 lots during the prior
year. The rate of home sales in the Bank's four active Communities declined to
944 units during fiscal 1995 from 1,370 units during fiscal 1994. The decline
in home sales in the four active Communities is consistent with changes in
general economic conditions.
-59-
<PAGE>
The Bank will continue to make financing available to homebuilders and home
purchasers in an attempt to facilitate sales of lots in the remaining two
Communities under active development. The following table presents, at the
periods indicated, the outstanding balances of loans provided by the Bank
(subsequent to its acquisition of title to the properties) to facilitate sales
of lots in such Communities.
<TABLE>
<CAPTION>
September 30,
--------------------------------------
1995 1994 1993
---------- --------- ----------
<S> <C> <C> <C>
(In thousands)
Residential construction loans........... $12,615 $13,367 $10,386
Single-family permanent loans(1)......... 50,096 54,642 79,104
------- ------- -------
Total.................................. $62,711 $68,009 $89,490
======= ======= =======
</TABLE>
__________________________
(1) Includes $2.3 million, $4.4 million and $8.8 million of loans classified as
held for sale at September 30, 1995, September 30, 1994 and September 30,
1993, respectively.
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 current policy is to
sell all such single-family loans for which it provides permanent financing. At
September 30, 1995, $2.3 million of such loans are classified as held for sale
and generally are expected to be sold in the first quarter of fiscal 1996.
In furtherance of its objective of facilitating sales, the Bank has
continued to develop some of the Communities. The following table presents the
net decrease in the balances of the five Communities for the periods indicated.
-60-
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------------
1995 1994 1993
--------------- ------------- ---------------
(In thousands)
<S> <C> <C> <C>
Sales proceeds.......................................... $65,211 $78,057 $66,291
Development costs....................................... 32,626 44,264 52,118
------- ------- -------
Net cash flow......................................... 32,585 33,793 14,173
Increase (decrease) in reserves and
other non-cash items................................... 16,884 (4,337) 7,899
------- ------- -------
Net decrease in balances of the
Communities............................................ $49,469 $29,456 $22,072
======= ======= =======
</TABLE>
The Bank currently anticipates that sales proceeds will continue to exceed
development costs in future periods. The sale of the 2,000 residential lots in
two of the Bank's Communities consummated in November 1995 eliminates the
requirement for the Bank to incur additional substantial costs related to these
lots. 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 2,400 acres, in Loudoun County, Virginia, which is
in the pre-development stage and was to be developed into approximately 4,200
residential units at September 30, 1995. At September 30, 1995, this property
had a book value of $23.8 million, after valuation allowances. Subsequent to
September 30, 1995, a zoning agreement was amended which increased the number of
authorized residential units from 4,200 units to 6,200 units.
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. In addition, in accordance with the OTS
extension of the five-year holding period for certain of its REO, the Bank is
required to submit a quarterly status report. See "Capital - Regulatory Action
and Requirements."
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. The 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 borrowers or properties
experiencing cash flow problems.
At September 30, 1995, potential problem assets totaled $8.2 million,
before valuation allowances of $1.5 million, as compared to $34.1 million,
before valuation allowances of $11.2 million, at September 30, 1994. The $25.9
million decrease in potential problem assets was primarily attributable to $12.5
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 one residential ground loan with
a principal balance of $8.8 million, the repayment of one
- 61 -
<PAGE>
commercial collateralized loan with a principal balance of $1.7 million and
other net principal reductions of $2.9 million also contributed to the decrease
in potential problem assets.
Delinquent Loans. At September 30, 1995, delinquent loans totaled $39.7
-----------------
million (or 1.4% of loans) compared to $31.8 million (or 1.2% of loans) at
September 30, 1994. The following table sets forth information regarding the
Bank's delinquent loans at September 30, 1995.
<TABLE>
<CAPTION>
Principal Balance
---------------------------------------
Total as a
Mortgage Non-Mortgage Percentage
Loans Loans Total of Loans (1)
---------- ------------- ---------- -------------------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Loans delinquent for:
30-59 days $4,024 $21,077 $25,101 0.9%
60-89 days 1,940 12,621 14,561 0.5%
------ ------- ------- ===
Total $5,964 $33,698 $39,662 1.4%
====== ======= ======= ===
</TABLE>
____________________________
(1) Includes loans held for sale and/or securitization, before deduction of
valuation allowances.
Mortgage loans classified as delinquent 30-59 days includes one residential
construction loan with a principal balance of $1.5 million. The remaining
balance of loans delinquent 30-89 days consists of single-family permanent
residential mortgage loans and home equity credit line loans. The increase in
total delinquent mortgage loans, from $4.3 million at September 30, 1994 to $6.0
million at September 30, 1995, was primarily attributable to the decline in the
financial condition of one borrower whose residential construction loan, with a
principal balance of $1.5 million, became 30-59 days delinquent during the
fourth quarter of fiscal 1995.
Non-mortgage loans (principally credit card loans) delinquent 30-89 days
increased to $33.7 million at September 30, 1995 from $27.5 million at September
30, 1994, but decreased as a percentage of total non-mortgage loans outstanding
to 2.4% at September 30, 1995 from 2.7% at September 30, 1994.
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.
-62-
<PAGE>
<TABLE>
<CAPTION>
September 30,
-----------------------------------
1995 1994
---------------- ---------------
(In thousands)
<S> <C> <C>
Troubled debt restructurings................. $17,344 $29,141
================ ===============
</TABLE>
At September 30, 1995, loans accounted for as troubled debt restructurings
included two commercial permanent loans with principal balances totaling $13.2
million, one residential ground loan with a principal balance of $3.4 million
and one commercial collateralized loan with a principal balance of $0.7 million.
The $11.8 million decrease in loans accounted for as troubled debt
restructurings from September 30, 1994 resulted from the principal repayment of
one residential ground loan with a principal balance of $8.8 million, which was
accounted for as a troubled-debt restructuring and classified as a potential
problem asset at September 30, 1994 and other net principal reductions. At
September 30, 1995, the Bank had commitments to lend $1.1 million of additional
funds on loans that have been restructured.
Real Estate Held for Investment. At September 30, 1995, real estate held
-------------------------------
for investment consisted of two properties with an aggregate book value of $3.6
million, net of valuation allowances of $0.2 million, as compared to seven
properties with an aggregate book value of $52.1 million, net of accumulated
depreciation of $13.6 million and valuation allowances of $9.9 million at
September 30, 1994. During fiscal 1995, the Bank sold two apartment buildings
previously classified as real estate held for investment which had an aggregate
net book value of $25.4 million and recognized a net gain of $5.4 million, and
sold its limited partnership interest in an office building which resulted in a
net gain of $4.5 million. Also during the current year, a loan to a developer
with a profit participation feature was transferred to REO and an office
building was transferred to property and equipment.
Allowances for Losses. The following tables show loss experience by asset
---------------------
type and the components of the allowance for losses on loans and the allowance
for losses on real estate held for investment or sale. These tables reflect
charge-offs taken against assets during the years indicated and may include
charge-offs taken against assets which the Bank disposed of during such years.
-63-
<PAGE>
COMPONENTS PF ALLOWANCE FOR LOSSES ON LOANS BY TYPE
---------------------------------------------------
(DOLLARS IN THOUSANDS)
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------------------------------------
1995 1994
---------------------- ------------------------
PERCENT OF PERCENT OF
LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------- ----------- ------- -----------
<S> <C> <C> <C> <C>
Balance at end of year allocated to:
Residential permanent $ 929 17.3% $ 1,384 53.8%
Home equity 164 1.0 133 1.4
Commercial and multifamily 8,523 2.9 8,506 3.3
Residential construction 1,159 0.8 1,455 1.2
Commercial construction 56 0.2 245 0.2
Ground 49 0.1 2,362 0.6
Credit card 46,325 34.4 34,530 25.5
Consumer and other 3,291 13.3 1,590 14.0
------- -------
Subtotal 60,496 50,205
Unallocated - -
------- -------
Total $60,496 $50,205
======= =======
<CAPTION>
SEPTEMBER 30,
------------------------------------------------------------------------------------
1993 1992 1991
-------------------- -------------------- --------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS TO LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------- ------------ ------- ----------- ------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at end of year allocated to:
Residential permanent $ 4,235 53.6 $ 2,335 41.6% $ 2,326 41.7%
Home equity 250 2.5 504 9.9 597 9.0
Commercial and multifamily 9,606 3.9 5,907 2.7 4,655 2.1
Residential construction 4,125 1.5 4,470 2.6 3,683 2.2
Commercial construction 345 0.4 729 0.5 1,754 0.7
Ground 1,412 0.7 2,624 1.0 2,168 1.3
Credit card 46,886 31.4 57,566 38.9 70,642 40.4
Consumer and other 1,181 6.0 4,683 2.8 2,997 2.6
------- -------- -------
Subtotal 68,040 78,818 88,822
Unallocated - - 923
------- -------- -------
Total $68,040 $78,818 $89,745
======== ======== ========
</TABLE>
64
<PAGE>
Analysis of Allowance for and Charge-offs of Loans
---------------------------------------------------
(Dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------------------------
1995 1994 1993 1992 1991
----------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $ 50,205 $ 68,040 $ 78,818 $ 89,745 $ 58,339
----------- ----------- ----------- ---------- -----------
Provision for loan losses 54,979 29,222 60,372 86,453 143,544
----------- ----------- ----------- ---------- -----------
Charge-offs:
Residential 1,174 1,641 45 581 78
Commercial and multifamily - 112 766 1,855 1,500
Ground 1,768 2,027 4,274 1,650 16,899
Residential construction - - - 1,971 3,564
Commercial construction - 447 - 1,431 13,421
Credit card 50,172 55,754 76,141 100,391 85,554
Consumer and other 3,463 1,058 3,664 1,898 1,695
----------- ----------- ----------- ---------- -----------
Total charge-offs 56,577 61,039 84,890 109,777 122,711
----------- ----------- ----------- ---------- -----------
Recoveries:
Residential 20 - - - -
Credit card 11,219 13,525 13,438 12,038 10,475
Other 650 457 302 359 98
----------- ----------- ----------- ---------- -----------
Total recoveries 11,889 13,982 13,740 12,397 10,573
----------- ----------- ----------- ---------- -----------
Charge-offs, net of recoveries 44,688 47,057 71,150 97,380 112,138
----------- ----------- ----------- ---------- -----------
Balance at end of year $ 60,496 $ 50,205 $ 68,040 $ 78,818 $ 89,745
=========== =========== =========== ========== ===========
Provision for loan losses to average loans (1) 1.85% 1.08% 2.83% 3.59% 4.61%
Net loan charge-offs to average loans (1) 1.51% 1.74% 3.33% 4.04% 3.60%
Ending reserve for losses on loans to total loans (1) (2) 2.06% 1.97% 2.83% 3.52% 2.79%
</TABLE>
________________________________________________________________________________
(1) Includes loans held for sale and/or securitization.
(2) Before deduction of reserves.
-65-
<PAGE>
COMPONENTS OF ALLOWANCE FOR LOSSES
----------------------------------
ON REAL ESTATE HELD FOR INVESTMENT OR SALE
------------------------------------------
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30,
----------------------------------------------------------------------------------
1995 1994 1993 1992 1991
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Allowance for losses on real estate
held for investment:
Commercial nad multifamily $ - $ 7,793 $ 7,945 $ 8,037 $ 2,389
Commercial construction - - - 4,995 506
Ground - 1,975 1,972 1,682 1,266
Other 193 131 265 205 -
-------------- -------------- -------------- -------------- -------------
Total 193 9,899 10,182 14,919 4,161
-------------- -------------- -------------- -------------- -------------
Allowance for losses on real estate
held for sale:
Residential 184 66 102 447 2,813
Home equity 2 4 53 21 4
Commercial and multifamily - 142 4,678 1,705 1,564
Commercial construction - 1,216 1,387 15,439 6,899
Residential construction - 1,942 2,924 2,294 1,664
Ground 134,857 105,704 92,318 74,219 40,393
-------------- -------------- -------------- -------------- --------------
Total 135,043 109,074 101,462 94,125 53,337
-------------- -------------- -------------- -------------- --------------
Total allowance for losses on real
estate held for investment or sale $ 135,236 $ 118,973 $ 111,644 $ 109,044 $ 57,498
============== ============== ============== ============== ==============
</TABLE>
- --------------------------------------------------------------------------------
-66-
<PAGE>
ANALYSIS OF ALLOWANCE FOR AND CHARGE - OFFS OF
----------------------------------------------
REAL ESTATE HELD FOR INVESTMENT OR SALE
---------------------------------------
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30
----------------------------------------------------
1995 1994 1993 1992 1991
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance at beginning 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
-------- -------- -------- -------- --------
Provisions for real estate losses:
Real estate held for investment (6,974) (283) 1,470 12,673 4,724
Real estate held for sale 33,295 14,335 28,945 47,923 43,259
-------- -------- -------- -------- --------
Total 26,321 14,052 30,415 60,596 47,983
-------- -------- -------- -------- --------
Charge-offs:
Real estate held for investment:
Commercial ground 2,732 - - 1,550 3,363
Commercial permanent - - - 365 -
Commercial construction - - 6,207 - -
-------- -------- -------- -------- --------
Total 2,732 - 6,207 1,915 3,363
-------- -------- -------- -------- --------
Real estate held for sale:
Residential - - - 3,002 -
Residential construction 1,924 911 79 - -
Residential ground 103 - 259 348 -
Commercial ground 2,827 - 1,353 3,785 -
Commercial permanent - 5,812 761 - -
Commercial construction 2,472 - 19,156 - -
-------- -------- -------- -------- --------
Total 7,326 6,723 21,608 7,135 -
-------- -------- -------- -------- --------
Total charge-offs on real estate
held for Investment or sale 10,058 6,723 27,815 9,050 3,363
-------- -------- -------- -------- --------
Balance at end of year:
Real estate held for investment 193 9,899 10,182 14,919 4,161
Real estate held for sale 135,043 109,074 101,462 94,125 53,337
-------- -------- -------- -------- --------
Total $135,236 $118,973 $111,644 $109,044 $ 57,498
======== ======== ======== ======== ========
</TABLE>
-67-
<PAGE>
The Bank maintains valuation allowances for estimated losses on loans and
real estate. The Bank's total valuation allowances for losses on loans and real
estate held for investment or sale increased by $26.5 million from the level at
September 30, 1994 to $195.7 million at September 30, 1995. The $26.5 million
increase was primarily attributable to increased valuation allowances on the
Communities and credit card loans. During fiscal 1995, the Bank recorded net
charge-offs of $13.0 million on loans secured by real estate and real estate
held for investment or sale and provided an additional $26.0 million of
valuation allowances on these assets.
The following table shows valuation allowances for losses on performing and
non-performing assets at the dates indicated.
<TABLE>
<CAPTION>
September 30, 1995
-------------------------------------------
Performing Non-performing Total
------------- ----------------- ---------
(In thousands)
<S> <C> <C> <C>
Allowances for losses on:
Loans:
Real estate ............................ $ 10,441 $ 439 $ 10,880
Credit card ............................ 44,468 1,857 46,325
Consumer and other ..................... 3,287 4 3,291
-------- -------- --------
Total allowance for losses
and loans ............................... 58,196 2,300 60,496
-------- -------- --------
Real estate held for
investment ............................. 193 - 193
Real estate held for sale ............... - 135,043 135,043
-------- -------- --------
Total allowance for losses
on real estate held for
investment for sale .................... 193 135,043 135,236
-------- -------- --------
Total allowance for losses .............. $ 58,389 $137,343 $195,732
======== ======== ========
</TABLE>
-68-
<PAGE>
<TABLE>
<CAPTION>
September 30, 1994
-------------------------------------------
Performing Non-performing Total
------------- ----------------- ---------
(In thousands)
<S> <C> <C> <C>
Allowances for losses on:
Loans:
Real estate ........................... $13,670 $ 415 $ 14,085
Credit card ........................... 32,907 1,623 34,530
Consumer and other .................... 1,588 2 1,590
------- -------- --------
Total allowance for losses and
loans ................................ 48,165 2,040 50,205
------- -------- --------
Real estate held for investment ........ 7,924 1,975 9,899
Real estate held for sale .............. - 109,074 109,074
------- -------- --------
Total allowance for losses on real
estate held for investment for
sale ................................. 7,924 111,049 118,973
------- -------- --------
Total allowance for losses ............. $56,089 $113,089 $169,178
======= ======== ========
</TABLE>
The allowance for losses on loans secured by real estate and real estate
held for investment or sale totaled $146.1 million at September 30, 1995, which
constituted 40.2% of total non-performing real estate assets, before valuation
allowances. This amount represented a $13.0 million increase from the September
30, 1994 level of $133.1 million, or 32.9% of total non-performing real estate
assets, before valuation allowances at that date.
Beginning October 1, 1994, the Bank has provided additional general
valuation allowances which are equal to, or exceed, the amount of the net
earnings generated by the development and sale of land in the Communities.
During fiscal 1995, the Bank provided an additional $16.1 million of general
valuation allowances against its Communities pursuant to this policy.
When real estate collateral securing an extension of credit is initially
recorded as REO, it is recorded at the lower of cost or written down to fair
value, less estimated selling costs, 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 valuation
allowances that would otherwise be recorded if the collateral had not become
REO. As circumstances change, it may be necessary to provide additional
valuation allowances based on new information. Depending on the nature of the
information, these new valuation allowances may be valuation allowances, which
reflect additional impairment with respect to a specific asset, or may be
unallocated valuation allowances, which provide protection against changes in
asset valuation factors. The allowance for losses on real estate held for sale
at September 30, 1995 is in addition to approximately $57.9 million of
cumulative charge-offs previously taken against assets remaining in the Bank's
portfolio at September 30, 1995.
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 cold be required to increase its valuation allowances.
-69-
<PAGE>
Net charge-offs of credit card loans for fiscal 1995 were $39.0 million,
compared to $42.2 million for fiscal 1994. The decrease in net charge-offs
resulted primarily from increased securitization activity of such loans. 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 valuation
allowances established at the beginning of the fiscal period.
The allowance for losses on credit card loans increased to $46.3 million at
September 30, 1995 from $34.5 million at September 30, 1994, primarily because
of the increased volume of credit card loans. The ratios of the allowance for
such losses to non-performing credit card loans and to outstanding credit card
loans were 249.5% and 4.6%, respectively, at September 30, 1995, compared to
212.8% and 5.3%, respectively, at September 30, 1994.
The allowance for losses on consumer and other loans increased to $3.3
million at September 30, 1995 from $1.6 million at September 30, 1994, primarily
because of the increased volume of consumer and other loans. The ratios of the
allowances for losses on consumer and other loans to non-performing consumer and
other loans and to outstanding consumer and other loans increased to 553.1% and
0.8%, respectively, at September 30, 1995 from 319.3% and 0.4%, respectively, at
September 30, 1994.
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 ARMs, adjustable-rate home equity
credit line loans and adjustable-rate credit card loans. At September 30, 1995,
adjustable-rate loans accounted for 79.1% of total loans, of which 44.7%
(including all credit card loans) will adjust in one year or less.
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.
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, a negative gap implies that
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
-70-
<PAGE>
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
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 investment portfolio when replacing
securities following normal portfolio maturation and turnover; lengthening or
shortening the maturity or repricing terms for any current period asset
securitizations; and altering the maturity or interest rate reset profile of
borrowed funds, if any, including funds borrowed from the FHLB of Atlanta.
The following table presents the interest rate sensitivity of the Bank's
interest-earning assets and interest-bearing liabilities at September 30, 1995,
which reflects management's estimate of mortgage loan prepayments and
amortization and provisions for adjustable interest rates. Adjustable and
floating rate loans are included in the period in which their interest rates are
next scheduled to adjust, and prepayment rates are assumed for the Bank's loans
based on recent actual experience. Statement savings and passbook accounts with
balances under $20,000 are classified based upon management's assumed attrition
rate of 17.5%, and those with balances of $20,000 or more, as well as all NOW
accounts, are assumed to be subject to repricing within six months or less.
-71-
<PAGE>
INTEREST RATE SENSITIVITY TABLE (GAP)
-------------------------------------
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
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
----------- ---------- ----------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1995
Mortgage loans:
Adjustable - rate $ 351,694 $ 178,901 $ 486,265 $ 214,348 $ 27,440 $ 1,258,648
Fixed - rate 10,621 9,774 36,517 52,584 75,136 184,632
Loans held for sale 68,679 - - - - 68,679
Home equity credit lines and second mortgages 35,419 29 24 - - 35,472
Credit card and other 763,568 26,749 65,671 32,772 20,268 909,028
Loans held for securitization and sale 500,000 - - - - 500,000
Mortgage-backed securities 125,223 182,312 550,472 6,353 15,848 880,208
Other investments 296,749 - 4,370 - - 301,119
----------- ---------- ----------- ---------- ---------- ------------
Total interest - earning assets 2,151,953 397,765 1,143,319 306,057 138,692 4,137,786
Total non-interest earning assets - - - - 810,209 810,209
----------- ---------- ----------- ---------- ---------- ------------
Total assets $ 2,151,953 $ 397,765 $ 1,143,319 $ 306,057 $ 948,901 $ 4,947,995
=========== ============ =========== ========== ========== ============
Deposits:
Fixed maturity deposits $ 565,357 $ 320,472 $ 290,536 $ 115,134 $ - $ 1,291,499
NOW, statement and passbook accounts 1,310,419 39,369 131,125 89,247 190,195 1,760,355
Money market deposit accounts 984,257 - - - - 984,257
Borrowings:
Capital notes - subordinated 10,000 - - - 150,000 160,000
Other 160,551 121 3,544 2,709 6,076 173,001
----------- ---------- ----------- ---------- ---------- ------------
Total interest - bearing liabilities 3,030,584 359,962 425,205 207,090 346,271 4,369,112
Total non-interest bearing liabilities - - - - 250,339 250,339
Stockholders' equity - - - - 328,544 328,544
----------- ---------- ----------- ---------- ---------- ------------
Total liabilities & stockholders' equity $ 3,030,584 $ 359,962 $ 425,205 $ 207,090 $ 925,154 $ 4,947,995
=========== ============ =========== ========== ========== ============
Gap ($878,631) $37,803 $718,114 $98,967 ($207,579)
Cumulative gap ($878,631) ($840,828) ($122,714) ($23,747) ($231,326)
Cumulative gap as a percentage
of total assets (17.8)% (17.0)% (2.5)% (0.5)% (4.7)%
</TABLE>
- --------------------------------------------------------------------------------
-72-
<PAGE>
The one-year gap, as a percentage of total assets, was a negative 17.0% at
September 30, 1995, compared to a negative 27.1% at September 30, 1994. 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. The improvement in the Bank's one-year gap was
primarily attributable to an increase in short-term assets at September 30, 1995
resulting from the scheduled securitizations and sales of credit card and
automobile loan receivables.
During fiscal 1995, the Bank purchased a series of interest rate caps which
management believes will limit significantly its exposure to rising short-term
interest rates during a four-year period beginning July 1, 1995 and ending June
30, 1999. The initial level of the protection was a notional principal amount of
$600 million, and such protection will decline to $200 million by March 31,
1998. The remaining $200 million of protection will expire on June 30, 1999. In
the event that the one-month London Inter-Bank Offered Rate ("LIBOR") exceeds
7.00% on certain predetermined dates, the Bank is entitled to receive
compensatory payments from the cap provider, which is a counterparty receiving
the highest investment rating from Standard & Poor's Corporation. Such payments
would be equal to the product of (a) the amount by which the one-month LIBOR
rate exceeds 7.00% and (b) the then outstanding notional principal amount for a
predetermined period of time. The Bank has no obligation to make payments to the
provider of the cap or any other party.
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, 1995, the Bank would not have been required to maintain
additional amounts of risk-based capital had the interest-rate risk component of
the OTS capital regulations been in effect. See "Business - 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, 1995, the Bank recorded a net
deferred tax asset of $42.0 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 NO. 109, "Accounting for
Income Taxes" ("SFAS 109").
TAX SHARING PAYMENTS. During fiscal 1995, after receiving OTS approval,
the Bank made tax sharing payments totaling $20.5 million to the Trust. The Bank
made an additional tax sharing payment of $10.0 million subsequent to September
30, 1995.
CAPITAL. At September 30, 1995, 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
-73-
<PAGE>
prompt corrective action regulations. On the basis of its September 30, 1995
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 "well capitalized" institutions under the prompt corrective action
regulations.
The following table shows the Bank's regulatory capital levels at September
30, 1995 in relation to the regulatory requirements in effect at that date. The
information below is based upon the Bank's understanding of the regulations and
interpretations currently in effect and may be subject to change.
-74-
<PAGE>
<TABLE>
<CAPTION>
Regulatory Capital
------------------
(Dollars in thousands)
- -----------------------------------------------------------------------------------------------------------------------------------
Minimum Excess
Actual Capital Requirement Capital
-------------------------------- ---------------------------------- ----------------------
As a % As a % As a %
Amount of Assets (4) Amount of Assets Amount of Assets
-------------- --------------- ---------------- ---------------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Capital per financial
statements $ 328,544
Net unrealized
holding losses (1) 3,112
--------------
Adjusted capital 331,656
Adjustments for tangible and
core capital:
Intangible assets (45,697)
Non-includable
subsidiaries (2) (2,122)
Non-qualifying
purchased/originated
loan servicing (1,493)
--------------
Total tangible capital 282,344 5.77% $ 73,438 1.50% $ 208,906 4.27%
====== ========== ====== ========== =====
Supervisory goodwill (3) -
--------------
Total core capital (4) 282,344 5.77% $ 195,835 4.00% $ 86,509 1.77%
-------------- ====== ========== ====== ========== =====
Tier 1 risk-based capital (4) 282,344 6.65% $ 169,873 4.00% $ 112,471 2.65%
-------------- ====== ========== ====== ========== =====
Adjustments for risk-based
capital:
Subordinated
capital debentures 151,400
Allowance for
general loan losses 53,264
--------------
Total supplementary
capital 204,664
Excess allowance
for loan losses (176)
--------------
Adjusted supplementary
capital 204,488
--------------
Total available capital 486,832
Equity investments (2) (25,702)
--------------
Total risk-based capital
(4) $ 461,130 11.63% $ 339,746 8.00% $ 121,384 3.63%
============== ======= ========== ===== ========== =====
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Pursuant to OTS policy, net unrealized holding gains (losses) are excluded
from regulatory capital.
(2) Reflects an aggregate offset of $3.7 million representing the allowance for
general loan losses maintained against the Bank's equity investments and
non-includable subsidiaries which, pursuant to OTS guidelines, is available
as a "credit" against the deductions from capital otherwise required for
such investments.
(3) Effective January 1, 1995, the amount of supervisory goodwill includable as
core capital under OTS regulations decreased from 0.375% to 0% of tangible
assets.
(4) Under the OTS "prompt corrective action" regulations, the standards for
classification as "well capitalized" are a leverage (or "core capital")
ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0%
and a total risk-based capital ratio of at least 10.0%.
-75-
<PAGE>
Regulatory Action and Requirements. The Bank is subject to a written
----------------------------------
agreement with the OTS, as amended in 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. The
Bank complied with these growth limitations during fiscal 1995.
The Bank has been able to maintain capital compliance in recent periods
despite the gradual-phase-out of various assets from regulatory capital. As of
September 30, 1995, the Bank had $45.7 million in supervisory goodwill, all of
which was excluded from core capital, and $29.2 million in equity investments,
all of which was excluded from total risk-based capital, pursuant to phase-outs
that had reached 100%. In addition, at September 30, 1995, the Bank had $3.9
million, after subsequent valuation allowances, of extensions of credit to, and
investments in, subsidiaries engaged in activities impermissible to national
Banks ("non-includable subsidiaries") which were subject at that date to a 60%
phase-out from all three FIRREA capital requirements. Pursuant to OTS
guidelines, $3.7 million of general valuation allowances 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 phase-out for non-includable subsidiaries will increase to 100%
on July 1, 1996.
The Bank's level of investment in non-includable subsidiaries was reduced
from $27.2 million at September 30, 1994 to $3.9 million at September 30, 1995
largely as a result of the sale of two apartment buildings held by one of the
Bank's subsidiaries. The Bank sold these projects pursuant to its strategy of
maintaining capital compliance through the reduction of investments in non-
includable subsidiaries subject to the capital deduction.
OTS capital regulations provide a five-year holding period (or such longer
period as may be approved by the OTS) for REO to qualify for an exception from
treatment as an equity investment. If an REO property is considered an equity
investment, its then-current book value is deducted from total risk-based
capital. Accordingly, if the Bank is unable to dispose of any REO property
(through bulk sales or otherwise) prior to the end of its applicable five-year
holding period and is unable to obtain an extension of such five-year holding
period from the OTS, the Bank could be required to deduct the then-current book
value of such REO property from total risk-based capital. In September 1995, the
Bank received from the OTS an extension through September 29, 1996 of the five-
year holding period for certain of its REO properties acquired through
foreclosure in fiscal 1990 and fiscal 1991. The following table sets forth the
Bank's REO at September 30, 1995, after valuation allowances of $135.0 million,
by the fiscal year in which the property was acquired through foreclosure.
-76-
<PAGE>
<TABLE>
<CAPTION>
Fiscal Year (In thousands)
-------------- --------------
<S> <C>
1990(1)(2) ........... $ 89,070
1991(2) .............. 90,207
1992 ................. 15,080
1993 ................. 4,809
1994 ................. 8,389
1995 ................. 11,679
--------
Total REO $219,234
========
</TABLE>
___________________________________
(1) Includes REO with an aggregate net book value of $29.2 million, which the
Bank treats as equity investments for regulatory capital purposes.
(2) Includes REO, with an aggregate net book value of $153.5 million, for which
the Bank received an extension of the five-year holding period through
September 29, 1996.
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, 1995, the Bank's
leverage, tier 1 risk-based and total risk-based capital ratios were 5.77%,
6.65% and 11.63%, 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 ability to maintain or increase its capital levels in future
periods 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
allowances for losses and further charge-offs. Any such developments would
adversely affect the Bank's earnings and thus its regulatory capital levels. In
addition, legislation is expected to be enacted shortly which would require the
Bank to pay as early as January 1, 1996 a one-time assessment estimated to be up
to 85 basis points on its SAIF-insured deposits and thereby reduce the Bank's
regulatory capital levels. See "Business - Pending Legislation - Balanced Budget
Act of 1995."
As a result of these factors, although the Bank's regulatory capital ratios
on a fully phased-in basis at September 30, 1995, would meet the ratios
established for "well capitalized" institutions, 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" under the prompt
corrective action standards.
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.
-77-
<PAGE>
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 liquidity ratio
for the month ended September 30, 1995 was 17.5%, compared to 18.6% for the
month ended September 30, 1994. The Bank met the liquidity level requirements
for each month of fiscal 1995.
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 and trading securities (iv)
securitizations and sales of loans and (v) 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,
1995, the Bank's portfolio included mortgage loans, U.S. Government securities
and mortgage-backed securities with outstanding principal balances of $1.0
billion, $4.4 million and $877.6 million, respectively. The estimated borrowing
capacity against mortgage loans, U.S. Government securities and mortgage-backed
securities that are available to be pledged to the FHLB of Atlanta and various
security dealers totaled $1.4 billion at September 30, 1995, 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 $1.6 billion of credit card receivables,
$252.2 million of automobile loan receivables and $150.5 million of home equity
credit line receivables during fiscal 1995. Additionally, during fiscal 1995,
the Bank securitized and sold $59.2 million of amounts on deposit in certain
spread accounts established in connection with certain of the Bank's outstanding
credit card securitizations. At September 30, 1995, the Bank was considering the
securitization and sale of the following receivables: (i) approximately $750.0
million of credit card receivables, including $300.0 million of receivables
outstanding at September 30, 1995 and $450.0 million of receivables which the
Bank expects to become available, either through additional fundings or
amortization of existing trusts, during the six months ending March 31, 1996;
(ii) approximately $250.0 million of automobile loan receivables, including
$200.0 million of receivables outstanding at September 30, 1995 and $50.0
million of receivables which the Bank expects to become available through
additional fundings during the six months ending March 31, 1996; and (iii)
approximately $30.0 million of amounts on deposit in certain spread accounts
during the six months ending March 31, 1996. As part of its operating strategy,
the Bank will continue to explore opportunities to sell assets and to securitize
and sell credit card, home equity credit line and automobile loan receivables to
meet liquidity and other balance sheet objectives.
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
fiscal 1995, 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 $13.9 billion, repay borrowings of $3.3
billion, fund existing and continuing loan commitments (including real estate
held for investment or sale) of $2.9 billion, purchase investments and loans of
$195.6 million and meet operating expenses, before depreciation and
amortization, of $271.7 million. These commitments were funded primarily through
proceeds from customer deposits and sales of certificates of deposit of $14.1
billion, proceeds from borrowings of $3.4 billion, proceeds from sales of loans,
trading securities and real estate of $2.6 billion, and principal and interest
collected on investments, loans, mortgage-backed securities and securities of
$744.3 million.
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<PAGE>
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. Of the $3.9 billion of outstanding trust certificate balances
at September 30, 1995, the primary recourse to the Bank was approximately $93.1
million.
The Bank also is obligated under various recourse provisions related to the
swap of single-family residential loans for participation certificates issued to
the Bank by FHLMC. At September 30, 1995, recourse to the Bank under these
arrangements was approximately $4.4 million.
The Bank's commitments at September 30, 1995 are set forth in the following
table:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
Commitments to originate loans $ 38,762
-----------
Loans in process (collateralized loans):
Home equity ...................................... 541,610
Real estate construction ......................... 21,088
Commercial and multifamily ....................... 226
-----------
Loans in process (unsecured loans): 562,924
-----------
Credit cards ..................................... 10,990,408
Overdraft lines .................................. 63,113
Commercial ....................................... 6,833
-----------
11,060,354
-----------
Total commitments to extend credit ............... 11,662,040
-----------
Letters of credit .................................. 38,604
Recourse arrangements on asset-backed
securitizations .................................... 93,059
Recourse arrangements on mortgage-backed
securities ....................................... 4,364
-----------
Total commitments $11,798,067
===========
</TABLE>
Based on historical experience, the Bank expects to fund substantially less
than the total amount of its outstanding credit card and home equity credit line
commitments, which together accounted for 97.7% of commitments at September 30,
1995.
At September 30, 1995, repayments of borrowed money scheduled to occur
during the next 12 months were $152.7 million. Certificates of deposit maturing
during the next 12 months amounted to $885.8 million, of which a substantial
portion is expected to remain with the Bank.
There were no material commitments for capital expenditures at September
30, 1995.
The Bank's liquidity requirements in years subsequent to fiscal 1995 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
-79-
<PAGE>
utilized from time to time will be determined by a number of factors, including
capital planning objectives, lending and investment strategies and market
conditions.
RESULTS OF OPERATIONS
The Bank's operating results historically have depended primarily on its
"net interest spread," which is the difference between the rates of interest
earned on its loans and securities investments and the rates of interest paid on
its deposits and borrowings. In the last three fiscal years, non-interest income
from securitizations of credit card, home equity credit line and automobile
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 1995 COMPARED TO FISCAL 1994
OVERVIEW. The Bank recorded income before income taxes, extraordinary item
and cumulative effect of change in accounting principle of $54.7 million and net
income of $37.3 million for the year ended september 30, 1995 ("fiscal 1995"),
compared to income before income taxes, extraordinary item and cumulative effect
of change in accounting principle of $52.7 million and net income of $29.0
million for the year ended September 30, 1994 ("fiscal 1994"). The increase in
income for fiscal 1995 was primarily attributable to a $73.0 million increase in
other (non-interest) income resulting primarily from an increase in loan
servicing fees and a $7.3 million increase in net interest income. The positive
effect of these items on income was partially offset by a $52.5 million increase
in operating expenses and a $25.8 million increase in the provision for loan
losses.
NET INTEREST INCOME. Net interest income, before the provision for loan
losses, increased $7.3 million (or 4.3%) in fiscal 1995. The Bank would have
recorded interest income of $7.2 million in fiscal 1995 if the Bank's non-
accrual assets and restructured loans had been current in accordance with their
original terms. Interest income of $2.0 million was actually recorded on non-
accrual assets and restructured loans during the fiscal year. The Bank's net
interest income in future periods will continue to be adversely affected by the
Bank's non-performing assets. 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.
-80-
<PAGE>
NET INTEREST MARGIN ANALYSIS
----------------------------
(Dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
-------------------------------------------
September 30, 1995
-------------------------------------------
1995 Average Yield/
Yield/Rate Balances Interest Rate
------------- -------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans receivable, net (1) 11.06 % $ 2,968,269 $294,575 9.92 %
Mortgage-backed securities 6.39 981,253 60,623 6.18
Federal funds sold and securities
purchased under agreements to resell 6.31 65,865 3,756 5.70
Trading securities - 4,843 373 7.70
Investment securities 4.37 4,405 194 4.40
Other interest-earning assets 6.18 126,792 5,815 4.59
------------ ------------
Total 9.70 4,151,427 365,336 8.80
------------ ------------ -------
Non-interest earning assets:
Cash 131,345
Real estate held for investment or sale 287,344
Property and equipment, net 157,426
Cost in excess of net assets acquired, net 46,700
Other assets 155,953
------------
Total assets $ 4,930,195
============
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits 2.91 $ 875,551 23,721 2.71
Savings deposits 3.45 1,048,783 35,125 3.35
Time deposits 5.83 1,025,111 53,033 5.17
Money market deposits 4.02 1,070,531 42,420 3.96
------------ ------------
Total deposits 4.24 4,019,976 154,299 3.84
Borrowings 7.69 496,938 34,815 7.01
------------ ------------
Total liabilities 4.50 4,516,914 189,114 4.19
------------ ------------ -------
Non interest-bearing items:
Non-interest bearing deposits 69,734
Other liabilities 48,702
Stockholders' equity 294,845
------------
Total liabilities and stockholders' equity $ 4,930,195
============
Net interest income $176,222
============
Net interest spread (2) 4.61 %
=======
Net yield on interest-earning assets (3) 4.24 %
=======
Interest-earning assets to interest-bearing liabilities 91.91 %
=======
<CAPTION>
--------------------------------------------
Year Ended September 30,
1994
-------------------------------------------
Average Yield/
Balances Interest Rate
-------------------------------------------
<S> <C> <C> <C>
Assets:
Interest-earning assets: $ 2,706,032 $255,324 9.44 %
Loans receivable, net (1) 1,229,898 70,937 5.77
Mortgage-backed securities
Federal funds sold and securities
purchased under agreements to resell 63,050 2,277 3.61
Trading securities 15,655 1,019 6.51
Investment securities 4,594 197 4.29
Other interest-earning assets 138,163 4,706 3.41
------------ ------------
Total 4,157,392 334,460 8.04
------------ -------
Non-interest earning assets:
Cash 116,388
Real estate held for investment or sale 356,486
Property and equipment, net 134,574
Cost in excess of net assets acquired, net 50,737
Other assets 163,541
------------
Total assets $ 4,979,118
============
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits $ 847,158 23,176 2.74
Savings deposits 1,208,041 40,720 3.37
Time deposits 751,299 29,723 3.96
Money market deposits 1,149,671 37,305 3.24
------------ ------------
Total deposits 3,956,169 130,924 3.31
Borrowings 622,010 34,620 5.57
------------ ------------
Total liabilities 4,578,179 165,544 3.62
------------ -------
Non interest-bearing items:
Non-interest bearing deposits 61,895
Other liabilities 37,059
Stockholders' equity 301,985
------------
Total liabilities and stockholders' equity $ 4,979,118
============
Net interest income $168,916
============
Net interest spread (2) 4.42 %
=======
Net yield on interest-earning assets (3) 4.06 %
=======
Interest-earning assets to interest-bearing liabilities 90.81 %
=======
<CAPTION>
-------------------------------------------
1993
-------------------------------------------
Average Yield/
Balances Interest Rate
-------------------------------------------
<S> <C> <C> <C>
Assets:
Interest-earning assets: $ 2,135,869 $241,166 11.29 %
Loans receivable, net (1) 1,508,948 95,085 6.30
Mortgage-backed securities
Federal funds sold and securities
purchased under agreements to resell 30,415 927 3.05
Trading securities - - -
Investment securities 125,255 7,929 6.33
Other interest-earning assets 152,300 4,430 2.91
------------ ------------
Total 3,952,787 349,537 8.84
------------ -------
Non-interest earning assets:
Cash 104,195
Real estate held for investment or sale 465,841
Property and equipment, net 137,534
Cost in excess of net assets acquired, net 54,583
Other assets 171,951
------------
Total assets $ 4,886,891
============
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits $ 750,816 18,569 2.47
Savings deposits 860,280 27,980 3.25
Time deposits 964,926 41,813 4.33
Money market deposits 1,242,175 39,430 3.17
------------ ------------
Total deposits 3,818,197 127,792 3.35
Borrowings 755,111 39,726 5.26
------------ ------------
Total liabilities 4,573,308 167,518 3.66
------------ -------
Non interest-bearing items:
Non-interest bearing deposits 46,670
Other liabilities 36,145
Stockholders' equity 230,768
------------
Total liabilities and stockholders' equity $ 4,886,891
============
Net interest income $182,019
============
Net interest spread (2) 5.18 %
=======
Net yield on interest-earning assets (3) 4.60 %
=======
Interest-earning assets to interest-bearing liabilities 86.43 %
=======
</TABLE>
________________________________________________________________________________
(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 ($10,062), ($4,097) and $742 of
amortized loan fees, premiums and discounts in interest income for the
years ended September 30, 1995, 1994 and 1993.
(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.
-81-
<PAGE>
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.
-82-
<PAGE>
<TABLE>
<CAPTION>
Volume and Rate Changes in Net Interest Income
---------------------------------------------------------------
(In thousands)
- ----------------------------------------------------------------------------------------------------------------
Year Ended September 30, 1995 Compared to
Year Ended September 30, 1994
Increase (Decrease) Due to Change in (1)
----------------------------------------------------
Total
Volume Rate Change
------------- ------------ -------------
<S> <C> <C> <C>
Interest income:
Loans (2) $ 25,743 $ 13,508 $ 39,251
Mortgage-backed securities (15,094) 4,780 (10,314)
Federal funds sold and securities
purchased under agreements to resell 78 1,015 1,093
Trading securities (805) 159 (646)
Investment securities (8) 5 (3)
Other interest-earning assets (339) 1,834 1,495
------------- ------------ -------------
Total interest income 9,575 21,301 30,876
------------- ------------ -------------
Interest expense:
Deposit accounts 2,139 21,236 23,375
Borrowings (7,752) 7,947 195
------------- ------------ -------------
Total interest expense (5,613) 29,183 23,570
------------- ------------ -------------
Increase (decrease) in
net interest income $ 15,188 $ (7,882) $ 7,306
============= ============ =============
<CAPTION>
Year Ended September 30, 1994 Compared to
Year Ended September 30, 1993
Increase (Decrease) Due to Change in (1)
----------------------------------------------------
Total
Volume Rate Change
------------- ------------ -------------
<S> <C> <C> <C>
Interest income:
Loans (2) $ 57,741 $ (43,583) $ 14,158
Mortgage-backed securities (16,598) (7,550) (24,148)
Federal funds sold and securities
purchased under agreements to resell 458 78 536
Trading securities 1,019 - 1,019
Investment securities (5,794) (1,938) (7,732)
Other interest-earning assets (152) 1,242 1,090
------------- ------------ -------------
Total interest expense 36,674 (51,751) (15,077)
------------- ------------ -------------
Interest expense:
Deposit accounts 4,650 (1,518) 3,132
Borrowings (7,335) 2,229 (5,106)
------------- ------------ -------------
Total interest expense (2,685) 711 (1,974)
------------- ------------ -------------
Increase (decrease) in
net interest income $ 39,359 $ (52,462) $ (13,103)
============= ============ =============
</TABLE>
________________________________________________________________________________
(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.
-83-
<PAGE>
Interest income in fiscal 1995 increased $30.9 million from the level in
fiscal 1994, primarily as a result of higher average balances of loans
receivable. Higher average yields earned by the Bank on all of its interest-
earning asset categories also contributed to the increase in interest income.
The effect on interest income of higher average balances of loans and higher
average yields was offset in part by lower average balances of mortgage-backed
securities.
The Bank's net yield on interest-earning assets increased to 4.24% in
fiscal 1995 from 4.06% in fiscal 1994. The increase primarily resulted from the
upward adjustment of interest rates on certain of the Bank's adjustable-rate
products to reflect increases in market interest rates to which rates on such
products are indexed. The effect of higher yields was offset in part by an
increase in the rates paid by the Bank on its interest-bearing liabilities.
Interest income on loans, the largest category of interest-earning assets,
increased by $39.3 million (or 15.4%) from fiscal 1994. The increase in interest
income on loans was primarily attributable to higher average balances. Average
balances of consumer loans (other than credit card loans), principally
automobile loans, increased $150.4 million (or 63.6%) in fiscal 1995. The higher
balances were largely responsible for the increase of $15.3 million (or 78.2%)
in interest income on consumer loans. Average balances of credit card loans
increased $81.4 million (or 8.9%) during fiscal 1995, largely as a result of new
account originations. The increase in balances of such loans contributed to an
$18.8 million (or 14.0%) increase in interest income from these assets. Average
balances of single-family residential permanent loans increased $68.2 million
(or 5.2%) as a result of increased originations of such loans during the current
year. Interest income on these loans increased $10.0 million (or 11.2%) from
fiscal 1994. Average balances of home equity credit line loans declined in
fiscal 1995, largely as a result of the Bank's securitization and sale activity.
The securitization and sale of $181.9 million and $150.5 million of home equity
credit line receivables in September 1994 and 1995, respectively, more than
offset the originations of $128.9 million of such loans during fiscal 1995, and
resulted in a decline of $25.9 million (or 19.1%) in average balances of home
equity credit line receivables.
Higher average yields on the loan portfolio also contributed to the
increase in interest income on loans. The average yield on the loan portfolio in
fiscal 1995 increased by 48 basis points (to 9.92% from 9.44%) from the average
yield in fiscal 1994. An increase in the average yield on credit card loans to
15.34% from 14.65% and on consumer loans to 8.99% from 8.25% contributed to the
increase in loan portfolio interest income. Increases in the average yields on
single-family residential permanent loans (to 7.20% from 6.81%), home equity
credit line loans (to 8.74% from 6.96%), commercial permanent loans (to 6.78%
from 6.37%) and construction loans (to 10.46% from 6.98%) also contributed to
the increased income on such assets. The increase in the average yields on these
loans reflected the upward adjustment of interest rates on such loans to reflect
increases in market interest rates to which rates on such products are indexed.
Interest income on mortgage-backed securities decreased $10.3 million (or
14.5%) primarily because of lower average balances. The reduced balances in
fiscal 1995 reflected the effects of scheduled principal paydowns and
unscheduled principal prepayments. The negative effect of the lower average
balances was offset in part by an increase in the average interest rates on
these securities to 6.18% from 5.77%, primarily as a result of higher market
interest rates in fiscal 1995.
Other interest income increased by $2.6 million (or 37.1%) in fiscal 1995
primarily as a result of higher average yields on federal funds sold and
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<PAGE>
securities purchased under agreements to resell, and, to a lesser extent,
Federal Home Loan Bank stock.
Interest expense increased $23.6 million in fiscal 1995 primarily because
of an increase of $23.4 million in interest expense on deposits, the largest
category of interest-bearing liabilities. Interest expense on deposits increased
as a result of an increase in average rates (to 3.84% from 3.31%), which
reflected higher market interest rates in fiscal 1995 and a shift in the
composition of the Bank's deposits to higher yielding certificates of deposit
(average rates on certificates of deposits increased 30.8%, to 5.17% from 3.96%)
as well as, to a lesser extent, an increase in average deposit balances of $63.8
million. See "Financial Condition - Asset and Liability Management."
The increase in interest expense paid on borrowings was primarily
attributable to an increase in the average cost of these borrowings (to 7.01%
from 5.57%), which reflected higher market interest rates in fiscal 1995. This
was particularly true for securities sold under repurchase agreements for which
the weighted average interest rate increased 226 basis points over the rate for
fiscal 1994. The increase in interest expense resulting from higher interest
rates was partially offset by a $125.1 million decrease in the average balances
of borrowings from $622.0 million for fiscal 1994 to $496.9 million for fiscal
1995.
PROVISION FOR LOAN LOSSES. The Bank's provision for loan losses increased
to $55.0 million in fiscal 1995 from $29.2 million in fiscal 1994. the $25.8
million increase over the prior year was attributable to increases of $20.9
million in the provision for losses on credit card loans, $3.5 million in the
provision for losses on consumer loans and $1.4 million in the provision for
losses on real estate loans. The higher provisions on credit card and consumer
loans resulted from increased origination volume of such loans. See "financial
condition - Asset Quality - Allowances for Losses."
OTHER INCOME. The increase in other (non-interest) income to $233.5
million in fiscal 1995 from $160.5 million in fiscal 1994 was primarily
attributable to an increase in loan servicing fees. The positive effect of this
item on other income was partially offset by decreases in most other categories
of non-interest income.
An increase of $77.7 million in excess servicing fees and $32.6 million of
servicing fees earned by the Bank for servicing its portfolios of securitized
credit card loans contributed to an increase of $114.4 million (or 163.7%) in
loan servicing fees. Such excess servicing fees and servicing fees have
increased in recent periods as a result of greater securitization activity by
the Bank.
Credit card fees, consisting of membership fees, late charges, interchange
fees and cash advance charges, decreased $11.2 million (53.2%) in fiscal 1995
from the level in fiscal 1994. The decrease was primarily attributable to a $3.0
million and $9.2 million decrease in late charges and interchange fees,
respectively. The decrease was partially offset by an increase in cash advance
charges as a result of increased account activity, which reflects the increase
in new account originations.
Gain on sales of credit card relationships, loans and mortgage-backed
securities decreased by $17.6 million primarily because the Bank realized a
significant gain from the sale of credit card relationships (or accounts) in
fiscal 1994, but did not consummate any such sale in fiscal 1995.
Gain on sales of mortgage servicing rights decreased by $4.4 million as a
result of a decline in the volume of mortgage servicing rights sold during the
current period. During fiscal 1995 and 1994, the Bank sold the rights to
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<PAGE>
service mortgage loans with principal balances of approximately $148.1 million
and $383.9 million, respectively.
The $6.0 million decrease in earnings on real estate held for investment or
sale was primarily attributable to an increase of $12.3 million in the provision
for losses on such assets and a decrease of $1.1 million in the operating income
generated by the REO properties. See "Financial Condition - Asset Quality -
Allowances for Losses." Partially offsetting these items was a $4.1 million
increase in partnership earnings recorded on real estate held for investment and
a $3.3 million increase in the gain recorded on sales of the Bank's REO
properties.
The $4.0 million decline in other income was primarily a result of the
establishment of a reserve on a fixed asset. A $6.2 million reserve, previously
established as a reserve against an REI property, was transferred with such
property to property and equipment. See "Financial Condition - Real Estate Held
for Investment."
OPERATING EXPENSES. Operating expenses for fiscal 1995 increased $52.5
million (21.2%) from the level in fiscal 1994. The main components of the
higher operating expenses were increases in salaries and employee benefits, data
processing and other expenses. The $21.0 million increase in salaries and
employee benefits resulted primarily from the addition of staff to the Bank's
credit card operations. The $12.5 million increase in data processing expenses
was principally attributable to an increase in the number of credit card
accounts outstanding and the activity generated by such accounts during fiscal
1995. The $15.6 million increase in other operating expenses was primarily a
result of increased credit card fraud losses during the current period.
FISCAL 1994 COMPARED TO FISCAL 1993
OVERVIEW. The Bank recorded income before income taxes, extraordinary item
and cumulative effect of change in accounting principal of $52.7 million and net
income of $29.0 million for the year ended September 30, 1994 ("fiscal 1994"),
compared to income before taxes, extraordinary item and cumulative effect of
change in accounting principle of $64.0 million and net income of $37.4 million
for the year ended september 30, 1993 ("fiscal 1993"). The decline in income
for fiscal 1994 was primarily attributable to a $57.2 million increase in
operating expenses, a $13.1 million decrease in total net interest income, a
$5.0 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 $31.2 million decrease in the provision for loan losses and
a $29.8 million increase in other (non-interest) income resulting primarily from
a $25.0 million increase in loan and deposit servicing fees and improved results
on real estate held for investment or sale.
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 17 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. See Note 1 to the
Consolidated Financial Statements in this report.
NET INTEREST INCOME. Net interest income, before the provision for loan
losses, decreased $13.1 million (or 7.2%) in fiscal 1994, as the average yield
on interest-earning assets decreased at a rate greater than the decrease in
-86-
<PAGE>
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 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."
Interest income in fiscal 1994 decreased $15.1 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 5.18%
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 $14.2 million (or 5.9%) 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.
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 185 basis points (to 9.44% from 11.29%) 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
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<PAGE>
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 $7.7 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 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 17 to the Consolidated
Financial Statements in this report.
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 $29.2 million in fiscal 1994 from $60.4 million in the prior fiscal year.
The decrease was primarily attributable to a decrease of $20.5 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 .Valuation Allowances For
Losses."
OTHER INCOME. The increase in other (non-interest) income to $160.5
million in fiscal 1994 from $130.7 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.
-88-
<PAGE>
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 $25.0 million (or 38.4%) 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 Note 1 to the Consolidated
Financial Statements in this report.
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, inter-change
fees and cash advance charges, decreased $5.0 million (19.4%) in fiscal year
1994 from the level in fiscal 1993). The decrease was primarily attributable to
a $7.3 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 $59.2 million (31.4%) 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
$31.3 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 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.
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<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION
CONTENTS
Page
- ----
(a) Report of Independent Public Accountants.............................. F-2
(b) Consolidated Statements of Financial Condition
at September 30, 1995 and 1994....................................... F-3
(c) Consolidated Statements of Operations for the
Years Ended September 30, 1995, 1994 and 1993........................ F-4
(d) Consolidated Statements of Stockholders' Equity
for the Years Ended September 30, 1995,
1994 and 1993......................................................... F-6
(e) Consolidated Statements of Cash Flows for
the Years Ended September 30, 1995, 1994 and 1993.................... F-7
(f) Notes to Consolidated Financial Statements............................ F-10
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
To the Board of Directors of
Chevy Chase Bank, F.S.B.:
We have audited the accompanying consolidated statements of financial condition
of Chevy Chase Bank, F.S.B. and subsidiaries as of September 30, 1995 and 1994,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended September 30, 1995.
These financial statements are the responsibility of the Bank'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 an 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 financial statements referred to above present fairly, in
all material respects, the financial position of Chevy Chase Bank, F.S.B. and
subsidiaries as of September 30, 1995 and 1994, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 1995, in conformity with generally accepted accounting principles.
As explained in Note 1 to the financial statements, effective December 31, 1992,
the Bank changed its method of accounting for foreclosed assets. Also, as
explained in Note 1 to the financial statements, effective October 1, 1993, the
Bank changed its method of accounting for income taxes, impaired loans, and
investments in securities and mortgage-backed securities. Also, as explained
in Note 1 to the financial statements, effective July 1, 1995, the Bank changed
its method of accounting for mortgage servicing rights.
/s/ Arthur Andersen LLP
Washington, D.C.
October 20, 1995, except with respect to Note 26 and
the last paragraph of Note 21, as to which the dates are
November 13, 1995 and November 20, 1995, respectively.
<PAGE>
CHEVY CHASE BANK, F.S.B.
-----------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
-----------------------------------------------
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30,
-----------------------------------
1995 1994
-------------- ---------------
ASSETS
------
<S> <C> <C>
Cash and due from banks $ 198,096 $ 166,752
Interest-bearing deposits 51,186 14,345
Federal funds sold and securities purchased under
agreements to resell 110,000 191,000
Loans held for sale 68,679 33,598
Loans held for securitization and sale 500,000 115,000
Investment securities (market value of $4,371 and
$4,364, respectively) 4,370 4,364
Mortgage-backed securities (market value of
$879,720 and $1,025,525, respectively) 880,208 1,025,525
Loans receivable (net of reserve for losses of
$60,496 and $50,205, respectively) 2,327,286 2,357,721
Federal Home Loan Bank stock 31,940 31,940
Real estate held for investment or sale (net of reserve
for losses of $135,236 and $118,973, respectively) 222,860 330,032
Property and equipment, net 174,673 138,274
Cost in excess of net assets acquired, net 44,528 48,637
Excess servicing assets, net 25,640 25,198
Mortgage servicing rights, net 28,369 15,075
Other assets 280,160 206,327
-------------- ---------------
Total assets $ 4,947,995 $ 4,703,788
============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Deposit accounts $ 4,159,252 $ 4,008,761
Securities sold under repurchase agreements
and other short-term borrowings 10,435 8,907
Bonds payable - 24,030
Notes payable 7,514 7,729
Federal Home Loan Bank advances 155,052 100,000
Custodial accounts 7,413 19,523
Amounts due to banks 32,240 30,373
Other liabilities 87,545 54,509
-------------- ---------------
4,459,451 4,253,832
Capital notes-subordinated 160,000 160,000
-------------- ---------------
Total liabilities 4,619,451 4,413,832
-------------- ---------------
Stockholders' equity:
13% Noncumulative Perpetual Preferred Stock, Series A,
$0.01 par value, 3,000,000 shares authorized, issued
and outstanding 30 30
Common stock, $1 par value, 10,000,000 shares -
authorized, 510,000 shares issued, 10,000 shares
outstanding 10 10
Capital contributed in excess of par 165,704 165,704
Retained earnings 165,912 138,340
Net unrealized holding gains (losses) (3,112) (14,128)
-------------- ---------------
Total stockholders' equity 328,544 289,956
-------------- ---------------
Total liabilities and stockholders' equity $ 4,947,995 $ 4,703,788
============== ===============
</TABLE>
- --------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-3
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------
1995 1994 1993
----------------- ------------------ ---------------
<S> <C> <C> <C>
Interest income
Loans $ 294,575 $ 255,324 $ 241,166
Mortgage-backed securities 60,623 70,937 95,085
Trading securities 373 1,019 -
Investment securities 194 197 7,929
Other 9,571 6,983 5,357
------------ ------------ ------------
Total interest income 365,336 334,460 349,537
------------ ------------ ------------
Interest expense
Deposit accounts 154,299 130,924 127,792
Short-term borrowings 18,094 11,439 13,333
Long-term borrowings 16,721 23,181 26,393
------------ ------------ ------------
Total interest expense 189,114 165,544 167,518
------------ ------------ ------------
Net interest income 176,222 168,916 182,019
Provision for loan losses 54,979 29,222 60,372
------------ ------------ ------------
Net interest income after provision
for loan losses 121,243 139,694 121,647
------------ ------------ ------------
Other income
Credit card fees 9,855 21,054 26,010
Loan servicing fees 184,275 69,878 46,631
Deposit servicing fees 24,442 20,347 18,575
Gain on sale of investment securities, net - - 8,895
Gain (loss) on sales of trading securities, net (600) 1,695 -
Earnings (loss) on real estate held for
investment or sale, net (4,672) 1,326 (12,722)
Gain on sales of credit card relationships, loans
and mortgage-backed securities, net 12,882 30,522 31,338
Gain on sales of mortgage servicing rights, net 1,397 5,833 4,828
Other 5,923 9,885 7,161
------------ ------------ ------------
Total other income 233,502 160,540 130,716
------------ ------------ ------------
Operating expenses
Salaries and employee benefits 108,432 87,390 69,739
Loan 15,720 14,915 19,985
Property and equipment 29,062 25,493 23,793
Marketing 46,117 46,441 15,138
Data processing 43,270 30,766 22,249
Deposit insurance premiums 10,749 11,527 11,273
Amortization of cost in excess of net
assets acquired 4,110 4,013 3,698
Other 42,633 27,025 22,494
------------ ------------ ------------
Total operating expenses 300,093 247,570 188,369
------------ ------------ ------------
</TABLE>
- --------------------------------------------------------------------------------
Continued on the following page.
F-4
<PAGE>
CHEVY CHASE BANK, F.S.B.
-----------------------
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------------------------------
1995 1994 1993
----------------- ------------------- ---------------
<S> <C> <C> <C>
Income before income taxes, extraordinary
item and cumulative effect of change in
accounting principle 54,652 52,664 63,994
Provision for income taxes 17,330 22,394 26,603
------- ------- -------
Income before extraordinary item and cumulative
effect of change in accounting principle 37,322 30,270 37,391
Extraordinary loss on early extinguishment of debt,
net of tax benefit of $4,143 - (6,333) -
------- ------- -------
Income before cumulative effect of change in
accounting principle 37,322 23,937 37,391
Cumulative effect of change in accounting for
income taxes - 5,103 -
-------- -------- --------
NET INCOME $ 37,322 $ 29,040 $ 37,391
======== ======== ========
PREFERRED STOCK DIVIDENDS 9,750 9,750 1,896
-------- -------- --------
EARNINGS AVAILABLE TO
COMMON STOCKHOLDERS $ 27,572 $ 19,290 $ 35,495
======== ======== ========
EARNINGS PER COMMON SHARE:
Before extraordinary item and cumulative
effect of change in accounting principle $ 2,757.20 $ 2,052.00 $ 3,549.50
Extraordinary item - (633.30) -
Cumulative effect of change in accounting
for income taxes - 510.30 -
---------- ---------- ----------
Earnings per common share $ 2,757.20 $ 1,929.00 $ 3,549.50
========== ========== ==========
</TABLE>
- --------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-5
<PAGE>
CHEVY CHASE BANK, F.S.B.
-----------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net
Capital Unrealized
Contributed Holding Total
Preferred Common in Excess Retained Gains Stockholders'
Stock Stock of Par Earnings (Losses) Equity
------------ ----------- -------------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1992 - 10 93,865 83,555 - 177,430
Net income - - - 37,391 - 37,391
Sale of 13% Noncumulative
Perpetual Preferred Stock,
Series A 30 - 71,839 - - 71,869
Cash dividends on 13%
Noncumulative Perpetual
Preferred Stock, Series A - - - (1,896) - (1,896)
------------ ----------- -------------- ------------ ------------- -------------
Balance, September 30, 1993 30 10 165,704 119,050 - 284,794
Cumulative effect of change
in accounting for securities - - - - 16,262 16,262
Net income - - - 29,040 - 29,040
Cash dividends on 13%
Noncumulative Perpetual
Preferred Stock, Series A - - - (9,750) - (9,750)
Decrease in net unrealized
holding gains (losses) - - - - (30,390) (30,390)
------------ ----------- -------------- ------------ ------------- -------------
Balance, September 30, 1994 30 10 165,704 138,340 (14,128) 289,956
Net income - - - 37,322 - 37,322
Cash dividends on 13%
Noncumulative Perpetual
Preferred Stock, Series A - - - (9,750) - (9,750)
Increase in net unrealized
holding gains (losses) - - - - 11,016 11,016
------------ ----------- -------------- ------------ ------------- -------------
Balance, September 30, 1995 $ 30 $ 10 $ 165,704 $ 165,912 $ (3,112) $ 328,544
============ =========== ============== ============ ============= =============
</TABLE>
- --------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-6
<PAGE>
Chevy Chase Bank, F.S.B.
-----------------------
Consolidated Statements of Cash Flows
-------------------------------------
Increase (Decrease) in Cash and Cash Equivalents
(In thousands)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
Year Ended September 30,
--------------------------------------------------
1995 1994 1993
--------------- -------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 37,322 $ 29,040 $ 37,391
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Accretion of premiums, discounts and net deferred loan fees (457) (1,299) (8,619)
Depreciation and amortization 21,461 18,056 15,945
Amortization of cost in excess of net assets acquired and
purchased mortgage servicing rights 6,264 10,114 15,763
Loss on extinguishment of debt - 10,476 -
Provision for loan losses 54,979 29,222 60,372
Net fundings of loans held for sale and/or securitization (390,634) (874,917) (903,941)
Proceeds from sales of trading securities 239,147 688,811 -
Proceeds from sales of loans and securities held
for sale and/or securitization 2,188,531 2,276,391 1,946,826
Equity earnings from investments in limited partnerships (4,470) (391) (1,694)
Gain on sales of real estate held for investment or sale, net (14,797) (11,466) (9,503)
Provision for losses on real estate held for investment or sale 26,321 14,052 30,415
Gain on sale of investment securities, net - - (8,895)
(Gain) loss on sales of trading securities, net 600 (1,695) -
Gain on sales of credit card relationships, loans and
mortgage-backed securities, net (12,882) (30,522) (31,338)
Gain on sales of mortgage servicing rights, net (1,397) (5,833) (4,828)
(Increase) decrease in excess servicimg assets (442) 2,375 1,976
(Increase) decrease in other assets (81,040) 45,456 (23,726)
Increase in other liabilities and accrued expenses 23,981 18,125 9,635
Other, net 3,176 10,278 6,907
-------------- ------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 2,095,663 2,226,273 1,132,686
-------------- ------------- -------------
Cash flows from investing activities:
Proceeds from maturities of investment sercurities 100 300 -
Proceeds from sales of loans 8 - 4,954
Net proceeds from sales of real estate 133,300 94,308 150,115
Net proceeds from sales of mortgage servicing rights 2,232 5,833 5,978
Net fundings of loans receivable (2,295,077) (1,700,831) (463,919)
Principal collected on mortgage-backed securities 183,166 447,666 447,951
Purchases of investment securities - - (4,682)
Purchases of mortgage-backed securities (107,127) (291,335) (664,284)
Purchases of loans receivable (88,518) (256,608) (259,770)
Purchases of property and equipment (55,924) (22,503) (4,602)
Purchases of mortgage servicing rights (3,847) (888) (20,716)
Disbursements for real estate held for investment or sale (37,346) (58,063) (74,320)
Other investing activities, net (411) 4,840 4,117
--------------- -------------- --------------
NET CASH USED IN INVESTING ACTIVITIES (2,269,444) (1,777,281) (879,178)
--------------- -------------- --------------
</TABLE>
- --------------------------------------------------------------------------------
Continued on the following page.
F-7
<PAGE>
CHEVY CHASE BANK, F.S.B.
-----------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------
1995 1994 1993
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from financing activities:
Proceeds from customer deposits and sales of
certificates of deposit 14,086,575 12,308,342 10,801,085
Customer withdrawals of deposits and payments
for maturing certificate (13,936,084) (12,169,604) (10,847,020)
Net increase (decrease) in securities sold under
repurchase agreements 777 (81,504) (363,216)
Advances from the Federal Home Loan Bank 992,073 824,300 744,000
Repayments of advances from the Federal Home Loan (937,021) (1,136,300) (607,000)
Proceeds from other borrowings 793,261 461,385 59,580
Repayments of other borrowings (816,755) (460,011) (59,658)
Net proceeds from sale of preferred - - 71,869
Cash dividends paid on preferred stock (9,750) (9,750) (1,896)
Repayment of capital note - subordinated - (134,153) -
Net proceeds received from capital - 143,603 -
Other financing activities, net (12,110) (6,402) 11,406
------------ ------------ ------------
Net cash provided by (used in) finanacing activities 160,966 (260,094) (190,850)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (12,815) 188,898 62,658
Cash and cash equivalents at beginning of year 372,097 183,199 120,541
------------ ------------ ------------
Cash and cash equivalent at end of year $ 359,282 $ 372,097 $ 183,199
============ ============ ============
</TABLE>
- --------------------------------------------------------------------------------
Continued on the following page.
F-8
<PAGE>
CHEVY CHASE BANK, F.S.B.
-----------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------------
1995 1994 1993
------------ ------------ ------------
<S> <C> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (net of amount capitalized) $ 189,717 $ 172,339 $ 169,867
Income taxes $ 19,133 $ 9,462 $ 11,496
Supplemental disclosures of non-cash investing and
financing activities:
Loans receivable exchanged for mortgage-backed securities $ - $ - $ 51,956
Loans held for sale exchanged for trading securities $ 133,014 $ 396,189 $ -
Loans held for sale exchanged for mortgage-backed
securities held for sale $ - $ - $ 442,017
Mortgage-backed securities available-for-sale transferred
mortgage-backed securities held-to-maturity $ 942,085 $ - $ -
Mortgage-backed securities transferred to
mortgage-backed securities available for sale $ - $ 1,501,192 $ -
Mortgage-backed securities transferred to loans and
securities held for sale $ - $ - $ 131,390
Investment securities transferred to loans and securities
held for sale $ - $ - $ 173,036
Investment securities transferred to investment securities
available-for-sale $ - $ 4,789 $ -
Investment securities available-for-sale transferred to
investment securities held-to-maturity $ 4,354 $ - $ -
Real estate acquired in settlement of loans transferred
to loans receivable $ - $ 15,008 $ -
Real estate held for investment transferred to real
estate held for sale $ 9,273 $ - $ -
Loans receivable transferred to loans held for sale and/or
securitization $ 2,387,690 $ 1,446,924 $ 440,361
Loans made in connection with the sale of real estate $ 10,826 $ 16,401 $ 54,061
Loans receivable transferred to real estate acquired in
settlement of loans $ 9,822 $ 4,106 $ 23,158
Loans receivable exchanged for mortgage-backed securities
held-to-maturity $ 23,155 $ - $ -
Loans held for sale and/or securitization transferred
to loans receivable $ 50,000 $ 3,507 $ -
Loans classified as in-substance foreclosed transferred to
loans receivable $ - $ 15,008 $ -
</TABLE>
- --------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-9
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES:
Chevy Chase Bank, F.S.B. is a federally chartered and federally insured stock
savings bank and, as such, is subject to comprehensive regulation, examination
and supervision by the Office of Thrift Supervision ("OTS") and by the Federal
Deposit Insurance Corporation ("FDIC"). The Bank is principally engaged in the
business of attracting deposits from the public and using such deposits,
together with borrowings and other funds, to make loans secured by real estate,
primarily residential mortgage loans, and various types of consumer loans,
primarily credit card loans.
A summary of significant accounting policies of Chevy Chase Bank, F.S.B. and
subsidiaries (collectively the "Bank") is as follows:
Affiliation of Corporations and Basis of Presentation:
All of the outstanding common stock of the Bank is owned by an affiliated
group of companies, with the majority (80%) owned by B. F. Saul Real Estate
Investment Trust (the "Trust").
The accompanying consolidated financial statements include the accounts of
the Bank and all subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
Cash and Cash Equivalents:
For the 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 $11,616,
$20,560 and $21,837 during the years ended September 30, 1995, 1994 and
1993, respectively.
Loans Held for Sale:
The Bank engages in mortgage banking activities. At September 30, 1995 and
1994, 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 23.
F-10
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (Continued):
Loans Held for Securitization and Sale:
The Bank periodically securitizes and sells certain pools of loan
receivables in the public and private markets. These securitizations are
recorded as sales. Gains on the sale of loans are limited to amounts
related to loans existing at the date of sale and do not include amounts
related to future loans expected to be sold during the reinvestment period,
if any. In the case of credit card receivables, because of the relatively
short average life of the loans, no gain or loss is recorded at the time of
sale. Rather, loan servicing fees are recognized monthly over the life of
the transaction when earned and transaction expenses are deferred and
amortized over the reinvestment period of the transaction as a reduction of
loan servicing fees. In the case of home equity credit line and automobile
loan receivables, gains or losses, net of related transaction expenses, are
recorded at the time of the sale and the resultant excess servicing assets
are amortized over the life of the transaction.
Loans held for securitization and sale are the lesser of loans eligible for
securitization or loans that management contemplates to securitize within
six months. Such loans held for securitization and sale are reported at the
lower of aggregate cost or aggregate market value for each asset type.
Investment Securities and Mortgage-backed Securities:
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
securities 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-11
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (Continued):
Investment Securities and Mortgage-backed Securities (Continued):
Effective October 1, 1993, the Bank adopted Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments
in Debt and Equity Securities" ("SFAS 115") which was issued in May 1993.
SFAS 115 required institutions to classify and account for debt and equity
securities as either "held-to-maturity", "available-for-sale" or "trading."
Simultaneous with the adoption of SFAS 115, the Bank classified all of the
investment securities and mortgage-backed securities it held on October 1,
1993, as available-for-sale.
During fiscal 1995, the Bank transferred all of its investment securities
and mortgage-backed securities previously classified as available-for-sale
to held-to-maturity and, as a result, all investment securities and
mortgage-backed securities are classified as held-to-maturity at September
30, 1995. These securities were transferred at their fair value. Net
unrealized holding losses, net of the related income tax effect, amounting
to $3,476 as of the date of the transfer, and $3,112 as of September 30,
1995, continue to be reported as a separate component of stockholders'
equity and are being amortized to income over the remaining lives of the
securities using the level-yield method.
Premiums and discounts on investment securities and mortgage-backed
securities are amortized or accreted using the level-yield method. Realized
gains and losses are determined using the specific identification method.
Trading Securities:
As part of its mortgage banking activities, the Bank exchanges loans held
for sale for mortgage-backed securities and then sells the mortgage-backed
securities 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 $239,147 and
$688,811 during the years ended September 30, 1995 and 1994, respectively.
The Bank realized a net loss of $600 and a net gain of $1,695 on the sales
of trading securities for the years ended September 30, 1995 and 1994,
respectively. 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, 1995 and 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.
F-12
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (Continued):
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 straight-line basis over the
privilege period which is generally one year.
Impaired Loans:
A loan is considered impaired when, based on all current information and
events, it is probable that the Bank will be unable to collect all amounts
due according to the contractual terms of the agreement, including all
scheduled principal and interest payments. Such impaired loans are measured
based on the present value of expected future cash flows, discounted at the
loan's effective interest rate or, as a practical expedient, impairment may
be measured based on the loan's observable market price, or, if the loan is
collateral-dependent, the fair value of the collateral. When the measure of
the impaired loan is less than the recorded investment in the loan, the
impairment is recorded through a valuation allowance. Loans for which
foreclosure is probable continue to be accounted for as loans. Certain
credit card loans for which customers have agreed to modified payment terms
are also classified as impaired loans.
Each impaired real estate loan is evaluated individually to determine the
income recognition policy. Generally, payments received are applied in
accordance with contractual terms of the note or as a reduction of
principal.
Interest income on impaired credit card loans is recognized 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.
At September 30, 1995, the Bank had one impaired real estate loan with a
book value of $698. At September 30, 1994, the Bank had no impaired real
estate loans. At September 30, 1995 and 1994, the Bank had impaired credit
card loans with a carrying value of $36,738, before the related allowance
for losses of $3,674, and $35,299, before the related allowance for losses
of $3,530, respectively. The Bank calculates its allowance 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 credit card and real estate loans for the year ended September 30,
1995 and 1994 was $33,525 and $39,021, respectively. The Bank recognized
interest income of $5,261 and $2,441 on its impaired loans for the years
ended September 30, 1995 and 1994, respectively.
F-13
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (Continued):
Allowances for Losses:
Management reviews the loan, real estate held for investment and real
estate held for sale portfolios to establish allowances for estimated
losses. The allowances for losses are reviewed periodically, and allowances
are provided after consideration of the borrower's financial condition
and/or the estimated value of collateral, including estimated selling and
holding costs. Allowances 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 allowances for losses are based on estimates, and ultimate losses may
vary from current estimates. As adjustments to the allowances become
necessary, provisions for losses are reported in operations in the periods
they are determined to be necessary.
Accrued Interest Receivable on Loans:
Loans are reviewed on a monthly basis and are placed on non-accrual status
when, in the opinion of management, the full collection of principal or
interest has become unlikely. Uncollectible accrued interest receivable on
non-accrual loans is charged against current period interest income.
Real Estate Held for Investment or Sale:
Real Estate Held for Investment:
--------------------------------
At September 30, 1995, real estate held for investment consists of
developed land, which is owned by one of the Bank's subsidiaries. At
September 30, 1994, real estate held for investment consisted of an office
building, two apartment buildings, developed land and an investment in
limited partnership all of which were owned by one of the Bank's
subsidiaries. Also included in real estate held for investment at September
30, 1994, was 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, was accounted for as an acquisition, development and
construction ("ADC") arrangement. Real estate held for investment is
carried at the lower of aggregate cost or net realizable value. See Note 6.
F-14
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (Continued):
Real Estate Held for Investment or Sale (Continued):
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. 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. Prior
to December 31, 1992, real estate acquired in settlement of loans was
carried at the lower of adjusted cost or net realizable value. 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 $4,512, $4,386 and
$10,208 for the years ended September 30, 1995, and 1994 and 1993,
respectively.
Property and Equipment:
Property and equipment is stated at cost, net of accumulated depreciation
and amortization. Depreciation and amortization are computed using the
straight-line method which allocates the cost of the applicable assets over
their estimated useful lives. Major improvements and alterations to office
premises and leaseholds are capitalized. Leasehold improvements are
amortized over the shorter of the terms of the respective leases (including
renewal options that are expected to be exercised) or 20 years. Maintenance
and repairs are charged to operating expenses as incurred.
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 25 years. Accumulated amortization was $42,730
and $38,620 at September 30, 1995 and 1994, respectively.
Mortgage Servicing Rights:
Effective July 1, 1995, the Bank adopted SFAS No. 122, "Accounting for
Mortgage Servicing Rights" ("SFAS 122"), an amendment of SFAS No. 65,
"Accounting for Certain Mortgage Banking Activities." SFAS 122 requires
that a mortgage banking enterprise recognize, as separate assets, rights to
service mortgage loans for others, however those servicing rights are
acquired. Under previous accounting guidance, separate mortgage servicing
assets were generally recognized only when purchased. A mortgage banking
enterprise that acquires mortgage servicing rights through either purchase
or origination of mortgage loans and sells or securitizes those loans with
servicing rights retained must allocate the total cost of the mortgage
loans to the mortgage servicing rights and the loans (without the mortgage
servicing rights) based on their relative fair values.
F-15
<PAGE>
CHEVY CHASE, BANK, F.S.B.
-------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (Continued):
Mortgage Servicing Rights (Continued):
Mortgage servicing rights, which are stated net of accumulated
amortization, are being amortized in proportion to the remaining net
revenues estimated to be generated by the underlying mortgage servicing
rights. Amortization of these assets amounted to $2,154, $6,101 and $12,065
for the years ended September 30, 1995, 1994 and 1993, respectively.
Accumulated amortization was $37,733 and $35,579 at September 30, 1995 and
1994, respectively. During fiscal 1995, 1994 and 1993, the Bank capitalized
$16,283, $888 and $20,716, respectively, related to the acquisition of
mortgage servicing rights. In fiscal 1993, the Bank sold approximately
$1,150 of rights previously purchased to service mortgage loans with
principal balances of approximately $76,062 and recognized a loss of $380.
There were no sales of previously purchased mortgage servicing rights
during the years ended September 30, 1995 and 1994.
In fiscal 1995, 1994 and 1993, the Bank sold the rights to service mortgage
loans with principal balances of approximately $148,149, $383,854 and
$476,111, respectively, which were originated by the Bank in connection
with its mortgage banking activities, and recognized gains of $1,397,
$5,833, and $5,208, respectively.
SFAS 122 requires that a mortgage banking enterprise evaluate its mortgage
servicing rights for impairment based upon fair value. To measure fair
value of its mortgage servicing rights, the Bank uses either quoted market
prices or discounted cash flow analyses using appropriate assumptions for
servicing fee income, servicing fee costs, prepayment rates and discount
rates. Additionally, the Bank stratifies its capitalized mortgage servicing
rights for purposes of evaluating impairment taking into consideration
relevant risk characteristics including loan type, note rate and date of
acquisition. The fair value of capitalized mortgage servicing rights at
September 30, 1995 was $31,191 and no impairment allowance was required.
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 $14,549, $13,492 and
$21,447 for the years ended September 30, 1995, 1994 and 1993,
respectively. Accumulated amortization was $80,498 and $65,949 at September
30, 1995, 1994 and 1993, respectively. Excess servicing assets capitalized
in fiscal 1995, 1994 and 1993 of $14,991, $11,117 and $19,471 respectively,
were the result of the servicing retained upon the securitization and sale
of home equity credit line receivables and automobile loan receivables. See
Note 9.
F-16
<PAGE>
CHEVY CHASE, BANK, F.S.B.
-------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (Continued):
Excess Servicing Assets (Continued):
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.
Interest Rate Cap Agreements:
Premiums paid for interest rate cap agreements are included in other assets
in the Consolidated Statements of Financial Condition and are amortized to
expense over the terms of the interest rate caps on a straight-line basis.
Funds payable to the Bank are recognized as income in the month such funds
are earned. At September 30, 1995, unamortized premiums amounted to $9,986.
There were no interest rate cap agreements in effect at September 30, 1994.
Income Taxes:
Effective October 1, 1993, the Bank adopted SFAS No. 109, "Accounting for
Income Taxes" ("SFAS 109") which was issued in February 1992. SFAS 109
established financial accounting and reporting standards for the effects of
income taxes that result from the Bank's activities during the current and
preceding years. The asset and liability approach of accounting for income
taxes required by SFAS 109 replaces the deferred method previously used
under Accounting Principles Board Opinion No. 11, "Accounting for Income
Taxes" ("APB 11").
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 deferred tax assets is more likely than not, such assets are
recognized.
The effect of adoption of SFAS 109 was to increase the Bank's net deferred
tax asset by $5,103. This increase was due to the reversal of temporary
differences related to the Bank's base year tax bad debt reserve and the
impact of the increase in statutory Federal income tax rates. The income
tax provision for fiscal 1993 was determined under APB 11 and has not been
restated to reflect adoption of SFAS 109. The Bank's net deferred tax asset
at September 30, 1995 and 1994 under SFAS 109 was $42,000 and $38,430,
respectively, and is included in other assets in the Consolidated
Statements of Financial Condition. At September 30, 1995 and 1994, there
was no valuation allowances recorded for gross deferred tax assets.
Earnings Per Common Share:
Dividends on preferred stock are deducted from earnings in the computation
of earnings per common share when declared by the Bank's Board of
Directors.
F-17
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data):
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Reclassifications:
Certain reclassification have been made to the consolidated financial
statements for the years ended September 30, 1994 and 1993 to conform with
the presentation used for the year ended September 30, 1995.
Adoption of Recently Issued Accounting Standards:
SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments" ("SFAS 119"), was issued in October 1994.
This new statement requires certain disclosures about financial
derivatives, including amounts, nature and terms of the instruments. The
disclosure requires the description of the objectives, strategies and
classes of derivatives and related gains and losses in the financial
statements or in the notes thereto. It also requires that a distinction be
made between financial instruments held or issued for trading purposes and
those held or issued for purposes other than trading. Disclosures required
by SFAS 119 are effective for fiscal years ended after December 15, 1994.
The Bank has presented such disclosures in Note 23.
Accounting Standards Issued but not yet Adopted:
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" ("SFAS 121"), was issued in March
1995. SFAS 121 establishes accounting standards for the impairment of long-
lived assets, certain identifiable intangibles, and goodwill related to
those assets, to be held and used and for long-lived assets and certain
identifiable intangibles to be disposed of. It addresses how impairment
losses should be measured and when such losses should be recognized. Under
SFAS 121, long-lived assets and certain identifiable intangibles to be held
and used shall be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If the sum of the expected cash flows (undiscounted and
without interest charges) is less than the carrying amount of the asset,
the entity shall recognize an impairment loss. Measurement of an impairment
loss for long-lived assets and identifiable intangibles that an entity
expects to hold and use should be based on the fair value of the asset.
Long-lived assets and certain identifiable intangibles to be disposed of
should generally be reported at the lower of carrying amount or fair value
less the cost to sell. SFAS 121 is effective for financial statements for
fiscal years beginning after December 15, 1995. The adoption of SFAS 121 is
not anticipated to have a material impact on the Bank's financial condition
or the results of operations.
F-18
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data):
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Accounting Standards Issued but not yet Adopted (Continued):
Statement of Position 94-6, "Disclosures of Significant Risks and
Uncertainties" ("SOP 94-6"), was issued in January 1995. SOP 94-6 requires
an entity to disclose certain information about the nature of its
operations and use of estimates in the preparation of its financial
statements. In addition, if specified criteria are met, it requires an
entity to disclose certain information about certain significant estimates
and current vulnerability to risk due to certain concentrations. SOP 94-6
is effective for financial statements for fiscal years ending after
December 15, 1995, and for financial statements for interim periods in
fiscal years subsequent to the year for which SOP 94-6 is first applied.
NOTE 2 - LOANS HELD FOR SECURITIZATION AND SALE.
Loans held for securitization and sale are composed of the following:
<TABLE>
<CAPTION>
September 30, September 30,
1995 1994
------------- -------------
<S> <C> <C>
Credit card receivables $ 300,000 $ 115,000
Automobile loan receivables 200,000 -
------------- -------------
Total $ 500,000 $ 115,000
============= =============
</TABLE>
NOTE 3 - INVESTMENT SECURITIES:
At September 30, 1995, all investment securities are classified as
held-to-maturity. Gross unrealized holding gains and losses on the Bank's
investment securities at September 30, 1995 are as follows:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
September 30, 1995
- ------------------
U.S. Government securities
Maturing within one year $ 4,370 $ 1 $ - $ 4,371
========= ========== ========== =========
</TABLE>
F-19
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 3 - INVESTMENT SECURITIES (Continued):
As discussed in Note 1, at September 30, 1994, investment securities were
classified as available-for-sale and carried at fair value. Gross unrealized
holding gains and losses on the Bank's investment securities at September 30,
1994 are as follows:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
Cost Gains Losses Value
----------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
September 30, 1994
- ------------------
U.S. Government securities $ 4,399 $ - $ (135) $ 4,264
Other securities 100 - - 100
----------- ---------- -------------- ------------
Total $ 4,499 $ - $ (135) $ 4,364
=========== ========== ============= ============
</TABLE>
Proceeds from sales of investment securities, including securities held for
sale, during fiscal 1993 were $181,819. Gross gains of $8,895 and gross losses
of $0 were realized on sales during fiscal 1993. There were no sales of
investment securities during the years ended September 30, 1995 and 1994.
At September 30, 1995, certain investment securities were pledged as collateral
for certain letters of credit. See Note 23.
NOTE 4 - MORTGAGE-BACKED SECURITIES:
At September 30, 1995, all mortgage-backed securities are classified as
held-to-maturity. Gross unrealized holding gains and losses on the Bank's
mortgage-backed securities at September 30, 1995 are as follows:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
Cost Gains Losses Value
---------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
September 30, 1995
- ------------------
FNMA $ 27,182 $ 50 $ (13) $ 27,219
FHLMC 718,640 833 (1,689) 717,784
Private label, AA-rated 134,386 364 (33) 134,717
---------- ---------- ----------- -----------
Total $ 880,208 $ 1,247 (1,735) $ 879,720
========== ========== =========== ===========
</TABLE>
F-20
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 4 - MORTGAGE-BACKED SECURITIES (Continued):
As discussed in Note 1, at September 30, 1994, mortgage-backed securities were
classified as available-for-sale and carried at fair value. Gross unrealized
holding gains and losses on the Bank's mortgage-backed securities at September
30, 1994 are as follows:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
Cost Gains Losses Value
----------- --------- ------------ -------------
<S> <C> <C> <C> <C>
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
=========== ========== ============ =============
</TABLE>
Proceeds from sales of mortgage-backed securities, including mortgage-backed
securities held for sale, were $810,771 during the year ended September 30,
1993. Gross gains of $10,166 and gross losses of $4,379 were realized on the
sale of mortgage-backed securities, including mortgage-backed securities held
for sale, during the year ended September 30, 1993. There were no sales of
mortgage-backed securities from the available-for-sale or the held-to-maturity
portfolios during the years ended September 30, 1995 and 1994. See Note 1 -
"Trading Securities."
Accrued interest receivable on mortgage-backed securities totaled $5,733 and
$6,342 at September 30, 1995 and 1994, respectively, and is included in other
assets in the Consolidated Statements of Financial Condition.
At September 30, 1995, certain mortgage-backed securities were pledged as
collateral for securities sold under repurchase agreements, other short-term
borrowings and other recourse arrangements. See Notes 13 and 23. Other
mortgage-backed securities with a book value of $22,284 were pledged as
collateral primarily for credit card settlement obligations.
F-21
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 5 - LOANS RECEIVABLE:
Loans receivable is composed of the following:
<TABLE>
<CAPTION>
September 30,
-----------------------------
1995 1994
------------ ------------
<S> <C> <C>
Single-family residential $ 1,322,772 $ 1,335,645
Home equity 29,024 34,708
Commercial and multifamily 86,007 84,639
Real estate construction 46,848 66,909
Ground 6,892 18,935
Credit card 712,548 535,199
Automobile 39,217 289,346
Overdraft lines of credit 15,049 8,365
Home improvement 112,705 37,526
Other 31,975 22,572
------------ ------------
2,403,037 2,433,844
------------ ------------
Less:
Undisbursed portion of loans 28,147 35,535
Unearned discounts 872 1,108
Net deferred loan origination costs (13,764) (10,725)
Reserve for losses on loans 60,496 50,205
------------ ------------
75,751 76,123
------------ ------------
Total $ 2,327,286 $ 2,357,721
============ ============
</TABLE>
The Bank serviced loans owned by others amounting to $5,250,817 and $3,943,846
at September 30, 1995 and 1994, respectively.
Accrued interest receivable on loans totaled $21,853 and $17,087 at September
30, 1995 and 1994, respectively, and is included in other assets in the
Consolidated Statements of Financial Condition.
F-22
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 6 - REAL ESTATE HELD FOR INVESTMENT OR SALE:
Real estate held for investment or sale is composed of the following:
<TABLE>
<CAPTION>
September 30,
--------------------------------
1995 1994
-------------- -------------
<S> <C> <C>
Land, development, construction
and rental properties $ 3,819 $ 69,586
Investment in limited partnership - (2,920)
Investment in real estate venture - 8,915
-------------- -------------
Total real estate held for investment 3,819 75,581
-------------- -------------
Real estate held for sale 354,277 387,024
-------------- -------------
Less:
Reserve for losses on real estate held
for investment 193 9,899
Reserve for losses on real estate held for sale 135,043 109,074
Accumulated depreciation and amortization - 13,600
-------------- -------------
135,236 132,573
-------------- -------------
Total real estate held for investment or sale $ 222,860 $ 330,032
============== =============
</TABLE>
Earnings (loss) on real estate held for investment or sale is composed of the
following:
<TABLE>
<CAPTION>
September 30,
-----------------------------------------
1995 1994 1993
------------ ------------ ------------
<S> <C> <C> <C>
Provision for losses $ (26,321) $ (14,052) $ (30,415)
Net income from operating properties 2,382 3,521 6,496
Equity earnings from investments in
limited partnerships 4,470 391 1,694
Net gain on sales 14,797 11,466 9,503
------------ ------------ ------------
Total $ (4,672) $ 1,326 $ (12,722)
============ ============ ============
</TABLE>
During fiscal 1995, the Bank sold two residential apartment buildings which were
previously classified as real estate held for investment and had an aggregate
net book value of $25,333 and recognized a net gain of $5,318. Also during
fiscal 1995, an office building, previously classified as real estate held for
investment, which had a book value of $24,469 at September 30, 1995, was
transferred to property and equipment as management plans to use a significant
portion of the building to satisfy the Bank's current and anticipated need for
additional office space. In addition, during fiscal 1995, the investment in real
estate venture was transferred to REO and the Bank sold its limited partnership
interest in an office building at an amount that exceeded its net carrying
value.
During fiscal 1994, the Bank sold its interest in three limited partnerships to
other partners at an aggregate amount that exceeded the net carrying values of
these assets.
F-23
<PAGE>
CHEVY CHASE BANK, F.S.B
-----------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 6 - REAL ESTATE HELD FOR INVESTMENT OR SALE:
At September 30, 1994, the Bank had an ADC arrangement with, and held a
partnership interest in, a limited partnership. As discussed above, the Bank
sold its limited partnership interest and transferred its ADC arrangement to REO
during fiscal 1995. The partnership and ADC arrangement were initially formed
for the purpose of acquiring, developing, operating and selling real estate and
were 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 Bank and the partnership relating to these investments other than reflected
below. Combined, condensed financial information for the partnerships and ADC
arrangements is presented below:
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
September 30,
1994
-------------
<S> <C>
ASSETS
- ------
Land, buildings, construction in progress
and other assets $ 49,567
=============
LIABILITIES AND PARTNERSHIP EQUITY
- ----------------------------------
Notes payable to the Corporations $ 8,915
Other liabilities 46,546
Partnership (deficit) equity:
-Corporations (2,920)
-Others (2,974)
-------------
$ 49,567
=============
</TABLE>
STATEMENTS OF OPERATIONS/(1)/
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------
1994 1993
----------- ------------
<S> <C> <C>
Income $ 7,280 $ 12,492
Expenses (7,360) (13,669)
Gain on sales of property - 4,892
----------- ------------
Net income (loss) $ (80) $ 3,715
=========== ============
</TABLE>
______________________________________________________________
/(1)/ There were no significant operations during fiscal 1995.
Prior to fiscal 1995, with respect to the ADC arrangement, the limited
partnership classified the Bank's investment in the real estate project as a
liability payable to the Bank rather than as equity.
F-24
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 7 - ALLOWANCES FOR LOSSES:
Activity in the allowances for losses on loans receivable and real estate held
for investment or sale is summarized as follows:
<TABLE>
<CAPTION>
Real Estate
Held for
Loans Investment
Receivable or Sale
----------- -------------
<S> <C> <C>
Balance, September 30, 1992 $ 78,818 $ 109,044
Provision for losses 60,372 30,415
Charge-offs (84,890) (27,815)
Recoveries 13,740 -
----------- -------------
Balance, September 30, 1993 68,040 111,644
Provison for losses 29,222 14,052
Charge-offs (61,039) (6,723)
Recoveries 13,982 -
----------- -------------
Balance, September 30, 1994 50,205 118,973
Provision for losses 54,979 26,321
Charge-offs (56,577) (10,058)
Recoveries 11,889 -
----------- -------------
Balance, September 30, 1995 $ 60,496 $ 135,236
=========== =============
</TABLE>
The allowances for losses at September 30, 1995 are based on management's
estimates of the amount of allowances required to reflect the risks in the loan
and real estate portfolios based on circumstances and conditions known at the
time. As adjustments to the allowances become necessary, provisions for losses
are reported in operations in the periods they are determined to be necessary.
F-25
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 8 - NON-PERFORMING ASSETS:
Non-performing assets are composed of the following at September 30, 1995:
<TABLE>
<CAPTION>
Non-accrual
Loans Real Estate (1) Total
---------------- --------------- --------------
<S> <C> <C> <C>
Single-family residential $ 8,593 $ 3,532 $ 12,125
Residential land, development and construction - 197,424 197,424
Office building 194 - 194
Commercial land - 18,278 18,278
---------------- --------------- --------------
Total real estate assets 8,787 219,234 228,021
Credit card 18,569 - 18,569
Other 595 - 595
---------------- --------------- --------------
Total non-performing assets $ 27,951 $ 219,234 $ 247,185
================ =============== ==============
Reserves for Losses
- -------------------
Real estate $ 10,880 $ 135,236 $ 146,116
Credit card 46,325 - 46,325
Other 3,291 - 3,291
---------------- --------------- --------------
Total $ 60,496 $ 135,236 $ 195,732
================ =============== ==============
Reserves for Losses as a Percentage of
- --------------------------------------
Non-Performing Assets (2)
- ------------------------
Real estate 123.82% 38.17% 40.25%
Credit card 249.47% - 249.47%
Other 553.11% - 553.11%
---------------- --------------- --------------
Total 216.44% 38.17% 51.21%
================ =============== ==============
</TABLE>
- --------------------------------------------------------------------------------
(1) Real estate acquired in settlement of loans is shown net of valuation
allowances.
(2) The ratio of reserves for losses to non-performing assets is calculated
before the deduction of such reserves.
Approximately 24.7% 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 58.4% 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 allowances and initial write-downs for real
estate acquired in settlement of loans. See Note 7. As circumstances change, it
may be necessary to provide additional allowances based on new information.
F-26
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
(Dollars in thousands, except per share data)
NOTE 8 - NON-PERFORMING ASSETS (Continued):
At September 30, 1995 and 1994, the Bank had $17,344 and $29,141, respectively,
of loans accounted for as troubled debt restructurings, all of which were
included as performing loans. At September 30, 1995, the Bank had commitments to
lend $1,079 of additional funds on loans which have been restructured.
The amount of interest income that would have been recorded if non-accrual
assets and restructured loans had been current in accordance with their original
terms was $7,234, $9,067 and $10,451 for the years ended September 30, 1995,
1994 and 1993, respectively. The amount of interest income that was recorded on
these loans was $2,035, $2,742 and $3,007 for the years ended September 30,
1995, 1994 and 1993, respectively.
NOTE 9 - SIGNIFICANT SALES TRANSACTIONS:
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 $1,550,000, $1,350,000 and
$350,000 for these asset-backed certificates during the years ended September
30, 1995, 1994 and 1993, 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 $3,226,316 and $1,953,792 at September
30, 1995 and 1994, respectively. The related receivable balances contained in
the trusts were $3,776,893 and $2,330,930 at September 30, 1995 and 1994,
respectively. The Bank continues to service the underlying loans and is
contingently liable under various credit enhancement facilities related to these
transactions. See Note 23.
During fiscal 1995, the Bank sold amounts on deposit in certain spread accounts
associated with certain outstanding credit card securitizations through an
asset-backed securitization, in which amounts on deposit in such spread accounts
were transferred to a trust, and the Bank sold certificates to investors
representing ownership interests in the trust. The amount of the asset-backed
certificates sold and gross proceeds received was $59,200. No gain or loss was
recorded on the transaction. The outstanding trust certificate balance related
to this securitization was $58,688 at September 30, 1995.
During fiscal 1994, the Bank sold credit card relationships with related
outstanding receivable balances of $96,493. Gains of $16,934 were recorded in
connection with this sale for the year ended September 30, 1994, and the Bank is
no longer servicing these relationships. No such sales occurred during the years
ended September 30, 1995 and 1993.
F-27
<PAGE>
CHEVY CHASE BANK, F.S.B
-----------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 9 - SIGNIFICANT SALES TRANSACTIONS (Continued):
The Bank periodically sells home equity credit line receivables through
asset-backed securitizations, in which home equity credit line receivables are
transferred to trusts, and the Bank sells certificates to investors representing
ownership interests in the trusts. The amount of asset-backed certificates sold
and gross proceeds received was $150,455, $181,924 and $340,362, during the
years ended September 30, 1995, 1994 and 1993, respectively. Gains recognized on
these transactions were $7,606, $9,530 and $16,773, during the years ended
September 30, 1995, 1994 and 1993, 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 $455,791 and $464,668,
respectively, at September 30, 1995. The outstanding trust certificate balances
and the related balances contained in the trusts were $485,428 at September 30,
1994. The Bank is contingently liable under various credit enhancement
facilities related to these transactions. See Note 23.
During the fiscal 1995, the Bank sold automobile loan receivables through an
asset-backed securitization, in which automobile loan receivables were
transferred to a trust, and the Bank sold certificates to investors representing
ownership interests in the trust. The amount of asset-backed certificates sold
and gross proceeds received was $252,235. The gain recognized on this
transaction was $3,988, and the Bank continues to service the underlying loans.
The outstanding trust certificate balances and the related receivable balances
contained in the trust were $218,287 at September 30, 1995. The Bank is
contingently liable under a credit enhancement facility related to this
transactions. See Note 23.
NOTE 10 - PROPERTY AND EQUIPMENT:
Property and equipment is composed of the following:
<TABLE>
<CAPTION>
Estimated
Useful September 30,
----------------------------
Lives 1995 1994
----------- ----------- ------------
<S> <C> <C> <C>
Land - $ 38,616 $ 24,035
Construction in progress - 6,446 1,532
Buildings and improvements 10-45 years 62,519 47,741
Leasehold improvements 5-20 years 56,674 43,618
Furniture and equipment 5-10 years 131,001 121,947
Automobiles 3-5 years 1,801 1,366
------------- -------------
297,057 240,239
Less:
Accumulated depreciation and amortization 122,384 101,965
------------- -------------
Total $ 174,673 $ 138,274
============= =============
</TABLE>
Depreciation expense amounted to $18,836, $18,278 and $14,531 for the years
ended September 30, 1995, 1994 and 1993, respectively.
F-28
<PAGE>
CHEVY CHASE BANK. F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 10 - PROPERTY AND EQUIPMENT (Continued):
During fiscal 1995, an office building previously classified as real estate held
for investment was transferred to property and equipment as management plans to
use a significant portion of the building to satisfy the Bank's current and
anticipated need for additional office space. This asset had a book value of
$24,469 at September 30, 1995.
NOTE 11 - LEASES:
The Corporations have noncancelable, long-term leases for office premises and
retail space, which have a variety of terms expiring from 1996 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, 1995:
<TABLE>
<CAPTION>
Year Ending
September 30,
-------------
<S> <C>
1996 $ 14,772
1997 11,954
1998 10,020
1999 8,028
2000 6,763
Thereafter 54,934
-----------
Total $ 106,471
===========
</TABLE>
Rent expense totaled $11,228, $9,677 and $9,162 for the years ended September
30, 1995, 1994 and 1993, respectively.
F-29
<PAGE>
CHEVY CHASE BANK. F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 12 - DEPOSIT ACCOUNTS:
An analysis of deposit accounts and the related weighted average effective
interest rates at year-end are as follows:
<TABLE>
<CAPTION>
September 30,
--------------------------------------------------------
1995 1994
--------------------------------------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
-------------- --------- ------------- ---------
<S> <C> <C> <C> <C>
Demand accounts $ 123,141 - $ 94,600 -
NOW accounts 826,977 2.91% 823,627 2.95%
Money market deposit accounts 984,257 4.02% 1,104,730 3.84%
Statement savings accounts 872,366 3.48% 1,201,141 3.49%
Other deposit accounts 61,011 2.98% 57,696 2.99%
Certificate accounts, less than $100 1,112,817 5.80% 657,134 4.13%
Certificate accounts, $100 or more 178,683 5.99% 69,833 4.52%
-------------- --------------
Total $ 4,159,252 4.11% $ 4,008,761 3.51%
============== ==============
</TABLE>
Interest expense on deposit accounts is composed of the following:
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------------------------
1995 1994 1993
------------- -------------- --------------
<S> <C> <C> <C>
NOW accounts $ 23,692 $ 23,147 $ 18,523
Money market deposit accounts 42,420 37,305 39,430
Statement savings accounts 33,394 39,147 26,598
Other deposit accounts 1,731 1,573 1,381
Certificate accounts 53,033 29,723 41,813
------------- -------------- --------------
154,270 130,895 127,745
Custodial accounts 29 29 47
------------- -------------- --------------
Total $ 154,299 $ 130,924 $ 127,792
============= ============== ==============
</TABLE>
Outstanding certificate accounts at September 30, 1995 mature in the years
indicated as follows:
<TABLE>
<CAPTION>
Year Ending
September 30,
-------------
<S> <C>
1996 $ 885,430
1997 224,455
1998 66,429
1999 29,078
2000 86,108
==============
Total $ 1,291,500
==============
</TABLE>
F-30
<PAGE>
CHEVY CHASE BANK. F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 12 - DEPOSIT ACCOUNTS: (Continued):
At September 30, 1995, certificate accounts of $100 or more have contractual
maturities as indicated below:
<TABLE>
<CAPTION>
<S> <C>
Three months or less $ 75,571
Over three months through six months 31,405
Over six months through 12 months 36,596
Over 12 months 35,111
------------
Total $ 178,683
============
</TABLE>
NOTE 13 - SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM
BORROWINGS:
Short-term borrowings are summarized as follows:
<TABLE>
<CAPTION>
September 30,
---------------------------------------------------
1995 1994 1993
---------------------------------------------------
<S> <C> <C> <C>
Securities sold under repurchase agreements:
Balance at year-end $ - $ - $ 83,151
Average amount outstanding during the year 159,044 103,299 265,176
Maximum amount outstanding at any month-end 353,615 202,256 478,534
Amount maturing within 30 days - - 83,151
Weighted average interest rate during the year 6.02% 3.78% 3.28%
Weighted average interest rate on year-end balances
balances - - 3.23%
Other short-term borrowings
Balances at year-end $ 10,435 $ 8,907 $ 5,115
Average amount outstanding during the year 20,451 13,336 2,212
Maximum amount outstanding at any month-end 53,242 51,992 5,115
Amount maturing within 30 days 10,435 8,907 5,115
Weighted average interest rate during the year 5.59% 3.42% 2.77%
Weighted average interest rate on year-end balances
balances 5.70% 4.87% 3.71%
</TABLE>
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, 1995, the Bank had pledged mortgage-backed securities with a
book value of $18,849 to secure certain other short-term borrowings.
F-31
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 14 - BONDS PAYABLE:
At September 30, 1994, bonds payable represented 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 $25,659. The assets
securing these bonds were included in real estate held for investment or sale.
During fiscal 1995, the Bank sold the apartment buildings. See Note 6. In
connection with the sale, the bonds were assumed by the purchaser.
The term bonds amounting to $23,725 at September 30, 1994 bore interest at 9.7%.
The serial bonds amounting to $305 at September 30, 1994 bore interest at 9.3%.
Deferred debt issuance costs, net of accumulated amortization, amounted to $504
at September 30, 1994 and were included in other assets in the Consolidated
Statements of Financial Condition. These amounts were amortized using the
level-yield method over the life of the related debt. In connection with the
sale discussed above, the remaining unamortized amounts became a component of
the gain on sale during fiscal 1995.
At September 30, 1994, $2,955 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 Corporation were unable to fund payments. This
amount was included in interest-bearing deposits in the Consolidated Statements
of Financial Condition. In connection with the sale discussed above, the
proceeds were released from the restrictions during fiscal 1995.
NOTE 15 - NOTES PAYABLE
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, 1995 are as follows:
<TABLE>
<CAPTION>
Year Ending
September 30,
-------------
<S> <C>
1996 $ 236
1997 260
1998 286
1999 314
2000 346
Thereafter 6,072
---------
Total $ 7,514
=========
</TABLE>
F-32
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994, and 1993
----------------------------------
(Dollars in thousands, except per share data)
NOTE 16 - FEDERAL HOME LOAN BANK ADVANCES:
At September 30, 1995, the advances from the Federal Home Loan Bank of Atlanta
totaled $155,052. Of the total advances at September 30, 1995, (a) $50,000 have
a current interest rate of 6.75%, reprice daily and mature in October 1995, and
(b) $100,000 have a current interest rate of 5.77%, adjust quarterly based on
the three-month London Interbank Offered Rate ("LIBOR") and mature in August
1996. The weighted average interest rate on the remaining $5,052 is 7.51% which
is fixed for the term of the advances and matures over varying periods ending
between December 1996 and September 2000.
Under a Specific Collateral Agreement with the FHLB, advances are secured by all
of the Bank's stock, qualifying first mortgage loans with a total principal
balance of $309,656 and mortgage-backed securities with a book value of
$138,603. 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, 1995 advances is available to
secure additional advances from the FHLB, subject to its collateralization
guidelines.
NOTE 17 - CAPITAL NOTES - SUBORDINATED:
Capital notes, which are subordinated to the interest of deposit account
holders, are composed of the following:
<TABLE>
<CAPTION>
September 30, Interest
---------------------
1995 1994 Rate
---------- ---------- --------------
<S> <C> <C> <C>
Private placement:
BACOB Bank, a.c,
due 1996 $ 10,000 $ 10,000 LIBOR + 3.0%
Public placement:
Subordinated debentures due 2005 150,000 150,000 91/4%
---------- ----------
Total $ 160,000 $ 160,000
========== ==========
</TABLE>
On November 23, 1993, the Bank sold $150.0 million 9 1/4% Subordinated
Debentures due 2005 (the "Debentures"). The Bank received net proceeds of
$143,603 from the sale of the Debentures, of which approximately $134,200 was
used to redeem $78,500 of debentures due in 2002 and $50,000 of debentures due
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
$6,333, after related income taxes, in connection with the redemption of these
debentures. The OTS approved the inclusion of the principal amount of the
Debentures in the Bank's supplementary capital for regulatory capital purposes.
F-33
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 17 - CAPITAL NOTES - SUBORDINATED (Continued):
The indenture pursuant to which the 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) $15,000, (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, provide 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
$5,898 and $6,223 at September 30, 1995 and 1994, respectively, and are included
in other assets in the Consolidated Statements of Financial Condition.
NOTE 18 - PREFERRED STOCK:
In April 1993, the Bank sold $75,000 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-34
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 19 - RETIREMENT PLAN:
The Bank participates in a defined contribution profit sharing retirement plan
(the "Plan") which covers those full-time employees who meet the requirements as
specified in the Plan. The Plan, which can be modified or discontinued at any
time, requires participating employees to contribute 2.0% of their compensation.
Corporate contributions, at the discretionary amount of three times the employee
contribution, were $3,920, $3,507 and $3,081 for the years ended September 30,
1995, 1994 and 1993, respectively. There are no part service costs associated
with the Plan and the Bank has no liability under the Plan other than its
current contributions. The Plan owns 4.0% of the Bank's common stock.
NOTE 20 - INCOME TAXES:
As discussed in Note 1, the Bank adopted SFAS 109 effective October 1, 1993. For
fiscal 1993, the Bank accounted for income taxes in accordance with APB 11. The
provision for income taxes for the years ended September 30, 1995, 1994 and
1993, consists of the following:
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Current provision (benefit):
Federal $ 25,661 $ 17,141 $ 14,189
State (4,761) 4,391 3,625
--------- --------- ---------
20,900 21,532 17,814
--------- --------- ---------
Deferred provision (benefit)
Federal (3,046) 1,348 8,795
State (524) (486) (6)
--------- --------- ---------
(3,570) 862 8,789
--------- --------- ---------
Provisions for income taxes 17,330 22,394 26,603
Tax effect of other items:
Cumulative effect of adoption of SFAS 109 - (5,103) -
Extraordinary item - (4,143) -
Tax effect of net unrealized holding gains (losses)
reported in stockholders' equity 7,207 (9,243) -
------------ --------- ---------
Total $ 24,537 $ 3,905 $ 26,603
============ ========= =========
</TABLE>
F-35
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 20 - INCOME TAXES (Continued):
The Bank's effective income tax rate varies from the statutory Federal income
tax rate as a result of the following factors:
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------
1995 1994 1993
---------- ---------- -----------
<S> <C> <C> <C>
Computed tax at statutory Federal income tax rate $ 19,129 $ 18,432 $ 22,238
Increase (decrease) in taxes resulting from:
Goodwill and other purchase accounting
adjustments 1,465 1,494 1,915
State franchise tax effect (3,451) 2,540 2,359
Other 187 (72) 91
---------- ---------- -----------
Total $ 17,330 $ 22,394 $ 26,603
========== ========== ===========
</TABLE>
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 Bank's Federal corporate income tax
rate for the years ended September 30, 1995, 1994 and 1993 was 35.00%, 35.00%
and 34.75%, respectively.
The net deferred tax asset is composed of the following:
<TABLE>
<CAPTION>
September 30,
--------------------------
1995 1994
------------ ------------
<S> <C> <C>
Deferred tax assets:
Provision for losses in excess of deductions $ 65,072 $ 54,903
Deferred loan fees - 3,309
Real estate mortgage investment conduit 675 3,655
State net operating losses 725 1,333
Unrealized losses on real estate owned 2,744 -
Other 2,600 1,210
---------- ----------
Gross deferred tax assets 71,816 64,410
---------- ----------
Deferred tax liabilities:
Net unrealized holding gains 8,833 10,324
Deferred loan fees 4,691 -
Depreciation 8,970 7,639
FHLB stock dividends 5,376 5,658
Other 1,946 2,359
---------- ----------
Gross deferred tax liabilities 29,816 25,980
---------- ----------
Net deferred tax asset $ 42,000 $ 38,430
========== ==========
</TABLE>
F-36
<PAGE>
CHEVY CHASE BANK. F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 20 - INCOME TAXES (Continued):
The net deferred tax asset, along with current taxes payable, is included in
other assets in the Consolidated Statements of Financial Condition. The
components are as follows:
<TABLE>
<CAPTION>
September 30,
-------------------------
1995 1994
----------- -----------
<S> <C> <C>
Current taxes payable $ (18,609) $ (10,129)
Net deferred tax assets 42,000 38,430
----------- -----------
Total $ 23,391 $ 28,301
=========== ===========
</TABLE>
Under APB 11, the following represents the tax effects of timing differences
resulting in a deferred income tax provision:
<TABLE>
<CAPTION>
Year Ended
September 30,
1993
--------------
<S> <C>
Provisions for losses in excess of deductions $ 14,437
Depreciation (2,864)
Deferred loan fees (938)
Valuation allowances 19
Real estate mortgage investment conduit (1,454)
State taxes (211)
State net operating losses (1,577)
Other 1,377
--------------
Total $ 8,789
==============
</TABLE>
NOTE 21 - REGULATORY MATTERS:
Under the Financial Institution Reforms, Recovery and Enforcement Act of 1989
("FIRREA"), the Bank's regulatory capital requirements at September 30, 1995
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, 1995, the Bank was in compliance with its tangible, core and total
risk-based regulatory capital requirements. In addition, on the basis of its
balance sheet at September 30, 1995, the Bank met the FIRREA-mandated fully
phased-in capital requirements and, on a fully phased-in basis, met the capital
standards established for "well capitalized" institutions under the "prompt
corrective action" regulations. The information below is based upon the Bank's
understanding of the applicable FIRREA and "prompt corrective action"
regulations and related interpretations.
F-37
<PAGE>
CHEVY CHASE BANK F.S.B.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1995, 1994,and 1993
(Dollars in thousands, except per share data)
NOTE 21 - REGULATORY MATTERS (CONTINUED):
<TABLE>
<CAPTION>
MINIMUM EXCESS
ACTUAL CAPITAL REQUIREMENTS CAPITAL
------------------------------ ----------------------------- ------------------------------
As a % of As a % of As a % of
Amount Assets/4/ Amount Assets Amount Assets
--------------- ------------- -------------- ------------- ----------------- ----------
<S> <C> <C> <C> <C> <C> <C>
Capital per financial statements $ 328,544
Net unrealized holding losses/(1)/ 3,112
---------------
Adjusted capital 331,656
Adjustments for tangible and
core capital:
Intangible assets (45,697)
Non-includable subsidiaries/(2)/ (2,122)
Non-qualifying purchases/
originated loan servicing (1,493)
---------------
Total tangible capital 282,344 5.77% $ 73,438 1.50% $ 208,906 4.27%
--------------- ============= ============== ============ ================= ==========
Supervisory goodwill/(3)/ -
--------------- ============= ============== ============ ================= ==========
Total core capital/(4)/ 282,344 5.77% $ 195,835 4.00% $ 86,509 1.77%
--------------- ============= ============== ============ ================= ==========
Tier 1 risk-based capital/(4)/ 282,344 6.65% $ 169,873 4.00% $ 112,471 2.65%
--------------- ============= ============== ============ ================= ==========
Adjustments for risk-based
capital:
Subordinated capital debentures 151,400
Allowances for general loan losses 53,264
---------------
Total supplementary capital 204,664
---------------
Excess allowances for loan losses (176)
---------------
Adjusted supplementary capital 204,488
---------------
Total available capital 486,832
Equity investments/(2)/ (25,702)
---------------
Total risk-based capital/(4)/ $ 461,130 11.63% $ 339,746 8.00% $ 121,384 3.63%
=============== ============= ============== ============ ================= ==========
</TABLE>
________________________________________________________________________________
/1/ Pursuant to OTS policy, net unrealized holding gains (losses) are excluded
from regulatory capital.
/2/ Reflects an aggregate offset of $3,695 representing the allowance for
general loan losses maintained against the Bank's equity investments and
non-includable subsidiaries which, pursuant to OTS guidelines, is
available as a "credit" against the deductions from capital otherwise
required for such investments.
/3/ Effective January 1, 1995, the amount of supervisory goodwill includable as
core capital under OTS regulations, decreased from 0.375% to 0% of tangible
assets.
/4/ Under the OTS "prompt corrective action" regulations, the standards for
classification as "well capitalized" are a leverage (or "core capital")
ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0%
and a total risk-based capital ratio of at least 10.0%.
At September 30, 1995, the Bank had $3,859 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): 60% beginning July 1, 1995, and 100% beginning July 1,
1996. At September 30, 1995, the Bank also had two equity investments with an
aggregate balance, after subsequent valuation allowances, of $29,204 which were
full phased-out from total risk-based capital.
F-38
<PAGE>
CHEVY CHASE, BANK, F.S.B.
-------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 21 - REGULATORY MATTERS (CONTINUED):
As of September 30, 1995, the Bank had $45,697 in supervisory goodwill, all of
which was excluded from core capital pursuant to statutory provisions.
OTS capital regulations provide a five-year holding period (or such longer
period as may be approved by the OTS) for REO to qualify for an exception from
treatment as an equity investment. If an REO property is considered an equity
investment, its then-current book value is deducted from total risk-based
capital. Accordingly, if the Bank is unable to dispose of any REO property
(through bulk sales or otherwise) prior to the end of its applicable five-year
holding period and is unable to obtain an extension of such five-year holding
period from the OTS, the Bank could be required to deduct the then-current book
value of such REO property from total risk-based capital. In September 1995, the
Bank received from the OTS a one-year extension of the five-year holding period
for certain of its REO properties. The following table sets forth the Bank's REO
at September 30, 1995, after valuation allowances of $135,043, by the fiscal
year in which the property was acquired through foreclosure.
<TABLE>
<CAPTION>
Fiscal Year (In thousands)
----------- --------------
<S> <C>
1990 $ 89,070 (1)(2)
1991 90,207 (2)
1992 15,080
1993 4,809
1994 8,389
1995 11,679
----------
Total REO $ 219,234
==========
</TABLE>
____________________________________
/(1)/ Includes REO with an aggregate net book value of $29,204, which the Bank
treats as equity investments for regulatory capital purposes.
/(2)/ Includes REO, with an aggregate net book value of $153,457, for which the
Bank received an extension of the five-year holding period through
September 29, 1996.
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, 1995.
Additionally, on a fully phased-in basis at September 30, 1995, the Bank's
regulatory capital ratios would exceed the ratios established for "well
capitalized" institutions.
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 settlements 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.
F-39
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 21 - REGULATORY MATTERS (Continued):
In November 1995, Congress passed and presented to President Clinton, the
Balanced Budget Act of 1995 (the "Budget Act") which could, among other things,
capitalize the Savings Association Insurance Fund ("SAIF") and either reduce or
eliminate the anticipated disparity between Bank Insurance Fund ("BIF") and SAIF
insurance premiums. Under the Budget Act: (i) thrift institutions would pay a
one-time assessment estimated to be up to 85 basis points on their SAIF-insured
deposits to increase the SAIF's reserve ratio to 1.25%; and (ii) effective
January 1, 1996, the assessment base for interest payments on Financing
Corporation bonds, which were issued in the late 1980s to resolve troubled
thrifts, would be expanded to cover all of FDIC-insured institutions, including
members of both the BIF and SAIF. If the legislation is enacted in its current
form, the Bank would be required to pay a one-time assessment of up to $35
million in the first quarter of calendar year 1996; however,the Bank's semi-
annual risk-based deposit insurance premiums should be reduced in future years.
NOTE 22 - TRANSACTIONS WITH RELATED PARTIES:
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, 1995 is
as follows:
<TABLE>
<S> <C>
Balance, September 30, 1994 $ 4,702
Additions 1,553
Reductions (2,350)
---------
Balance, September 30, 1995 $ 3,905
=========
</TABLE>
Services:
B.F. Saul Company, which is a shareholder of the Trust, and its subsidiaries
provide certain services to the Bank. These services include property
management, cafeteria management, insurance brokerage and leasing. Fees for
these services were $460, $548 and $630 for the years ended September 30, 1995,
1994 and 1993, respectively.
The law firm in which one director of the Bank is a partner received $2,756,
$2,430 and $2,704 for legal services rendered to the Bank during the years ended
September 30, 1995, 1994 and 1993, respectively.
For the years ended September 30, 1995, 1994 and 1993, one of the directors of
the Bank was paid $30, $30 and $28, respectively, for consulting services
rendered to the Bank. Another director of the Bank was paid total fees of $75
and $50 for the years ended September 30, 1995 and 1994, respectively, for
consulting services.
F-40
<PAGE>
CHEVY CHASE BANK F.S.B.
-----------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 22 - TRANSACTIONS WITH RELATED PARTIES (Continued):
Services (Continued):
A former director of the Bank and his wife are entitled to $125 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 received compensation under an
agreement for ongoing services provided to the Bank. Amounts paid to the
director under these agreements totaled $165, $167 and $165 in fiscal 1995,
1994 and 1993, respectively.
Tax Sharing Agreement:
The Bank and the other companies in the Trust's affiliated group are
parties to a tax sharing agreement dated June 28, 1990 (the "Tax Sharing
Agreement"). The Tax Sharing Agreement provides for payments to be made by
members of the Trust's affiliated group to the Trust based on their
separate company tax liabilities. The Tax Sharing Agreement also provides
that, to the extent net operating losses or tax credits of a particular
member are used to reduce the overall tax liability of the Trust's
affiliated group that have taxable income in an amount equal to such tax
reduction. The Bank paid $20,500, $9,585 and $5,000 to the Trust during
fiscal 1995, 1994 and 1993, respectively, under the Tax Sharing Agreement.
OTS approval of the tax sharing payments during fiscal 1995, 1994 and 1993
was conditioned on a pledge by the Trust of certain assets to secure
certain of its obligations under the Tax Sharing Agreement. 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
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, 1995 and 1994, the estimated tax sharing
payment payable to the Trust by the Bank was $17,700 and $12,015,
respectively.
Other:
The Bank paid $4,210, $3,899 and $3,476 for office space leased from or
managed by companies affiliated with the Bank or its directors during the
years ended September 30, 1995, 1994 and 1993, respectively.
The Trust, the B.F. Saul Company and Chevy Chase Lake Corporation ("Lake"),
an affiliate of the Bank, from time to time maintain interest-bearing
deposit accounts with the Bank. Those accounts totaled $26,577 at September
30, 1995. The Bank paid interest on the accounts amounting to $1,125 in
fiscal 1995.
During fiscal 1995, the Bank purchased land and building plans from Lake
for $1,332 for the purpose of constructing a building to house some of the
Bank's operations.
F-41
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 22 - TRANSACTIONS WITH RELATED PARTIES (Continued):
Other (Continued):
During fiscal 1994, the Bank sold 12.70 acres of retail land to Saul Holdings,
L.P., at an amount equal to its net carrying value.
The Bank 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, L.P., a newly formed partnership in which the Trust, other affiliated
entities of the Trust and public shareholders, directly and indirectly, own
partnership interests. 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.
NOTES 23 - FINANCIAL INSTRUMENTS:
The Bank in the normal course of business, is a party to financial instruments
with off-balance-sheet risk and other derivative financial instruments to meet
the financing needs of its customers and to reduce its own exposure to
fluctuations in interest rates. These financial instruments include commitments
to extend credit at both fixed and variable rates, letters of credit, interest-
rate cap agreements and assets sold with limited recourse. All such financial
instruments are held or issued for purposes other than trading.
These instruments involve, to varying degrees, elements of credit and interest-
rate risk in excess of the amount recognized in the Consolidated Statement of
Financial Condition.
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. The Bank is also a party to
derivative financial instruments that do not have off-balance-sheet risk (e.g.
interest-rate cap agreements).
Commitments to Extend Credit:
The Bank had $11,662,040 of commitments to extend credit at September 30, 1995.
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.
F-42
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
SEPTEMBER 30, 1995, 1994 AND 1993
---------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 23 - FINANCIAL INSTRUMENTS (Continued):
Commitments to Extend Credit (Continued):
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%.
Forward Commitments:
To manage the potentially adverse impact of interest rate movements on the
fixed-rate mortgage loan pipeline, the Bank hedges its pipeline by entering
into whole loans and mortgage-backed security forward sale commitments.
Forward sale commitments are used to sell specific financial instruments
(whole loans or mortgage-backed securities) at a future date for a specified
price. Forward sale commitments generally settle within 90 days. Gains and
losses are deferred and recorded as a component of the gain on sales of loans
at the time the forward sale commitment matures. At September 30, 1995, the
Bank had whole loans and mortgage-backed security forward sale commitments of
$8,950 and $87,565, respectively. In addition, at September 30, 1995, the Bank
had $9,370 in mortgage-backed security forward purchase commitments related to
its hedging activities.
Letters Of Credits:
Letters of credit are conditional commitments issued by the Bank to guarantee
the performance of a customer to a third party. At September 30, 1995, the
Bank had written letters of credit in the amount of $38,604, which were issued
to guarantee the performance of and irrevocably assure payment by customers
under construction projects.
Of the total $21,670 will expire in fiscal 1996 and the remainder will expire
over time though fiscal 1999. The credit rink 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
$10,866 were pledged as collateral for certain of these letters of credit at
September 30, 1995.
Resource Arrangements:
The Bank is obligated under various recourse provisions (primarily related to
credit losses) related to the securitization and sale of credit card
receivables, home equity credit line receivables, automobile loan receivables
and amounts on deposit in certain spread accounts through the asset-backed
securitization described in Note 9. At September 30, 1995 and 1994, the
primary recourse to the Bank was $93,059 and $65,907, respectively. As a
result of these recourse provisions the Bank maintained restricted cash
accounts amounting to $98,420 and $71,251, at September 30, 1995 and 1994,
respectively, which are included in other assets in the Consolidated
Statements of Financial Condition.
F-43
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 23 - FINANCIAL INSTRUMENTS (Continued):
Recourse Arrangements (Continued):
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, 1995, recourse to the Bank under these arrangements was
$4,364. 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, 1995, mortgage-backed securities pledged as collateral under these
obligations had a book value of $5,102.
Interest Rate Cap Agreements:
Interest rate cap agreements are used to limit the Bank's exposure to
rising short-term interest rates related to certain of its asset-backed
securitizations. At September 30, 1995, the Bank was a party to nine
interest rate cap agreements with an aggregate notional amount of $600,000
with maturity dates ranging from June 30, 1996 through June 30, 1999. The
interest rate cap agreements entitle the Bank to receive compensatory
payments from the cap provider, which is a AAA-rated (by Standard & Poor's)
counterparty, equal to the product of (a) the amount by which the one-month
LIBOR exceeds 7.00% and (b) the then outstanding notional principal amount
for a predetermined period of time. The Bank has no obligation to make
payments to the provider of the cap or any other party. The Bank is exposed
to credit losses in the event of nonperformance by the counterparty, but
does not expect the counterparty to fail to meet its obligation given its
credit rating.
Concentrations of Credit:
The Bank's principal real estate lending market is the metropolitan
Washington, D.C. area. In addition, approximately 17.6% of the Bank's
outstanding credit card loans at September 30, 1995 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-44
<PAGE>
CHEVY CHASE BANK. F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 24 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS:
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, 1995 and 1994 are as follows:
<TABLE>
<CAPTION>
September 30, 1995 September 30, 1994
--------------------------- ----------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------- ----------- ---------------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Cash, due from banks,
interest-bearing deposits, Federal
funds sold and securities purchased
under agreements to resell $ 359,282 $ 359,282 $ 372,097 $ 372,097
Loans held for sale 68,697 68,729 33,598 33,771
Loans held for securitization and sale 500,000 500,000 115,000 115,000
Investment securities 4,370 4,371 4,364 4,364
Mortgage-backed securities 880,208 879,720 1,025,525 1,025,525
Loans receivable, net of reserve 2,327,286 2,351,729 2,357,721 2,334,515
Interest rate cap agreements 9,986 3,255 -- --
Other financial assets 298,077 299,561 236,934 238,417
Financial liabilities:
Deposit accounts with
no stated maturities 2,867,752 2,867,752 3,281,794 3,281,794
Deposit accounts with
stated maturities 1,291,500 1,295,816 726,967 734,547
Securities sold under
repurchase agreements and other
short-term borrowings, bonds payable,
notes payable and Federal Home Loan
Bank advances 173,001 173,813 140,162/(1)/ 142,027
Capital notes-subordinated 154,102/(1)/ 159,250 153,777/(1)/ 146,500
Other financial liabilities 80,149 80,149 72,111 72,111
</TABLE>
________________________________________________________________________________
/(1)/ Net of deferred debt issuance costs which are included in other assets in
the Consolidated Statements of Financial Condition.
F-45
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
SEPTEMBER 30, 1995, 1994 AND 1993
---------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 24 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED):
The following methods and assumptions were used to estimate the fair value
amounts at September 30, 1995 and 1994:
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.
LOANS HELD FOR SECURITIZATION SALE: The carrying value of 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, automobile loans, home improvement 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, of 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.
INTEREST RATE CAP AGREEMENTS: FAIR VALUE IS BASED ON DEALER QUOTES
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
receivable approximates fair value. The fair value of one of the Bank's
investments 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.
<PAGE>
CHEVY CHASE BANK, F.S.B
-----------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
September 30, 1995, 1994 and 1993
---------------------------------
(Dollars in thousands, except per share data)
NOTE 24 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued):
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 Debentures is based on quoted
market prices. The carrying amount of the $10,000 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.
Off-balance sheet instruments: The difference between the original fees charged
by the Bank for commitments to extend credit and letters of credit and the
current fees charged to enter into similar agreements is immaterial. 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, which is immaterial.
NOTE 25 - LITIGATION:
During the normal course of business, the Bank is involved in certain
litigation, including litigation arising out of the collection of loans, the
enforcement or defense of the priority of its security interests, the continued
development and marketing of certain of its real estate properties and certain
employment claims. Although the amounts claimed in some of these suits in which
the Bank is a defendant are material, the Bank denies liability and, in the
opinion of management, litigation which is currently pending will not have a
material impact on the financial condition of future operations of the Bank.
NOTE 26 - SUBSEQUENT EVENTS:
On November 13, 1995, the Bank sold approximately 2,000 residential lots in its
Planned Unit Developments at an amount that approximated its net carrying value.
The impact of the transaction was to reduce real estate held for sale, net of
allowance for losses, by approximately $49,200.
F-47
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
DIRECTORS
The following table sets forth certain information with respect to each
director of Chevy Chase as of November 30, 1995.
<TABLE>
<CAPTION>
Director Position(s) Held
Name Age Since with Chevy Chase
---- --- -------- ----------------
<S> <C> <C> <C>
B. Francis Saul II (1)(2)(7) 63 1969 Chairman of the Board
and Chief Executive
Officer
Alexander R. M. Boyle (1)(5) 58 1985 Vice Chairman of the
Board
Vincent C. Burke, Jr. (3)(5) 73 1989 Director
Donald G. Conrad (6) 65 1988 Director
Gavin Malloy Farr (5) 52 1970 Director
Gilbert M. Grosvenor (4)(7) 64 1988 Director
Penne Percy Korth (4)(7) 53 1994 Director
LaSalle D. Leffall (4)(6) 65 1994 Director
William F. McSweeny (3)(4)(7) 66 1985 Director
Garland P. Moore, Jr. (1)(2)(3)(6) 63 1983 Director
Jesse F. Nicholson (3)(6) 83 1978 Director
George M. Rogers, Jr. (1)(2)(5) 62 1969 Director
Leonard L. Silverstein (4)(5) 73 1994 Director
</TABLE>
- ----------------
(1) Member of the Executive Committee.
(2) Member of the Compensation Committee.
(3) Member of the Audit Committee.
(4) Member of the Community Relations Advisory Committee.
(5) Term as director expires in 1996.
(6) Term as director expires in 1997.
(7) Term as director expires in 1998.
The Board of Directors currently consists of 13 directors divided into
three classes of directors, with each class as nearly equal in number to the
other classes as possible. The members of each class are elected for a term of
three years and until their successors shall be elected and shall qualify.
-90-
<PAGE>
The business experience of each director during the past five years is as
follows:
B. Francis Saul II serves as Chairman of the Board and Chief Executive
Officer of the Bank. He also has been President and Chief Operating Officer of
B. F. Saul Company since 1969 and President and Chief Executive Officer of Manor
Investment Company, a wholly-owned subsidiary of Chevy Chase, since 1971. Mr.
Saul has served as the Chairman of B.F. Saul Real Estate Investment Trust since
1969 and as a trustee since 1964. He is also a director of Derwood Investment
Corporation. At September 30, 1995, B. F. Saul Real Estate Investment Trust
and Derwood Investment Corporation owned of record 80% and 16%, respectively, of
the Bank's outstanding common stock. Mr. Saul is also Chairman of the Board of
Directors of Chevy Chase Financial Limited and Chevy Chase Property Company
Limited and a past Chairman of Financial General Bankshares. He serves as
Chairman of the Board and Chief Executive Officer of Saul Centers, Inc., a
public real estate investment trust. He also serves as a Trustee of the
National Geographic Society, a member of the Trustees Council of the National
Gallery of Art and an Honorary Trustee of the Brookings Institute. In addition,
Mr. Saul is a director of Colonial Williamsburg Hotel Properties, Inc., a member
of the Folger Shakespeare Library and the Board of Visitors and Governors of
Washington College.
Alexander R. M. Boyle has been Vice Chairman of the Board of Directors
since 1985. Prior to beginning service in this position, Mr. Boyle was the
President and a member of the Board of Directors of Government Services Savings
and Loan, Inc. from 1975 until its merger with the Bank in 1985. He has served
as a director of the U.S. League of Savings Institutions and as chairman of the
Maryland League of Financial Institutions. He currently serves as a director of
the Association of Financial Services Holding Companies and serves on the
Chancellor's Advisory Council of the University of Maryland and is a member of
the Rotary Club of Bethesda-Chevy Chase.
Vincent C. Burke, Jr. is currently retired. Prior to his retirement, he
completed over 30 years service with The Riggs National Bank of Washington,
D.C., where he served as Trust Officer, President of the Bank and Chairman of
the Board of Directors.
Donald G. Conrad is currently Chairman of Lang Capital Associates, Inc.
Prior to assuming this position, he served as Executive Vice President and a
director of Aetna Life & Casualty, one of the Country's largest insurance and
financial services organizations and also served as its Chief Financial and
Investment Officer. Mr. Conrad is a member of the Board of Directors of
Commercial Union Insurance Co. and Lebenthal Mutual Funds, and is Chairman
Emeritus of the National Board of Directors of the American Council for the
Arts.
Gavin Malloy Farr has been President and a director of Chevy Chase Land Co.
since July 1981, prior to which date he served as Vice President and Treasurer.
In 1992, Mr. Farr was elected Chairman of the Board of Chevy Chase Land Co. Mr.
Farr is the Vice President and a director of Newlands Company, Chevy Chase,
Maryland, a company engaged in real estate investment, and is a director of
Columbia Hospital for Women, Washington, D.C.
Gilbert M. Grosvenor has served as Editor of National Geographic since
1970, and became its President in 1980. He has been a member of the National
Geographic Society's Board of Trustees since 1966 and has served as Chairman
since 1987. Mr. Grosvenor is a trustee of the Wildlife Conservation Society,
National Wildflower Research Center and B. F. Saul Real Estate Investment
Trust. He also serves as a director for Saul Centers, Inc., the World Wildlife
Fund, Ethyl Corp., Charles Allman Trust, Marriott International, Inc., American
Farmland Trust and Federal City Council.
-91-
<PAGE>
Penne Percy Korth is a principal of the consulting firm of Firestone and
Korth, Ltd. Prior to forming this firm, Mrs. Korth was nominated by President
Bush to the position of United States Ambassador Extraordinary and
Plenipotentiary to Mauritius in August 1989 and served in this position until
December 9, 1992. Mrs. Korth was the first woman to be appointed by President
Bush when she was named as Co-Chair of the American Bicentennial Presidential
Inaugural Committee in 1988-1989. Mrs. Korth serves on the boards of Meridien
International Center, the Van Cliburn Foundation and the Council of American
Ambassadors.
LaSalle D. Leffall, Jr., M.D., F.A.C.S. has been the chairman of the
Department of Surgery at Howard University College of Medicine since 1970. He
is a diplomat of the American Board of Surgery and fellow of the American
College of Surgeons and the American College of Gastroenterology. He was
recently named President of the American College of Surgeons. Dr. Leffall has
served as an officer or board member of numerous professional and civil
organizations. In 1987, the Biennial LaSalle D. Leffall Jr. Award was
established by the M.D. Anderson Hospital and Tumor Institute, Houston, Texas
recognizing Dr. Leffall's contributions to cancer prevention, treatment and
education in minority and economically disadvantaged communities. In 1992, Dr.
Leffall was named the Charles R. Drew Professor, occupying the first endowed
Chair in the Department of Surgery at Howard University. In addition, Dr.
Leffall has served as a director of Columbia First Federal Savings and Loan
Association.
William F. McSweeny is currently retired. He served as President of
Occidental International Corporation, a subsidiary of the Occidental Petroleum
Corporation, from 1969 until his retirement in March 1991. He also served as
Executive Vice President and a member of the Board of Directors of the
Occidental Petroleum Corporation. Mr. McSweeny is currently the Chairman of The
Ford's Theater, a trustee of the Kennedy Center for the Performing Arts, and is
active in a number of other cultural, educational and philanthropic
organizations in Washington, D.C.
Garland P. Moore, Jr., since 1977, has been President and a director of
Moore and Company, Inc., a company engaged in financial consulting, real estate
development, and mortgage and real estate brokerage. Mr. Moore is a director of
Realty Investment Co., Inc., a company engaged in real estate development. Mr.
Moore served as Vice President of Equitable Trust Company, Baltimore, Maryland,
from 1956 to 1976.
Jesse F. Nicholson is currently retired. Mr. Nicholson formerly served as
Vice President of Maryland National Bank, Silver Spring, Maryland, and as
Executive Director and Secretary/Treasurer of the Maryland-National Capital Park
and Planning Commission. Mr. Nicholson is a trustee emeritus of Suburban
Hospital Association, Bethesda, Maryland.
George M. Rogers, Jr., a practicing attorney admitted to practice in the
District of Columbia, has been a partner at Shaw, Pittman, Potts & Trowbridge,
Washington, D.C., since 1970. Mr. Rogers is a director of the B.F. Saul
Company, and a director and officer of Chevy Chase Property Company Limited and
Chevy Chase Lake Corporation. He also serves as a director of Derwood
Investment Corporation and as a Trustee of B. F. Saul Real Estate Investment
Trust.
Leonard L. Silverstein, a practicing attorney admitted to practice in
Pennsylvania and the District of Columbia, is a partner at the Washington, D.C.
law firm of Silverstein and Mullens. Mr. Silverstein currently serves as Member
and Vice Chairman, Board of Trustees, John F. Kennedy Center for the Performing
Arts; Member, Board of Directors, National Symphony Orchestra Association;
Trustee, The French-American Foundation; President, Alliance Francaise de
Washington; Member, Board of Directors, White House Historical
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<PAGE>
Association; and Chairman, The Fund for Arts and Culture of Central and Eastern
Europe.
BOARD MEETINGS AND COMMITTEES
The Board of Directors held a total of 11 regular meetings during fiscal
1995. During fiscal 1995, all members attended at least 75% of the aggregate
number of Board meetings and meetings of the Board committees on which they
served.
The Board has four standing committees. The Audit Committee annually
reviews and recommends to the Board of Directors the firm to be engaged to audit
the accounts and records of the Bank. The Committee reviews with such
independent auditors the plan and results of the audit engagement and the scope
and results of the Bank's procedures for internal auditing, inquires as to the
adequacy of internal accounting controls and considers each professional service
that may be provided by the independent auditors with a view to whether the
providing of such service may affect the independence of the auditors. In
addition, the Committee is directly responsible for the operations of the
internal audit staff. The Audit Committee held five meetings during fiscal
1995.
The Executive Committee may exercise all of the authority of the Board of
Directors, with certain limited exceptions, when the Board of Directors is not
in session.
The Compensation Committee has the responsibility for determining the
compensation of the Bank's senior officers, in accordance with the guidelines
and requirements of the OTS.
The Community Relations Advisory Committee oversees the Bank's involvement
within the community and identifies programs which deserve the Bank's support.
All directors who are not executive officers of the Bank receive an annual
base fee of $14,000 and $800 for each meeting of the Board of Directors
attended.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following sets forth information, as of November 30, 1995, with respect
to executive officers of the Bank who do not serve on the Bank's Board of
Directors.
Guy F. Campbell III, age 51, serves as Senior Vice President of the Bank
and President of Manor Investment Company, a wholly-owned subsidiary of the
Bank. Prior to joining Chevy Chase in 1983, Mr. Campbell was a Vice President
of Chemical Bank with responsibilities in lending and strategic planning.
George P. Clancy, Jr., age 52, joined Chevy Chase in March 1995 as
Executive Vice President/Commercial and Consumer Lending and Credit
Administration. Before joining Chevy Chase, Mr. Clancy was Senior Executive
Vice President of Signet Banking Corp. and President and Chief Executive Officer
of Signet Bank N.A. Prior to Signet Banking Corp., Mr. Clancy was with the
Riggs National Corporation for 19 years, where he served in various capacities
including President and Chief Operating Officer.
Stephen R. Halpin, Jr., age 40, serves as Executive Vice President and
Chief Financial Officer. Mr. Halpin is also the Chief Financial Officer for the
B. F. Saul Company and B. F. Saul Real Estate Investment Trust. He is a
Trustee of the B. F. Saul Employees Profit Sharing Retirement Trust. In
addition, Mr. Halpin is a Trustee for Hospice Caring, Inc. Before joining the
Bank in 1983, Mr. Halpin was with a regional accounting firm.
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<PAGE>
Paul N. Jackman, age 54, currently serves as Senior Vice President and
Treasurer. Mr. Jackman joined the Bank in 1972 as Controller, and was appointed
Vice President in 1973. Prior to joining the Bank, Mr. Jackman had 13 years of
diversified experience in commercial banking and real estate.
David W. Larson, age 45, joined Chevy Chase in February 1989 as Senior Vice
President/Residential Lending, the position he currently holds. Mr. Larson is
also President of the B. F. Saul Mortgage Company, a wholly-owned subsidiary of
the Bank. Prior to joining Chevy Chase, Mr. Larson was with Citicorp for seven
years, where he served in various capacities.
Robert H. Spicer II, age 51, serves as Executive Vice President/Chief
Information Officer. Prior to joining Chevy Chase in 1984, Mr. Spicer had over
20 years of experience in data processing. He has served as Vice President of
Data Processing for Honolulu Federal Savings and Loan, Senior Systems Engineer
for McDonnell Douglas and as a member of the Senior Advisory Group for Computer
Data Systems.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION
GENERAL. The following table sets forth the cash compensation paid by the
Bank and its subsidiaries for or with respect to fiscal 1995, 1994 and 1993, to
the Chief Executive Officer of the Bank and to each of the four other most
highly compensated executive officers of the Bank during fiscal year 1995, for
all capacities in which they served.
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<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Compensation
-------------------
Other
Name and Principal Annual All Other
Position Year Salary Bonus Compensation Compensation
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
B. Francis Saul II 1995 $830,441 $400,000 $ - $228,138(1)
Chairman and Chief 1994 682,966 300,000 - 109,860(2)
Executive Officer 1993 432,504 - - 128,048(3)
Alexander R.M. Boyle 1995 $307,701 $ 45,000 $ - $ 78,808(1)
Vice Chairman of 1994 292,945 42,900 - 45,622(2)
the Board 1993 212,480 - - 45,813(3)
Stephen R. Halpin, Jr. 1995 $304,627 $ 44,250 $ - $ 51,830(1)
Executive Vice 1994 281,369 41,400 - 31,993(2)
President and Chief 1993 183,877 - - 23,354(3)
Financial Officer
David W. Larson 1995 $290,702 $ 43,200 $ - $ 42,961(1)
Senior Vice President 1994 283,330 41,400 - 28,063(2)
1993 212,480 - - 19,532(3)
Robert H. Spicer II 1995 $272,694 $ 39,750 $ - $ 63,704(1)
Executive Vice 1994 261,325 38,200 - 32,094(2)
President 1993 196,136 - - 35,483(3)
</TABLE>
_____________________
(1) The total amounts shown in the "All Other Compensation" column for fiscal
1995 consist of the following: (i) contributions made by the Bank to the
Bank's Supplemental Executive Retirement Plan on behalf of Mr. Saul
($73,847), Mr. Boyle ($5,308), Mr. Halpin ($5,193), Mr. Larson ($4,454)
and Mr. Spicer ($3,692); (ii) the taxable benefit of premiums paid by the
Bank for group term insurance on behalf of Mr. Boyle ($9,589), Mr. Halpin
($1,450), Mr. Larson ($2,211) and Mr. Spicer ($5,411); (iii) contributions
to the B. F. Saul Company Employees Profit Sharing Retirement Plan (the
"Retirement Plan"), a defined contribution plan, on behalf of Mr. Boyle
($15,993), Mr. Halpin ($15,763), Mr. Larson ($15,580) and Mr. Spicer
($15,054); and (iv) accrued earnings on awards previously made under the
Bank's Deferred Compensation Plan on behalf of Mr. Saul ($154,291), Mr.
Boyle ($47,918), Mr. Halpin ($29,424), Mr. Larson ($20,716) and Mr.
Spicer ($39,547).
(2) The total amounts shown in the "All Other Compensation" column for fiscal
1994 consist of the following: (i) contributions made by the Bank to the
Bank's Supplemental Executive Retirement Plan on behalf of Mr. Saul
($42,337), Mr. Boyle ($6,389), Mr. Halpin ($4,177), Mr. Larson ($5,722) and
Mr. Spicer ($3,488); (ii) the taxable benefit of premiums paid by the
Bank for group term life insurance on behalf of Mr. Boyle ($2,876), Mr.
Halpin ($500), Mr. Larson ($815) and Mr. Spicer ($1,183); (iii)
contributions to the Retirement Plan, on behalf of Mr. Boyle ($13,762), Mr.
Halpin ($15,189), Mr. Larson ($13,762) and Mr. Spicer ($9,000); and (iv)
accrued earnings on awards previously made under the Bank's Deferred
Compensation Plan on behalf of Mr. Saul ($67,523), Mr. Boyle ($22,595), Mr.
Halpin ($12,127), Mr. Larson ($7,764) and Mr. Spicer ($18,423).
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<PAGE>
(3) The total amounts shown in the "All Other Compensation" column for fiscal
1993 consist of the following: (i) contributions made by the Bank to the
Bank's Supplemental Executive Retirement Plan on behalf of Mr. Saul
($25,740) (no contributions were made on behalf of any of the other named
executive officers); (ii) the taxable benefit of premiums paid by the Bank
for group term life insurance on behalf of Mr. Boyle ($6,102), Mr. Halpin
($765), Mr. Larson ($1,383) and Mr. Spicer ($2,165), and (iii)
contributions to the Retirement Plan, on behalf of Mr. Boyle ($12,749), Mr.
Halpin ($11,033), Mr. Larson ($12,749) and Mr. Spicer ($11,768); and (iv)
accrued earnings on awards previously made under the Bank's Deferred
Compensation Plan on behalf of Mr. Saul ($102,308), Mr. Boyle ($26,962),
Mr. Halpin ($11,556), Mr. Larson ($5,400) and Mr. Spicer ($21,550).
LONG-TERM INCENTIVE PLAN AWARDS. The following table sets forth certain
information concerning the principal contributions (the "Principal
Contributions") credited by the Bank to the accounts (the "Accounts") of the
executive officers of the Bank named above for fiscal 1995 under the Bank's
Deferred Compensation Plan (the "Plan").
LONG-TERM INCENTIVE PROGRAM - AWARDS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
Estimated Future Payouts(1)
Performance Under Non-Stock Price-Based Plans
------------------------------------
or Other Period
Until Maturation
Name or Payout Threshold Target(2) Maximum
- ---- ----------------- --------- ------ -------
<S> <C> <C> <C> <C>
B. Francis Saul II (3)(4) 1995 $ - $1,037,497 $2,476,695
Alexander R. M. Boyle(3) 1997 - 233,437 557,256
wStephen R. Halpin, Jr. 2005 - 233,437 557,256
David W. Larson 2005 - 181,562 433,422
Robert H. Spicer II 2005 - 233,437 557,256
</TABLE>
_____________________
(1) The estimated future payouts shown in the table are based on assumed
performance rates for the Bank during each year in the ten-year performance
period. The actual payouts under the Plan may vary substantially from the
payouts shown in the table, depending upon the Bank's actual rate of return
on average assets for each fiscal year in the ten-year performance period
ending September 30, 2005.
(2) The Plan does not establish any target performance levels. The payout
amounts shown in this column have been calculated assuming that the Bank's
rate of return on average assets during each of the years in the
performance period are the same as the Bank's rate of return during the
fiscal year ended September 30, 1995.
(3) The payout amounts shown for Mr. Saul and Mr. Boyle are the estimated
amounts that would be payable to such participants if their employment
continued with the Bank for the entire ten-year performance period of the
Plan. Mr. Boyle will attain the age of 60 in 1997, at which time he will
become fully vested. Under the Plan, if Mr. Boyle were to retire after
that date, he could elect to have the Bank pay out the Net Contribution (as
defined) in his Account prior to the year 2005. As of September 30, 1995,
Mr. Saul was fully vested in the Account maintained for his benefit under
the Plan. As of September 30, 1995, the Account balance maintained for
Mr. Saul's benefit under the Plan was $1,312,424.
(4) In addition, in fiscal 1995, the Bank also credited Mr. Saul's Account
under the plan with a Principal Contribution with respect to fiscal 1993.
Mr. Saul had previously elected to forego a Principal
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<PAGE>
Contribution to his Account for such fiscal year. The threshold, target and
maximum estimated future payouts under the Plan with respect to such
Principal Contribution are $-, $749,827 and $1,378,736. The payout amounts
have been calculated using the Bank's actual rate of return on average
assets during each of fiscal years 1993, 1994 and 1995 and assuming that
the Bank's rate of return on average assets during each of the remaining
years in the performance period is the same as the Bank's rate of return
during the fiscal year ended September 30, 1995.
The Plan provides that, as of the end of each fiscal year in the ten-year
period ending September 30, 2005 (or the executive officer's earlier termination
of employment with the Bank), the Bank will add to or deduct from each executive
officer's Account a contribution or deduction, as the case may be, which
represents the hypothetical interest (which may be positive or negative) earned
on the Principal Contribution, based on the Bank's rate of return on average
assets (as computed under the Plan) for the fiscal year then ended. (The
Principal Contribution, plus or minus any interest credited or deducted, is
referred to as the "Net Contribution.")
Executive officers are entitled to receive the Net Contribution in their
respective Account only upon full or partial vesting. Plan participants become
fully vested in their Account under the Plan, provided that they remain
continuously employed by the Bank during the vesting period, upon the earliest
to occur of any of the following: (i) September 30, 2005; (ii) attainment
of age 60; (iii) death; (iv) total and permanent disability; or (v) a change
in control of the Bank (as defined in the Plan). Plan participants become
partially vested, to the extent of 50% of the Net Contribution in the Account,
upon the termination of their employment by the Bank without cause (as defined
in the Plan) after September 30, 2000.
Payouts are made under the Plan within 120 days after September 30, 2005,
or the earlier termination of the executive officer's employment with the Bank,
provided that vesting or partial vesting has occurred under the Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. Mr. B.
Francis Saul II, Mr. Garland P. Moore, Jr. and Mr. George M. Rogers, Jr. are the
current members of the Compensation Committee of the Board of Directors of the
Bank. All of the current members also served as members of the Compensation
Committee during fiscal 1994 and fiscal 1993. Mr. Saul is the Chairman of the
Board and Chief Executive Officer of the Bank.
The Saul Company and its subsidiaries provide certain services to the Bank
and its subsidiaries. These services have included property management,
cafeteria management, leasing, insurance brokerage and data processing. The
Bank paid the Saul Company fees for these services totaling $460,000 in fiscal
1995. Subject to certain restrictions under applicable OTS conflict of interest
rules, the Bank intends to continue using the Saul Company and its subsidiaries
for many of these services, provided that the fees remain competitive with fees
charged for similar services by unrelated parties.
The Bank or a wholly-owned subsidiary leases certain branch offices from
affiliates of which Mr. Saul is an officer, director and may be deemed to own
beneficially more than 10% of the equity. In fiscal 1995, total payments under
such leases were $951,000.
The Bank leases its operations center from Chevy Chase Lake Corporation
("Lake"), an affiliate of which Mr. Saul is an officer, director and may be
deemed to own beneficially more than 10% of the equity. Payments under this
lease totaled approximately $1.5 million in fiscal 1995.
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<PAGE>
Lake, the Trust and the Saul Company from time to time maintain interest-
bearing deposit accounts with the Bank. Those accounts totaled $26.6 million at
September 30, 1995. The Bank paid interest on the accounts amounting to $1.1
million in fiscal 1995.
The law firm of Shaw, Pittman, Potts & Trowbridge, of which the
professional corporation of Mr. Rogers is a member, has rendered legal services
to the Bank, for which the firm received $2.8 million during fiscal 1995,
excluding reimbursement of expenses.
Mr. Moore was paid $30,000 in fiscal 1995 for consulting services rendered
to the Bank.
During fiscal 1995, the Bank purchased land and building plans from Lake
for $1.3 million for the purpose of constructing a building to house some of the
Bank's operations.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Bank's charter (the "Charter") authorizes the Bank to issue 10,000,000
shares of common stock, of which 10,000 shares were outstanding at November 30,
1995, and 10,000,000 shares of preferred stock in series, of which 3,000,000
shares were outstanding at November 30, 1995.
The following table sets forth information, at November 30, 1995, with
respect to those persons known to the Bank who own, or who may be deemed to own,
beneficially more than 5% of the common stock of the Bank.
<TABLE>
<CAPTION>
Shares As a Percentage
of Common Stock of Common Stock
Name and Address (1)(2) Beneficially Owned Outstanding
- ------------------------- ------------------ ---------------
<S> <C> <C>
B. F. Saul Real Estate
Investment Trust (3) 8,000 80%
Derwood Investment
Corporation (3) 1,600 16
----- --
Total 9,600 96%
===== ===
</TABLE>
________________
(1) The address of each shareholder listed above is 8401 Connecticut Avenue,
Chevy Chase, Maryland 20815.
(2) Pursuant to Rule 13d-3 under the Securities Exchange Act of 1934, Mr. B.
Francis Saul II, Chairman of the Board and Chief Executive Officer of the
Bank, may be deemed to possess beneficial ownership of some or all of the
common stock of the Bank owned by B. F. Saul Real Estate Investment Trust
and Derwood Investment Corporation because he has, or may be deemed to
have, sole or shared voting and/or investment power of such shares of
common stock.
(3) All of the shares of the Bank's common stock currently owned by B. F. Saul
Real Estate Investment Trust and all of the shares of the Bank's common
stock currently owned by Derwood Investment Corporation are pledged to
secure various obligations.
The B. F. Saul Company Employees' Profit Sharing and Retirement Trust
beneficially owns the remaining 400 shares, or 4%, of the Bank's outstanding
common stock.
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<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Set forth below are certain transactions between the Bank and its executive
officers, directors and certain of its affiliates. Additional information
regarding such transactions is set forth under the caption "Executive
Compensation - Compensation Committee Interlocks and Insider Participation."
Management believes that the transactions with related parties described herein
have been conducted on substantially the same terms as similar transactions with
unrelated parties.
The Bank leases a portion of its main offices and one branch from a company
in which Mr. Gavin Malloy Farr, a director of the Bank, serves as president and
a director. Total payments under the leases were $1.8 million in fiscal 1995.
Mr. Milton L. Drewer, Jr., a former 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 Mr. Drewer's
former employment as a Vice Chairman of the Bank. In addition to these
benefits, Mr. Drewer also received compensation under an agreement for ongoing
services provided to the Bank. Amounts paid to Mr. Drewer under this agreement
totaled $165,000 in fiscal 1995.
Mr. William F. McSweeny, a director of the Bank, was paid $75,000 in fiscal
1995 for consulting services rendered to the Bank.
The Bank traditionally has offered home mortgage loans, home equity credit
line loans, automobile loans and credit card loans to its executive officers and
directors and to executive officers and directors of its subsidiaries.
Management does not believe these loans involve more than the normal risk of
collectibility. Each loan bears interest at prevailing market rates. All such
loans are currently made to executive officers and directors of the Bank on
substantially the same terms prevailing at the time for comparable transactions
with unrelated parties. FIRREA imposes certain limits on loans, including
prohibitions on preferential loans, by the Bank to its directors, executive
officers, principal shareholders and their related interests.
As of September 30, 1995, the aggregate dollar amount of the indebtedness
to the Bank of executive officers and directors of the Bank and their immediate
family members or companies with which they are affiliated was $3.1 million.
This amount represented 1.0% of the Bank's stockholders' equity as of that date.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) The following consolidated financial statements of Chevy Chase and
its subsidiaries are included in Item 8 of this report:
Report of Independent Public Accountants
Consolidated Statements of Financial Condition at September 30, 1995 and
1994
Consolidated Statements of Operations for the Years Ended September 30,
1995, 1994 and 1993
Consolidated Statements of Stockholders' Equity for the Years Ended
September 30, 1995, 1994 and 1993
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<PAGE>
Consolidated Statements of Cash Flows for the Years Ended September 30,
1995, 1994 and 1993
Notes to Consolidated Financial Statements
(a)(2) All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission and Office of
Thrift Supervision are not required under the related instruction or are
inapplicable and therefore have been omitted.
(a)(3) Exhibits:
3.1 Federal Stock Charter of the Bank, as amended (incorporated herein by
reference to Exhibit 3.1 of the Bank's Annual Report on Form 10-K for
the fiscal year ended September 30, 1994)
3.2 Bylaws of the Bank, as amended (incorporated herein by reference to
Exhibit 3.3 of Form OC filed by the Bank, which became effective on
August 11, 1993)
10.1 Loan Agreement, dated as of December 15, 1986, between the Bank and
BACOB Bank, s.c. (incorporated herein by reference to Exhibit 10.1 of
Form OC filed by the Bank, which became effective on July 14, 1987)
10.2 Written Agreement, dated September 30, 1991, between the Office of
Thrift Supervision and the Bank, (incorporated herein by reference to
Exhibit 10(b) of the Bank's Annual Report on Form 10-K for the fiscal
year ended September 30, 1992)
10.3 B. F. Saul Company's Employees' Profit Sharing Retirement Plan, as
amended and restated through May 19, 1993 (incorporated herein by
reference to Exhibit 10.5 of Form OC filed by the Bank, which became
effective on August 11, 1993)
10.4 B. F. Saul Company's Supplemental Executive Retirement Plan
(incorporated herein by reference to Exhibit 10.6 of Form OC filed by
the Bank, which became effective on August 11, 1993)
10.5 Deferred Compensation Plan of the Bank (incorporated herein by
reference to Exhibit 10.7 of Form OC filed by the Bank, which became
effective on August 11, 1993)
10.6 Tax Sharing Agreement, dated June 28, 1990, as amended, among the
Bank, B.F. Saul Real Estate Investment Trust and certain of their
subsidiaries (incorporated herein by reference to Exhibit 10.9 of
Form OC filed by the Bank, which became effective on November 17,
1993)
10.7 Agreement between the Bank, and Milton L. Drewer, Jr. (incorporated
herein by reference to Exhibit 10.10 of Form OC filed by the Bank,
which became effective on November 17, 1993)
10.8 Amendment to Written Agreement, dated October 29, 1993, between the
Office of Thrift Supervision and the Bank (incorporated herein by
reference to Exhibit 10.3 of Form OC filed by the Bank, which became
effective November 17, 1993)
10.9 Certificate of Designation setting forth the rights, privileges and
preferences of the 13% Noncumulative Perpetual Preferred Stock,
Series A (incorporated herein by reference to Exhibit 3.2
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<PAGE>
of Form OC filed by the Bank, which became effective on August 11,
1993)
10.10 Indenture, dated as of November 23, 1993, between the Bank and
Bankers Trust Company, as trustee (incorporated herein by reference
to Exhibit 4.1 of Form OC filed by the Bank, which became effective
on November 17, 1993)
21 Subsidiaries of the Bank (filed herewith).
(b) No reports on Form 8-K were issued during the three months ended
September 30, 1995.
____________________________
* Filed herewith.
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<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in Chevy Chase,
Maryland on December 28, 1995.
CHEVY CHASE BANK, F.S.B.
By: /s/ B. Francis Saul II
----------------------
B. Francis Saul II
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
<S> <C> <C>
/s/Alexander R.M. Boyle Vice Chairman of the Board December 28, 1995
- -----------------------
Alexander R.M. Boyle
/s/Vincent C. Burke, Jr. Director December 28, 1995
- ------------------------
Vincent C. Burke, Jr.
/s/Donald G. Conrad Director December 28, 1995
- ---------------------
Donald G. Conrad
/s/Gavin Malloy Farr Director December 28, 1995
- --------------------
Gavin Malloy Farr
/s/Joel A. Friedman Senior Vice President December 28, 1995
- -------------------
Joel A. Friedman and Controller
(Principal Accounting Officer)
______________________ Director December 28, 1995
Gilbert M. Grosvenor
/s/Stephen R. Halpin, Jr. Executive Vice President and December 28, 1995
- -------------------------
Stephen R. Halpin, Jr. Chief Financial Officer
(Principal Financial Officer)
_______________________ Director December 28, 1995
Penne Percy Korth
_______________________ Director December 28, 1995
LaSalle D. Leffall
/s/William F. McSweeny Director December 28, 1995
- ----------------------
William F. McSweeny
/s/Garland P. Moore, Jr. Director December 28, 1995
- ------------------------
Garland P. Moore, Jr.
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
/s/Jesse F. Nicholson Director December 28, 1995
- ---------------------
Jesse F. Nicholson
/s/George M. Rogers, Jr. Director December 28, 1995
- ------------------------
George M. Rogers, Jr.
/s/B. Francis Saul II Chairman of the Board and December 28, 1995
- ---------------------
B. Francis Saul II Chief Executive Officer
(Principal Executive Officer)
________________________ Director December 28, 1995
Leonard L. Silverstein
</TABLE>
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<PAGE>
Exhibit 22
SUBSIDIARIES
------------
<TABLE>
<CAPTION>
CURRENT
DATE OF PRINCIPAL
SITE OF ACQUISITION/ BUSINESS
NAME NOTE INCORPORATION FORMATION ACTIVITY
---- ---- ------------- --------- --------
<S> <C> <C> <C> <C>
Ashborn Village Development (A) Maryland 1991 Real Estate
Corporation Owned (REO)
Bailey's Corporation (A) Maryland 1993 REO
Balmoral Golf Corporatation (B) Maryland 1992 Inactive
Bondy Way Development (A) Maryland 1990 REO
Corporation
Brambleton Land Corporation (A) Maryland 1977 REO
Brooke Manor Land Corporation (A) Maryland 1990 REO
B.F. Saul Mortgage Company (A) Maryland 1984 Residential Loan
Origination
CCB Holding Corporation (A) Delaware 1994 Investments
CCRE, Inc. (C) Maryland 1984 Inactive
Cherrytree Corporation (A) Maryland 1993 REO
Chevy Chase Insurance Agency, (A) Maryland 1985/1971 Insurance Agency
Inc.
Chevy Chase Mortgage Company (A) Maryland 1972 Inactive
Chevy Chase Securities, Inc. (A) Maryland 1984 Securities
Brokeer/Dealer
Consumer Finance Corporation (A) Virginia 1994 Consumer Loan
Origination
Duvall Village Corporation (A) Maryland 1992 REO
First Balmoral Corporation (A) Maryland 1991 REO
Goldsbore Heights Property (A) Maryland 1992 Inactive
Corp. (sold remaining loss
8/9/95)
Great Seneca Development (A) Maryland 1991 REO
Corporation
Group Investment Corporation (C) Maryland 1986 Inactive
Inglewood Corporation (A) Maryland 1990 REO
Manor Investment Company (A) Maryland 1971 Real Estate
Ownership
Development
Marbury I Corporation (A) Maryland 1991 REO
Marbury II Corporation (A) Maryland 1991 REO
Marlboro Square, Inc. (A) Maryland 1992 Inactive
(sold property 5/1/95)
</TABLE>
<PAGE>
EXHIBIT 22
<TABLE>
<S> <C> <C> <C> <C>
NML Corporation (A) Maryland 1992 REO
North Ods Street Development (C) Maryland 1981 Real Estate
Corporation Finance/
Development
Oak Den. Inc. (A) Maryland 1991 Inactive
(sold remaining lots 10/28/94)
Old Chapel Corporation (A) Maryland 1992 REO
PMC corporation (A) Maryland 1991 Inactive
(sold remaining lots 2/10/95)
Presley Corporation (A) Maryland 1993 Real Estate
Ownership
Primrose Development (A) Maryland 1990 REO
Corporation
Ridgeview Centre Corp. (A) Maryland 1992 REO
Ronam Corporation (A) Maryland 1986 Real Eastate
Finance/
Development
Seven Lakes Development (A) Maryland 1991 Inactive
Corporation (sold property
12/5/94)
Shoppers of Jefferson Ltd. (A) Virginia 1991 Inactive
(sold property 7/31/95)
Six Commerce Park Corp. (A) Virginia 1991 Inactive
(sold property 5/31/95)
Sully Park Corporation (A) Maryland 1990 REO
Sully Station Corporation (A) Maryland 1990 REO
Syscolin-Loesburge Corporation (A) Maryland 1992 REO
Termination Drive Properties (A) Maryland 1991 REO
Corporation
</TABLE>
________________________
(A) Subsidiary of Chevy Chase Bank, F.S.B.
(B) Subsidiary of First Balmoral Corporation
(c) Subsidiary of Manor Investment Company
<PAGE>
CHEVY CHASE BANK, F.S.B.
FORM 10-Q
June 30, 1996
<PAGE>
- --------------------------------------------------------------------------------
FORM 10-Q
OFFICE OF THRIFT SUPERVISION
Washington, D.C. 20552
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _____________
OTS FILE NUMBER 08145
CHEVY CHASE BANK, F.S.B.
(Exact name of registrant as specified in its charter)
UNITED STATES 52-0897004
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8401 CONNECTICUT AVENUE
CHEVY CHASE, MARYLAND 20815
(Address of principal executive offices) (Zip Code)
(301) 986-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No___
---
The number of shares outstanding of the registrant's sole class of common
stock is 10,000 shares, $1 par value, as of August 1, 1996.
- --------------------------------------------------------------------------------
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
C O N T E N T S
---------------
PART I - FINANCIAL INFORMATION Page
----
Item 1. Condensed Consolidated Financial Statements:
Statements of Financial Condition as of
June 30, 1996 and September 30, 1995......................... 1
Statements of Operations for the Three Months and
Nine Months Ended June 30, 1996 and 1995..................... 2
Statements of Stockholders' Equity for the
Nine Months Ended June 30, 1996.............................. 4
Statements of Cash Flows for the Nine Months Ended
June 30, 1996 and 1995....................................... 5
Notes to Condensed Consolidated Financial Statements......... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................... 10
PART II - OTHER INFORMATION
Item 6a. Exhibits.................................................... 42
-i-
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
---------------------------------------------------------
(IN THOUSANDS)
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
June 30, September 30,
1996 1995
------------ ---------------
<S> <C> <C>
ASSETS
------
Cash and other deposits $ 252,415 $ 249,282
Ferderal funds sold and securities purchased
under agreements to resell 219,000 110,000
Loans held for sale 102,079 68,679
Loans held for securitization and sale 315,000 500,000
Investment securities (market value of $9,741 and
$4,371, respectively) 9,749 4,370
Mortgage-backed securities (market value of
$842,618 and $879,720, respectively) 847,029 880,208
Loans receivable (net of allowance for losses of
$71,619, and $60,496, respectively) 2,459,803 2,327,286
Federal Home Loan Bank stock 31,940 31,940
Real estate held for investment or sale (net of allowance
for losses of $127,958 and $135,236, respectively) 140,033 222,860
Property and equipment, net 204,162 174,673
Cost in excess of net assets acquired, net 41,525 44,528
Other assets 397,784 334,169
------------ ---------------
TOTAL ASSETS $ 5,020,519 $ 4,947,995
============ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Deposit accounts $ 4,225,110 $ 4,159,252
Borrowings 24,461 17,949
Federal Home Loan Bank advances 116,749 155,052
Other liabilities 137,230 127,198
------------ ---------------
4,503,550 4,459,451
Capital notes-subordinated 160,000 160,000
------------ ---------------
TOTAL LIABILITIES 4,663,550 4,619,451
------------ ---------------
Stockholders' equity:
13% Noncumulative Perpetual Preferred Stock, Series A,
$0.01 par value, 3,000,000 shares authorized, issued
and outstanding 30 30
Common stock, $1 par value, 10,000,000 shares
authorized, 510,000 shares issued, 10,000 shares
outstanding 10 10
Capital contributed in excess of par 165,704 165,704
Retained earnings 193,435 165,912
Net unrealized holding gains (losses) (2,210) (3,112)
------------ ---------------
TOTAL STOCKHOLDERS' EQUITY 356,969 328,544
------------ ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,020,519 $ 4,947,995
============ ===============
</TABLE>
- --------------------------------------------------------------------------------
See the accompanying Notes to Condensed Consolidated Financial Statements.
-1-
<PAGE>
CHEVY CHASE BANK, F.S.B.
---------------------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30 ,
-----------------------------------------------------------------
1996 1995 1996 1995
--------------- --------------- ---------- -----------
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans $ 82,690 $ 79,858 $ 231,571 $ 216,720
Mortgage - backed securities 11,481 15,217 36,966 46,257
Trading securities 281 76 640 220
Investment securities 74 49 171 146
Other 4,739 1,972 14,781 6,883
--------------- --------------- ---------- -----------
Total interest income 99,265 97,172 284,129 270,226
--------------- --------------- ---------- -----------
INTEREST EXPENSE
Deposit accounts 39,929 39,654 123,333 112,257
Borrowings 5,472 11,623 17,137 28,480
--------------- --------------- ---------- -----------
Total interest expense 45,401 51,277 140,470 140,737
--------------- --------------- ---------- -----------
NET INTEREST INCOME 53,864 45,895 143,659 129,489
Provision for loan losses 30,062 13,604 70,825 35,829
--------------- --------------- ---------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 23,802 32,291 72,834 93,660
--------------- --------------- ---------- -----------
OTHER INCOME
Credit card fees 7,964 2,526 18,682 9,197
Loan and deposit servicing fees 77,805 58,037 220,903 145,044
Gain (loss) on sales of trading securities, net 401 (250) 1,061 (579)
Earnings (loss) on real estate held for
investment or sale, net (5,875) 5,160 (19,376) 2,861
Gain on sales of loans, net 11,850 4,483 17,092 4,721
Other 4,790 (1,894) 14,109 5,502
--------------- --------------- ---------- -----------
Total other income 96,935 68,062 252,471 166,746
--------------- --------------- ---------- -----------
OPERATING EXPENSES
Salaries and employee benefits 32,670 28,156 93,354 78,739
Loan 7,007 3,461 19,742 10,290
Property and equipment 8,572 7,150 24,560 20,857
Marketing 14,473 11,656 35,568 34,835
Data processing 12,504 11,365 37,081 31,525
Deposit insurance premiums 2,712 2,298 8,046 8,136
Amortization of cost in excess of net
assets acquired 1,001 1,102 3,003 3,108
Other 10,665 11,795 36,364 31,529
--------------- --------------- ---------- -----------
Total operating expenses 89,604 76,983 257,718 219,019
--------------- --------------- ---------- -----------
</TABLE>
- --------------------------------------------------------------------------------
Continued on the following page.
-2-
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
--------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
------------------------------- ----------------------------
1996 1995 1996 1995
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Income before income taxes 31,133 23,370 67,587 41,387
Provision for income taxes 13,534 8,162 27,751 13,439
----------- ---------- ---------- ----------
NET INCOME $ 17,599 $ 15,208 $ 39,836 $ 27,948
=========== ========== ========== ==========
PREFERRED STOCK DIVIDENDS 2,438 2,438 7,313 7,313
----------- ---------- ---------- ----------
EARNINGS AVAILABLE TO COMMON
STOCKHOLDERS $ 15,161 $ 12,770 $ 32,523 $ 20,635
=========== ========== ========== ==========
EARNINGS PER COMMON SHARE $ 1,516.10 $ 1,277.00 $ 3,252.30 $ 2,063.50
=========== ========== ========== ==========
</TABLE>
- --------------------------------------------------------------------------------
See the accompanying Notes to Condensed Consolidated Financial Statements.
-3-
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
(IN THOUSANDS)
(UNAUDITED)
================================================================================
<TABLE>
<CAPTION>
Net
Capital Unrealized
Contributed Holding Total
Preferred Common in Excess Retained Gains Stockholders'
Stock Stock of Par Earnings (Losses) Equity
------------- ------------ --------------- ----------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1995 $ 30 $ 10 $ 165,704 $ 165,912 $ (3,112) $ 328,544
Net income - - - 39,836 - 39,836
Cash dividends on 13%
Noncumulative Perpetual
Preferred Stock, Series A - - - (7,313) - (7,313)
Cash dividends on
Common Stock - - - (5,000) - (5,000)
Increase in net unrealized
holding gains (losses) - - - - 902 902
------------ ------------ --------------- ----------- ------------ ------------
Balance, June 30, 1996 $ 30 $ 10 $ 165,704 $ 193,435 $ (2,210) $ 356,969
============ ============ =============== =========== ============ ============
</TABLE>
- --------------------------------------------------------------------------------
See the accompanying Notes to Condensed Consolidated Financial Statements.
-4-
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended June 30,
-------------------------------
1996 1995
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 39,836 $ 27,948
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Amortization (accretion) of premiums, discounts and
net deferred loan fees 2,742 (1,145)
Depreciation and amortization 17,943 15,914
Amortization of cost in excess of net assets acquired and
mortgage servicing rights 8,536 4,005
Provision for loan losses 70,825 35,829
Net fundings of loans held for sale and/or securitization (530,783) (251,804)
Proceeds from sales of trading securities 257,257 78,323
Proceeds from sales of loans held for sale
and/or securitization 1,585,916 1,810,474
Earnings on real estate (1,597) (7,331)
Provision for losses on real estate held for investment
or sale 20,152 16,000
(Gain) loss on sales of trading securities, net (1,061) 579
Gain on sales of loans, net (17,092) (4,721)
(Increase) decrease in excess servicing assets (19,383) 1,578
Increase in other assets (39,650) (25,907)
Increase (decrease) in other liabilities and accrued expenses 3,184 (30,604)
Other, net (9,622) 7,462
---------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,387,203 1,676,600
---------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of investment securities 4,410 100
Proceeds from sales of loans - 8
Net proceeds from sales of real estate 46,046 110,131
Net proceeds from sales of mortgage servicing rights 966 1,270
Net fundings of loans receivable (1,088,856) (2,021,848)
Principal collected on mortgage-backed securities 166,790 121,659
Purchases of investment securities (10,000) -
Purchases of mortgage-backed securities (135,125) -
Purchases of loans receivable (209,480) (73,183)
Purchases of property and equipment (47,635) (45,546)
Purchases of mortgage servicing rights (9,902) -
Disbursements for real estate held for investment or sale (15,359) (30,202)
Other investing activities, net (5,527) 544
----------- --------------
NET CASH USED IN INVESTING ACTIVITIES (1,303,672) (1,937,067)
----------- --------------
</TABLE>
- --------------------------------------------------------------------------------
Continued on the following page.
-5-
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
-----------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
(UNAUDITED)
- -------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended June 30,
----------------------------------------------
1996 1995
-------------------- ---------------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from customer deposits and
sales of
certificates of deposit 11,255,134 10,575,028
Customer withdrawals of deposits and
payments
for maturing certificates of deposit (11,189,276) (10,466,126)
Net increase (decrease) in securities
sold under
repurchase agreements (1,055) 90,037
Advances from the Federal Home Loan 11,904 851,213
Bank
Repayments of advances from the (50,207) (817,005)
Federal Home Loan Bank
Proceeds from other borrowings 1,399,981 487,277
Repayments of other borrowings (1,392,414) (467,885)
Cash dividends paid on preferred stock (7,313) (7,313)
Cash dividends paid on common stock (5,000) -
Other financing activities, net 6,848 (4,191)
--------------- -----------
NET CASH PROVIDED BY FINANCING 28,602 241,035
ACTIVITIES --------------- -----------
NET INCREASE (DECREASE) IN CASH AND 112,133 (19,432)
CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS AT BEGINNING 359,282 372,097
OF PERIOD --------------- ------------------
CASH AND CASH EQUIVALENTS AT END OF $ 471,415 $ 352,665
PERIOD =============== ==================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $ 158,755 $ 144,168
Income taxes $ 27,751 $ 12,006
SUPPLEMENTAL DISCLOSURES OF NON-CASH
INVESTING AND
FINANCING ACTIVITIES:
Loans held for sale exchanged for $ 256,770 $ 79,253
trading securities
Mortgage-backed securities
available-for-sale transferred to
mortgage-backed securities $ - $ 942,085
held-to-maturity
Loans receivable transferred to loans
held for sale and/or
securitization $ 1,142,802 $ 2,202,235
Investment securities
available-for-sale transferred to
investment securities $ - $ 4,354
held-to-maturity
Real estate held for investment
transferred to real
estate held for sale $ - $ 9,273
Loans made in connection with the $ 42,441 $ 8,337
sale of real estate
Loans receivable transferred to real
estate acquired in
settlement of loans $ 4,891 $ 6,320
Loans receivable exchanged for
mortgage-backed securities
held-to-maturity $ - $ 23,154
</TABLE>
- --------------------------------------------------------------------------------
See the accompanying Notes to Condensed Consolidated Financial Statements.
-6-
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION:
The accompanying condensed consolidated financial statements of Chevy Chase
Bank, F.S.B. (the "Bank") have been prepared in accordance with the instructions
for Form 10-Q and, therefore, do not include all information and notes necessary
for a fair presentation of financial condition, results of operations and cash
flows in conformity with generally accepted accounting principles. The
accompanying condensed consolidated financial statements should be read in
conjunction with the audited consolidated financial statements included in the
Form 10-K of the Bank for the fiscal year ended September 30, 1995.
The accompanying condensed consolidated financial statements include the
accounts of the Bank and all subsidiaries. All significant intercompany
balances and transactions have been eliminated. The condensed consolidated
financial statements as of June 30, 1996 and for the three months and nine
months ended June 30, 1996 and 1995 are unaudited but include all adjustments
(consisting only of normal recurring adjustments) which the Bank considers
necessary for a fair presentation of its financial condition and results of
operations for those periods. The Condensed Consolidated Statements of
Operations for the three months and nine months ended June 30, 1996 are not
necessarily indicative of the results that will be achieved for the entire year.
Certain reclassifications of prior periods' information have been made to
conform with the presentation for the three months and nine months ended June
30, 1996.
NOTE 2 - EARNINGS PER COMMON SHARE:
Earnings per common share are calculated based upon the weighted average number
of common shares outstanding during each period presented, which amounted to
10,000 shares in each such period. Dividends on preferred stock are deducted
from earnings in the computation of earnings per common share when declared by
the Bank's Board of Directors.
NOTE 3 - LOANS HELD FOR SALE:
At June 30, 1996 and September 30, 1995, loans held for sale is composed of
single-family residential loans.
-7-
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
----------------------------------------------------------------
(Unaudited)
NOTE 4 - LOANS HELD FOR SECURITIZATION AND SALE:
Loans held for securitization and sale are composed of the following:
<TABLE>
<CAPTION>
June 30, September 30,
1996 1995
------------ --------------
(In thousands)
<S> <C> <C>
Credit card receivables $ 180,000 $ 300,000
Automobile loan receivables 50,000 200,000
Home equity credit line receivables 85,000 -
---------- ----------
Total $ 315,000 $ 500,000
========== ==========
</TABLE>
NOTE 5 - LOANS RECEIVABLE:
<TABLE>
<CAPTION>
June 30, September 30,
1996 1995
-------------- --------------
(In thousands)
<S> <C> <C>
Single-family residential $1,398,126 $1,322,772
Home equity 13,482 29,024
Commercial and multifamily 79,245 86,007
Real estate construction 41,911 46,848
Ground 43,300 6,892
Credit card 776,538 712,548
Automobile 63,044 39,217
Overdraft lines of credit 19,629 15,049
Home improvement and
other consumer 44,901 112,705
Other 87,890 31,975
---------- ----------
2,568,066 2,403,037
---------- ----------
Less:
Undisbursed portion of loans 48,534 28,147
Unearned discounts 721 872
Net deferred loan origination
costs (12,611) (13,764)
Allowance for loan losses 71,619 60,496
---------- ----------
108,263 75,751
---------- ----------
Total $2,459,803 $2,327,286
========== ==========
</TABLE>
-8-
<PAGE>
CHEVY CHASE BANK, F.S.B.
------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
----------------------------------------------------------------
(Unaudited)
NOTE 6 - REAL ESTATE HELD FOR INVESTMENT OR SALE:
The Bank's real estate held for investment is carried at the lower of aggregate
cost or net realizable value. The Bank's real estate acquired in settlement of
loans is considered to be held for sale and is carried at the lower of cost or
fair value (less estimated selling costs).
Real estate held for investment or sale is composed of the following:
<TABLE>
<CAPTION>
June 30, September 30,
1996 1995
--------- -------------
(In thousands)
<S> <C> <C>
Real estate held for investment $ 3,819 $ 3,819
-------- --------
Real estate held for sale 264,172 354,277
-------- --------
Less:
Allowance for losses on real estate
held for investment 188 193
Allowance for losses on real estate
held for sale 127,770 135,043
-------- --------
127,958 135,236
-------- --------
Total real estate held for
investment or sale $140,033 $222,860
======== ========
</TABLE>
NOTE 7 - REGULATORY MATTERS:
In connection with the termination of the Bank's written agreement with the OTS
in March 1996, the Board of Directors of the Bank adopted a resolution which,
among other things, authorizes the Bank: (i) to make tax sharing payments to
the B. F. Saul Real Estate Investment Trust of up to $15 million relating to any
single fiscal year without OTS approval; and (ii) to declare dividends on its
common stock in any quarterly period up to the lesser of (A) 50% of its after
tax net income for the immediately preceding quarter or (B) 50% of the average
quarterly after tax net income for the immediately preceding four quarter
period, minus (in either case) dividends declared on the Bank's preferred stock
during that quarterly period. The resolution also provides that the Bank will
present a plan annually to the OTS detailing anticipated consumer loan
securitization activity.
-9-
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
GENERAL. The Bank recorded pre-tax income of $31.1 million and net income of
$17.6 million during the June 1996 quarter, compared to pre-tax income of $23.4
million and net income of $15.2 million in the prior corresponding period. The
$7.7 million increase in pre-tax income for the current quarter was primarily a
result of an increase in credit card loan servicing fee income and gains on
sales of loans reflecting the Bank's securitization activity during the June
quarter. A $19.8 million increase in loan and deposit servicing fees over the
June 1995 quarter contributed to a $28.9 million increase in non-interest
income. The Bank's net interest income before provision for loan losses
increased $8.0 million primarily as a result of a decline in the Bank's interest
expense. Partially offsetting the positive effect of these items on income was
a $12.6 million increase in operating expenses and a $16.5 million increase in
the provision for loan losses. See "Results of Operations."
At June 30, 1996, the Bank's tangible, core, tier 1 risk-based and total risk-
based regulatory capital ratios were 6.30%, 6.30%, 6.91% and 12.04%,
respectively. The Bank's capital ratios exceeded the requirements under the
Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA")
as well as the standards established for "well capitalized" institutions under
the prompt corrective action regulations issued pursuant to the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"). On the basis of its
balance sheet at June 30, 1996, the Bank met the FIRREA-mandated fully phased-in
capital requirements and, on a fully phased-in basis, met the capital standards
established for "well capitalized" institutions under the prompt corrective
action regulations. See "Capital."
In the June 1996 quarter, the Bank securitized and sold $227.7 million of
automobile loan receivables and recognized a gain of $2.7 million in connection
with this sale. The Bank also securitized and sold $153.5 million of home loan
receivables in the current quarter and recognized a gain of $9.5 million. See
"Liquidity."
Real estate owned, net of valuation allowances, declined 6.9% during the June
1996 quarter to $136.4 million at June 30, 1996, from $146.5 million at March
31, 1996. This reduction resulted primarily from sales of residential properties
and increased valuation allowances on the real estate owned portfolio. See
"REO."
During the June 1996 quarter, the Bank paid, out of the retained earnings of the
Bank, cash dividends on its Common Stock in the amount of $500 per share, $200
per share of which was declared during the March 1996 quarter. Subsequent to
June 30, 1996, the Bank declared a cash dividend on its Common Stock in the
amount of $350 per share, to be paid upon the expiration of the applicable OTS
notice period.
-10-
<PAGE>
ASSET QUALITY. Non-Performing Assets. The Bank's level of non-performing
---------------------
assets continued to decline during the third quarter of fiscal 1996 from the
level at September 30, 1995. The following table sets forth information
concerning the Bank's non-performing assets at the dates indicated. The figures
shown are after charge-offs and, in the case of real estate acquired in
settlement of loans, after all valuation allowances.
-11-
<PAGE>
NON-PERFORMING ASSETS
----------------------
(DOLLARS IN THOUSANDS)
================================================================================
<TABLE>
<CAPTION>
June 30, March 31, September 30,
1996 1996 1995
----------- ------------ ---------------
<S> <C> <C> <C>
NON-PERFORMING ASSETS:
Non-accrual loans:
Residential $ 7,626 $ 9,688 $ 8,593
Commercial and multifamily - 305 194
----------- ------------ ---------------
Total non-accrual real estate loans 7,626 9,993 8,787
Credit card 20,584 21,030 18,569
Consumer and other 2,277 1,155 595
----------- ------------ ---------------
Total non-accrual loans (1) 30,487 32,178 27,951
----------- ------------ ---------------
Real estate acquired in settlement of loans 264,172 268,566 354,277
Allowance for losses on real estate acquired in settlement
of loans (127,770) (122,111) (135,043)
----------- ------------ ---------------
Real estate acquired in settlement of loans, net 136,402 146,455 219,234
----------- ------------ ---------------
Total non-performing assets $ 166,889 $ 178,633 $ 247,185
=========== ============ ===============
Allowance for losses on loans $ 71,619 $ 60,879 $ 60,496
Allowance for losses on real estate held for investment 188 188 193
Allowance for losses on real estate acquired in settlement
of loans 127,770 122,111 135,043
----------- ------------ ---------------
Total allowances for losses $ 199,577 $ 183,178 $ 195,732
=========== ============ ===============
RATIOS:
Non-performing assets, net to total assets (2) 1.89% 2.33% 3.77%
Allowance for losses on real estate loans to non-accrual
real estate loans (1) (4) 143.55% 112.34% 123.82%
Allowance for losses on credit card loans to non-accrual
credit card loans (1) (4) 248.16% 219.12% 249.47%
Allowance for losses on consumer and other loans to
non-accrual consumer and other loans (1) (4) 157.71% 309.26% 553.11%
Allowance for losses on loans to non-accrual loans (1) 234.92% 189.19% 216.44%
Allowance for losses on loans to total loans receivable (3) 2.41% 2.07% 2.05%
</TABLE>
================================================================================
(1) Before deduction of allowance for losses.
(2) Non-performing assets is presented after the allowance for losses on loans
and the allowance for losses on real estate held for investment or sale.
real estate held for investment or sale.
(3) Includes loans receivable and loans held for sale and/or securitization ,
before deduction of allowance for losses on loans.
(4) Excludes a $6.0 million unallocated valuation allowance at June 30, 1996
which can be used to offset losses on any of the Bank's loan portfolios.
-12-
<PAGE>
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) and real estate acquired in settlement of
loans, either through foreclosure or deed-in-lieu of foreclosure.
Non-performing assets totaled $166.9 million, after valuation allowances on real
estate held for sale or real estate owned ("REO") of $127.8 million, at June 30,
1996, compared to $178.6 million, after valuation allowances on REO of $122.1
million, at March 31, 1996. In addition to the valuation allowances on REO, the
Bank maintained $1.5 million of valuation allowances on its non-accrual loans at
June 30, 1996 compared to $1.6 million at March 31, 1996. The decrease in non-
performing assets for the current quarter was primarily attributable to a net
decrease in REO of $10.1 million. See "REO."
Non-accrual Loans. The Bank's non-accrual loans totaled $30.5 million at June
- -----------------
30, 1996, as compared to $32.2 million at March 31, 1996. At June 30, 1996,
non-accrual loans consisted of $7.6 million of non-accrual real estate loans,
$20.6 million of non-accrual credit card loans and $2.3 million of non-accrual
consumer and other loans.
REO. At June 30, 1996, the Bank's REO totaled $136.4 million, after valuation
- ---
allowances on such assets of $127.8 million. The principal component of REO
consists of the five planned unit developments (the "Communities"), which had an
aggregate book value of $102.8 million at that date. Four of the five
Communities are under active development. However, as a result of the sale in
the December 1995 quarter of the remaining residential lots in two of the
Communities, the Bank owns only commercial land in two of the four active
Communities.
During the three months ended June 30, 1996, REO decreased $10.1 million. This
decrease was primarily attributable to sales in the Communities and other
residential properties and an increase in the valuation allowances against these
properties.
During the three months ended June 30, 1996, the Bank received revenues of
approximately $8.1 million upon the disposition of REO, which consisted of 147
residential lots or units in the Communities and other smaller residential
properties ($7.5 million) and various single-family residential properties ($0.6
million).
At June 30, 1996, the Bank had executed contracts to sell two additional REO
properties at their aggregate book value of $9.2 million at that date.
In addition to the active Communities, REO includes a fifth Community,
consisting of approximately 2,400 acres in Loudoun County, Virginia, which is in
the pre-development stage.
-13-
<PAGE>
Potential Problem Assets. Although not considered non-performing assets,
- -------------------------
primarily because the loans are not 90 or more days past due and the borrowers
have not abandoned control of the properties, potential problem assets are
experiencing problems sufficient to cause management to have serious doubts as
to the ability of the borrowers to comply with present repayment terms. The
majority of the Bank's potential problem assets involve borrowers or properties
experiencing cash flow problems. At June 30, 1996, potential problem assets
totaled $6.4 million, before valuation allowances of $1.2 million, as compared
to $7.1 million, before valuation allowances of $1.4 million, at March 31, 1996.
The $0.7 million decrease in potential problem assets was primarily attributable
to net principal reductions.
Delinquent Loans. At June 30, 1996, delinquent loans totaled $47.7 million (or
- -----------------
1.6% of loans) compared to $41.6 million (or 1.4% of loans) at March 31, 1996.
The following table sets forth information regarding the Bank's delinquent loans
at June 30, 1996.
<TABLE>
<CAPTION>
Principal Balance Total as a
------------------------------------
Mortgage Non-Mortgage Percentage
Loans Loans Total of Loans (1)
-------- ------------ --------- ------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Loans delinquent for:
30-59 days............. $ 5,339 $ 26,601 $ 31,940 1.1%
60-89 days............. 1,187 14,527 15,714 0.5%
-------- --------- --------- ---------
Total................ $ 6,526 $ 41,128 $ 47,654 1.6%
======== ========= ========= =========
</TABLE>
- ----------------
(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 were $6.5 million at June 30, 1996 compared to
$6.4 million at March 31, 1996.
Non-mortgage loans (principally credit card loans) delinquent 30-89 days
increased to $41.1 million at June 30, 1996 from $35.2 million at March 31,
1996, and increased as a percentage of total non-mortgage loans to 3.4% from
2.7%. The increased percentage of delinquent non-mortgage loans to total non-
mortgage loans outstanding resulted primarily from the increase in delinquent
non-mortgage loans, but also reflected the securitization and sale of $227.7
million of automobile loan receivables and $153.5 million of home loan
receivables, which transactions reduced the Bank's portfolio of non-mortgage
loans.
Troubled Debt Restructurings. At June 30, 1996, loans accounted for as troubled
- ----------------------------
debt restructurings totalled $14.4 million and included two commercial permanent
loans with principal balances totaling $13.2 million, one residential ground
loan with a principal balance of $0.6 million and one commercial collateralized
loan with a principal balance of $0.6 million. The $1.2 million decrease in
loans accounted for as troubled debt restructurings from $15.6 million at March
31, 1996 resulted from net principal reductions. At June 30, 1996, the Bank had
commitments to lend $0.7 million of additional funds on loans that have been
restructured.
-14-
<PAGE>
Real Estate Held for Investment. At June 30, 1996 and September 30, 1995, real
- -------------------------------
estate held for investment consisted of two properties with an aggregate book
value of $3.6 million, net of valuation allowances of $0.2 million.
Allowances for Losses. The following tables show loss experience by asset type
- ---------------------
and the components of the allowance for losses on loans and the allowance for
losses on real estate held for investment or sale. These tables reflect charge-
offs taken against assets during the periods indicated and may include charge-
offs taken against assets which the Bank disposed of during such periods.
-15-
<PAGE>
COMPONENTS OF ALLOWANCE FOR LOSSES ON LOANS BY TYPE
---------------------------------------------------
(DOLLARS IN THOUSANDS)
================================================================================
<TABLE>
<CAPTION>
June 30, March 31, September 30,
1996 1996 1995
----------------------- ------------------------ ------------------------
Percent of Percent of Percent of
Loans to Loans to Loans to
Amount Total Loans Amount Total Loans Amount Total Loans
-------- ------------- -------- ------------- -------- -------------
<S> <C> <C> <C>
Balance at end of period allocated to:
Residential permanent $ 896 50.8% $ 992 48.1% $ 929 47.3%
Home equity 374 3.3 307 2.5 164 1.0
Commercial and multifamily 8,402 2.7 8,453 2.8 8,523 2.9
Residential construction 862 0.6 1,031 0.7 1,159 0.8
Commercial construction 21 0.1 16 0.1 56 0.2
Ground 392 1.3 427 1.4 49 0.1
Credit card 51,081 32.4 46,081 30.2 46,325 34.4
Consumer and other 3,591 8.8 3,572 14.2 3,291 13.3
Unallocated 6,000 - - - - -
--------- -------- ---------
Total $ 71,619 $ 60,879 $ 60,496
========= ======== =========
</TABLE>
- --------------------------------------------------------------------------------
-16-
<PAGE>
ANALYSIS OF ALLOWANCE FOR AND CHARGE-OFFS OF LOANS
--------------------------------------------------
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
==========================================================================================================
Three Months
Nine Months Ended Ended
June 30, June 30,
---------------------------
1996 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Balance at beginning of period $ 60,496 $ 50,205 $ 60,879
------------ ------------ ------------
Provision for loan losses 70,825 35,829 30,062
------------ ------------ ------------
Charge-offs:
Residential 655 866 229
Credit card 62,804 34,617 20,163
Other 4,790 2,369 1,745
------------ ------------ ------------
Total charge-offs 68,249 37,852 22,137
------------ ------------ ------------
Recoveries:
Residential 16 14 10
Credit card 8,172 8,388 2,686
Other 359 491 119
------------ ------------ ------------
Total recoveries 8,547 8,893 2,815
------------ ------------ ------------
Charge-offs, net of recoveries 59,702 28,959 19,322
------------ ------------ ------------
Balance at end of period $ 71,619 $ 57,075 71,619
============ ============ ============
Provision for loan losses to average loans (1) (2) 3.28% 1.60% 4.10%
Net loan charge-offs to average loans (1) (2) 2.77% 1.29% 2.63%
Ending allowance for losses on loans to total
loans (2) (3) 2.43% 1.95% 2.43%
==========================================================================================================
</TABLE>
(1) Annualized.
(2) Includes loans held for sale and/or securitization.
(3) Before deduction of reserves
-17-
<PAGE>
<TABLE>
<CAPTION>
COMPONENTS OF ALLOWANCE FOR LOSSES
------------------------------------
ON REAL ESTATE HELD FOR INVESTMENT OR SALE
--------------------------------------------
(IN THOUSANDS)
================================================================================
June 30, March 31, September 30,
1996 1996 1995
----------- ----------- -------------
<S> <C> <C> <C>
Allowance for losses on
real estate
held for investment $ 188 $ 188 $ 193
----------- ----------- -------------
Allowance for losses on
real estate
held for sale:
Residential 160 115 184
Home equity 38 35 2
Ground 127,572 121,961 134,857
----------- ----------- ------------
Total 127,770 122,111 135,043
----------- ----------- ------------
Total allowance for losses on real
estate held for investment or sale $ 127,958 $ 122,299 $ 135,236
=========== =========== ============
</TABLE>
================================================================================
-18-
<PAGE>
ANALYSIS OF ALLOWANCE FOR AND CHARGE-OFFS OF
--------------------------------------------
REAL ESTATE HELD FOR INVESTMENT OR SALE
---------------------------------------
(IN THOUSANDS)
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months
Nine Months Ended Ended
June 30, June 30,
-------------------------------
1996 1995 1996
----------- ------------- --------------
<S> <C> <C> <C>
Balance at beginning of period:
Real estate held for investment $ 193 $ 9,899 $ 188
Real estate held for sale 135,043 109,074 122,111
------------ ------------- ------------
Total 135,236 118,973 122,299
------------ ------------- ------------
Provision for real estate losses:
Real estate held for investment (5) (8,556) -
Real estate held for sale 20,157 24,556 7,197
------------ ------------- ------------
Total 20,152 16,000 7,197
------------ ------------- ------------
Charge-offs:
Real estate held for investment:
Commercial ground - 750 -
------------ ------------- --------------
Total - 750 -
------------ ------------- --------------
Real estate held for sale:
Residential construction - 1,924 -
Commercial construction - 933 -
Commercial ground - 925 -
Residential ground 27,430 103 1,538
------------ ------------- --------------
Total 27,430 3,885 1,538
------------ ------------- --------------
Total charge-offs on real estate
held for investment or sale 27,430 4,635 1,538
------------ ------------- --------------
Balance at end of period:
Real estate held for investment 188 1,343 188
Real estate held for sale 127,770 129,745 127,770
---------- ------------ --------------
Total $ 127,958 $ 130,338 $ 127,958
========== ============ ==============
</TABLE>
- --------------------------------------------------------------------------------
-19-
<PAGE>
The Bank maintains valuation allowances for estimated losses on loans and real
estate. The Bank's total valuation allowances for losses on loans and real
estate held for investment or sale increased by $16.4 million from the level at
March 31, 1996 to $199.6 million at June 30, 1996. The $16.4 million increase
was primarily attributable to increased valuation allowances on credit card
loans and real estate held for investment or sale, as well as the Bank's
establishment during the June 1996 quarter of a $6.0 million unallocated
valuation allowance to offset losses from any of the Bank's loan portfolios.
The allowance for losses on loans secured by real estate and real estate held
for investment or sale totaled $138.9 million at June 30, 1996, which
constituted 51.1% of total non-performing real estate assets, before valuation
allowances. This amount represented a $5.4 million increase from the March 31,
1996 level of $133.5 million, or 47.9% of total non-performing real estate
assets, before valuation allowances at that date.
During the nine months ended June 30, 1996, the Bank provided an additional
$20.9 million of valuation allowances on loans secured by real estate and real
estate held for investment or sale and recorded net charge-offs of $28.1 million
on these assets. The allowance for losses on real estate held for sale at June
30, 1996 is in addition to approximately $53.3 million of cumulative charge-offs
previously taken against assets remaining in the Bank's portfolio at June 30,
1996.
During the June 1996 quarter, the Bank provided an additional $2.0 million of
general valuation allowances against its Communities pursuant to its policy of
providing additional general valuation allowances equal to, or in excess of, the
amount of the net earnings generated by the development and sale of land in the
Communities.
Net charge-offs of credit card loans for the nine months ended June 30, 1996
were $54.6 million, compared to $26.2 million for the nine months ended June 30,
1995. The increase in net charge-offs resulted primarily from continued
maturation of the Bank's portfolio and reflects the industry-wide decline in the
performance of credit card loans. The allowance for losses on credit card loans
increased to $51.1 million at June 30, 1996 from $46.1 million at March 31,
1996. The increase in such allowance for losses resulted primarily from an
increase in the reserve percentage used to calculate allowances for losses
reflecting the recent trend of increased charge-offs and an increase in the
ending balance of such loans. The ratios of the allowance for such losses to
non-performing credit card loans and to outstanding credit card loans increased
to 248.2% and 5.3%, respectively, at June 30, 1996 from 219.1% and 5.2%,
respectively, at March 31, 1996.
The allowance for losses on consumer and other loans remained constant at $3.6
million from March 31, 1996 to June 30, 1996. The ratios of the allowances for
losses on consumer and other loans to non-performing consumer and other loans
and to outstanding consumer and other loans were 157.7% and 1.4%, respectively,
at June 30, 1996 compared to 309.3% and 0.9%, respectively, at March 31, 1996.
-20-
<PAGE>
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 following table presents the interest rate sensitivity of the Bank's
interest-earning assets and interest-bearing liabilities at June 30, 1996, which
reflects management's estimate of mortgage loan prepayments and amortization and
provisions for adjustable interest rates. Adjustable and floating rate loans
are included in the period in which their interest rates are next scheduled to
adjust, and prepayment rates are assumed for the Bank's loans based on recent
actual experience. Statement savings and passbook accounts with balances under
$20,000 are classified based upon management's assumed attrition rate of 17.5%,
and those with balances of $20,000 or more, as well as all NOW accounts, are
assumed to be subject to repricing within six months or less.
-21-
<PAGE>
INTEREST RATE SENSITIVITY TABLE (GAP)
-------------------------------------
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
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
------------ ----------- ------------- ------------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1996
Mortgage loans:
Adjustable-rate $ 292,293 $ 244,219 $ 687,275 $ 135,152 $ 8,792 $ 1,367,731
Fixed-rate 12,717 8,542 37,363 81,426 30,398 170,446
Loans held for sale 102,079 - - - - 102,079
Home equity credit lines
and second mortgages 20,432 195 646 473 1,213 22,959
Credit card and other 877,802 17,886 39,222 24,198 11,178 970,286
Loans held for securitization
and sale 315,000 - - - - 315,000
Mortgage-backed securities 198,785 324,695 306,489 5,765 11,295 847,029
Other investments 375,237 - 4,995 - - 380,232
------------ ----------- ------------- ------------- ------------ -----------
Total interest-earning assets 2,194,345 595,537 1,075,990 247,014 62,876 4,175,762
Total non - interest earning assets - - - - 844,757 844,757
Total assets $ 2,194,345 $ 595,537 $ 1,075,990 $ 247,014 $ 907,633 $ 5,020,519
============ =========== ============= ============= ============ ===========
Deposits:
Fixed maturity deposits $ 649,772 $ 266,493 $ 191,463 $ 109,907 $ - $ 1,217,635
NOW, statement and passbook accounts 1,390,450 40,649 135,386 92,147 196,376 1,855,008
Money market deposit accounts 1,000,733 - - - - 1,000,733
Borrowings:
Capital notes - subordinated 10,000 - - - 150,000 160,000
Other 117,193 3,125 3,968 9,695 7,229 141,210
------------ ----------- ------------- ------------- ------------ -----------
Total interest-bearing liabilities 3,168,148 310,267 330,817 211,749 353,605 4,374,586
Total non-interest bearing
liabilities - - - - 288,964 288,964
Stockholders' equity - - - - 356,969 356,969
Total liabilities &
stockholders' equity $ 3,168,148 $ 310,267 $ 330,817 $ 211,749 $ 999,538 $ 5,020,519
============ =========== ============= ============= ============ ===========
Gap ($973,803) $285,270 $745,173 $35,265 ($290,729)
Cumulative gap ($973,803) ($688,533) $56,640 $91,905 ($198,824)
Cumulative gap as a percentage
of total assets (19.4)% (13.7)% 1.1% 1.8% (4.0)%
</TABLE>
- --------------------------------------------------------------------------------
-22-
<PAGE>
The interest sensitivity "gap" shown in the table represents the sum of all
interest-earning assets minus all interest-bearing liabilities subject to
repricing within the same period. The one-year gap, as a percentage of total
assets, was a negative 13.7% at June 30, 1996, compared to a negative 14.1% at
March 31, 1996. A negative gap like that shown for the Bank implies that, if
market 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.
TAX SHARING PAYMENTS. During the June 1996 quarter, the Bank made a tax sharing
payment of $5.0 million to B. F. Saul Real Estate Investment Trust (the
"Trust"), which owns 80% of the Bank's Common Stock. Subsequent to June 30,
1996, the Bank made an additional tax sharing payment of $2.7 million to the
Trust.
CAPITAL. At June 30, 1996, 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 June 30, 1996 balance sheet,
the Bank also met the fully phased-in capital requirements under FIRREA that
took effect on July 1, 1996 as the last of the phase-in periods for the
deductions from capital expired and, after giving effect to those deductions,
met the capital standards for "well capitalized" institutions under the prompt
corrective action regulations.
The following table shows the Bank's regulatory capital levels at June 30, 1996
in relation to the regulatory requirements in effect at that date. The
information below is based upon the Bank's understanding of the regulations and
interpretations currently in effect and may be subject to change.
-23-
<PAGE>
REGULATORY CAPITAL
-------------------
(DOLLARS IN THOUSANDS)
================================================================================
<TABLE>
<CAPTION>
Minimum Excess
Actual Capital Requirement Capital
----------------------------- -------------------------- ------------------------
As a % As a % As a %
of of of
Amount Assets Amount Assets Amount Assets
------------- ------------ ----------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Capital per financial statements $ 356,969
Net unrealized holding losses (1) 2,210
-------------
Adjusted capital 359,179
Adjustments for tangible and core capital:
Intangible assets (42,213)
Non-includable subsidiaries (2) (4) (2,078)
Non-qualifying purchased/originated
loan servicing (1,410)
-------------
Total tangible capital 313,478 6.30% $ 74,634 1.50% $ 238,844 4.80 %
------------- ============ =========== ========== =========== ===========
Total core capital (3) (4) 313,478 6.30% $ 199,023 4.00% $ 114,455 2.30 %
------------- ============ =========== ========== =========== ===========
Tier 1 risk-based capital (3) 313,478 6.91% $ 181,511 4.00% $ 131,967 2.91 %
------------ ============ =========== ========== =========== ===========
Adjustments for risk-based capital:
Subordinated capital debentures 150,000
Allowance for general loan losses 64,387
-------------
Total supplementary capital 214,387
Excess allowance for loan losses (7,570)
-------------
Adjusted supplementary capital 206,817
-------------
Total available capital 520,295
Equity investments (2) (20,169)
-------------
Total risk-based capital (3) $ 500,126 12.04 % $ 363,022 8.00% $ 137,104 4.04 %
============= ============= =========== =========== =========== ===========
</TABLE>
- --------------------------------------------------------------------------------
(1) Pursuant to OTS policy, net unrealized holding gains (losses) are excluded
from regulatory capital.
(2) Reflects an aggregate offset of $1.3 million representing the allowance for
general loan losses maintained against the Bank's equity investments and
non-includable subsidiaries which, pursuant to OTS guidelines, is available
as a "credit" against the deductions from capital otherwise required for
such investments.
(3) Under the OTS "prompt corrective action" regulations, the standards for
classification as "well capitalized" are a leverage (or "core capital")
ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0%
and a total risk-based capital ratio of at least 10.0%.
(4) Effective July 1, 1996, the percentage of non-includable subsidiaries
required to be phased out from core capital increased from 60% to 100%. If
this phase-out had been in effect at June 30, 1996, the Bank's tangible,
core and risk-based regulatory capital ratios would have been 6.27%, 6.27%
and 12.00%.
-24-
<PAGE>
Regulatory Action and Requirements. In connection with the termination of the
- ----------------------------------
Bank's written agreement, the Board of Directors of the Bank adopted a
resolution which, among other things, authorizes the Bank: (i) to make tax
sharing payments to the Trust of up to $15 million relating to any single fiscal
year without OTS approval; and (ii) to declare dividends on its common stock in
any quarterly period up to the lesser of (A) 50% of its after tax net income for
the immediately preceding quarter or (B) 50% of the average quarterly after tax
net income for the immediately preceding four quarter period, minus (in either
case) dividends declared on the Bank's preferred stock during that quarterly
period. The resolution also provides that the Bank will present a plan annually
to the OTS detailing anticipated consumer loan securitization activity.
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. In September 1995, the Bank received from the OTS an extension through
September 29, 1996 of the five-year holding period for certain of its REO
properties acquired through foreclosure in fiscal 1990 and fiscal 1991. The
following table sets forth the Bank's REO at June 30, 1996, after valuation
allowances of $127.8 million, by the fiscal year in which the property was
acquired through foreclosure.
<TABLE>
<CAPTION>
Fiscal Year (In thousands)
----------- --------------
<S> <C>
1990 (1) (2)...... $ 38,958
1991 (2).......... 75,641
1992.............. 3,339
1993.............. 4,853
1994.............. 1,474
1995.............. 8,979
1996.............. 3,158
--------
Total REO.. $136,402
========
</TABLE>
_______________________
(1) Includes REO with an aggregate net book value of $20.2 million, which the
Bank treats as equity investments for regulatory capital purposes.
(2) Includes REO with an aggregate net book value of $92.5 million, for which
the Bank received an extension of the five-year holding period through
September 29, 1996.
-25-
<PAGE>
Although the Bank's regulatory capital ratios on a fully phased-in basis at June
30, 1996 would meet the ratios established for "well capitalized" institutions,
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" under the prompt corrective action standards.
Deposit Insurance Premiums. Thrift institutions insured by the Savings
- --------------------------
Association Insurance Fund ("SAIF"), including the Bank, currently pay
substantially higher deposit insurance premiums than similarly situated
commercial banks insured by the Bank Insurance Fund ("BIF"). Legislation
designed to reduce or eliminate the disparity between BIF and SAIF insurance
premiums by, among other things, imposing on thrift institutions a one-time
assessment estimated to be up to 85 basis points on their SAIF-insured deposits
to capitalize the SAIF, remains under consideration by Congress although it
remains unclear if, and in what form, such legislation will be enacted. In the
absence of such legislation, the Bank and other SAIF-insured institutions will
continue to pay higher deposit insurance premiums than commercial banks, which
could lead to a competitive disadvantage in the pricing of loans and deposits
and additional operating expenses. In addition, regulators have recently begun
approving applications by several thrift organizations to establish or acquire
BIF-insured affiliates and prolonged continuation of the disparity in deposit
insurance premiums could lead to more widespread efforts to shift insured
deposits from SAIF to BIF thus further destabilizing the SAIF.
Bad Debt Reserves. Provisions that would repeal the thrift bad debt provisions
- -----------------
of the Internal Revenue Code have been included in the Small Business Jobs
Protection Act of 1996 that passed the House of Representatives and the Senate
on August 2, 1996. The bad debt provisions of this legislation also would
require thrifts to recapture and pay tax on bad debt reserves accumulated since
1987 over a six year period, beginning with a thrift's first taxable year
starting after December 31, 1995 (or, if the thrift meets a loan origination
test, beginning up to two years later). Bad debt reserves accumulated prior to
1988 would not have to be recaptured under this legislation. Enactment of this
legislation will not have a material impact on the Bank's financial statements
which already reflect a tax liability related to the bad debt reserves
accumulated since 1987.
LIQUIDITY. The Bank's average liquidity ratio for the month ended June 30, 1996
was 21.1%, compared to 22.7% for the month ended March 31, 1996. Additionally,
the Bank met the liquidity level requirements imposed by the OTS for each month
of the first nine months of fiscal 1996.
In recent periods, the proceeds from the securitization and sale of credit card,
home equity credit line, automobile and home improvement and other consumer loan
receivables have been significant sources of liquidity for the Bank. The Bank
securitized and sold $699.0 million of credit card receivables, $475.3 million
of automobile loan receivables and $153.5 million of home loan receivables
during the first nine months of fiscal 1996. Additionally, during the March
1996 quarter, the Bank securitized and sold $42.1 million of amounts on deposit
in certain spread accounts established in connection with certain of the Bank's
outstanding credit card securitizations. At June 30, 1996, the Bank was
considering the securitization and sale of the following receivables: (i)
approximately $650.0 million of credit card receivables, including $180.0
million of receivables outstanding at June 30, 1996 and $470.0 million of
receivables which the Bank expects to become available through additional
fundings during the six months ending December 31, 1996; (ii) approximately
$325.0 million of automobile loan receivables, including
-26-
<PAGE>
$50.0 million of receivables outstanding at June 30, 1996 and $275.0 million of
receivables which the Bank expects to become available through additional
fundings during the six months ending December 31, 1996; and (iii) approximately
$100.0 million of home equity credit line receivables, including $85.0 million
of receivables outstanding at June 30, 1996 and $15.0 million of receivables
which the Bank expects to become available through additional fundings or
maturation of existing transactions during the six months ending December 31,
1996. To the extent these receivables were outstanding at June 30, 1996, such
receivables are classified as held for securitization and sale in the Condensed
Consolidated Statements of Financial Condition. As part of its operating
strategy, the Bank will continue to explore opportunities to securitize and sell
credit card, home equity credit line, automobile and home loan receivables to
meet liquidity and other balance sheet objectives.
The Bank is obligated under various recourse provisions related to the
securitization and sale of receivables. Of the $4.9 billion of outstanding
trust certificate balances at June 30, 1996, the primary recourse to the Bank
was approximately $108.5 million. The Bank is also obligated under various
recourse provisions related to the swap of single-family residential loans for
participation certificates issued to the Bank by the Federal Home Loan Mortgage
Corporation. At June 30, 1996, recourse to the Bank under these arrangements
was approximately $4.3 million.
There were no material commitments for capital expenditures at June 30, 1996.
The Bank's liquidity requirements in fiscal 1996 and for years subsequent to
fiscal 1996 will continue to be affected both by the asset size of the Bank, the
growth of which will be constrained by capital requirements, and the composition
of the asset portfolio. Management believes that the Bank's primary sources of
funds, 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.
-27-
<PAGE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1996 COMPARED TO THREE MONTHS ENDED JUNE 30, 1995
OVERVIEW. The Bank recorded pre-tax income of $31.1 million and net income of
$17.6 million for the three months ended June 30, 1996 (the "1996 quarter"),
compared to pre-tax income of $23.4 million and net income of $15.2 million for
the three months ended June 30, 1995 (the "1995 quarter"). The increase in
income for the 1996 quarter was primarily attributable to a $28.9 million
increase in other (non-interest) income resulting primarily from an increase in
loan and deposit servicing fees. In addition, the Bank's net interest income
before provision for loan losses increased $8.0 million primarily as a result of
a decline in the Bank's interest expense. These increases were partially offset
by a $12.6 million increase in operating expenses and a $16.5 million increase
in the provision for loan losses.
NET INTEREST INCOME. Net interest income, before the provision for loan losses,
increased $8.0 million (or 17.4%) in the 1996 quarter. The Bank would have
recorded interest income of $1.9 million for the 1996 quarter if the Bank's non-
accrual assets and restructured loans had been current in accordance with their
original terms. Interest income of $0.4 million was actually recorded on non-
accrual assets and restructured loans for the 1996 quarter. 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.
-28-
<PAGE>
NET INTEREST MARGIN ANALYSIS
----------------------------
(DOLLARS IN THOUSANDS)
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended June 30,
---------------------------
1996 1995
---- ----
Average Yield/ Average Yield/
Balances Interest Rate Balances Interest Rate
-------- -------- ------ -------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans receivable, net (1) $ 2,935,244 $ 82,690 11.27% $ 3,261,730 $ 79,858 9.79%
Mortgage-backed securities 756,641 11,481 6.07 969,236 15,217 6.28
Securities purchased under agreements
to resell and federal funds sold 230,889 3,066 5.31 52,403 792 6.05
Trading securities 16,396 281 6.86 3,842 76 7.91
Investment securities 5,532 74 5.35 4,403 49 4.45
Other interest-earning assets 155,837 1,673 4.29 110,324 1,180 4.28
------------ --------- ---- ---------- -------- -------
Total 4,100,539 99,265 9.68 4,401,938 97,172 8.83
------------ --------- ---- ---------- -------- -------
Noninterest-earning assets:
Cash 169,883 132,938
Real estate held for investment or sale 148,533 287,462
Property and equipment, net 199,090 153,580
Cost in excess of net assets acquired, net 42,144 46,205
Other assets 268,131 154,687
------------ ----------
Total assets $ 4,928,320 $ 5,176,810
============ ==========
Liabilites and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits $ 950,959 5,683 2.39 $ 875,599 5,902 2.70
Savings deposits 954,954 8,038 3.37 986,373 8,276 3.36
Time deposits 1,249,602 16,770 5.37 1,122,574 15,293 5.45
Money market deposits 993,476 9,438 3.80 1,034,252 10,183 3.94
------------ ---------- ---- ---------- ------
Total deposits 4,148,991 39,929 3.85 4,018,798 39,654 3.95
Borrowings 292,830 5,472 7.47 685,410 11,623 6.78
------------ --------- ---- ---------- ------ ----
Total 4,441,821 45,401 4.09 4,704,208 51,277 4.36
------------ --------- ---- ---------- ------ ----
Noninterest-bearing items:
Noninterest-bearing deposits 80,336 78,517
Other liabilities 61,672 85,951
Stockholders' equity 344,491 308,134
------------ ----------
Total liabilities and stockholders' equity $ 4,928,320 $ 5,176,810
============ ==========
Net interest income $ 53,864 $ 45,895
========= ======
Net interest spread (2) 5.59% 4.47%
===== ====
Net yield on 5.25% 4.17%
=====
interest-earning assets (3) =====
Interest-earning assets to interest-bearing liabilities 92.32% 93.57%
====== =====
</TABLE>
__________________________________________________
(1) Includes loans held for sale and/or securitization. Interest on non-
accruing loans has been included only to the extent reflected in the
Condensed Consolidated Statements of Operations; however, the loan balance
is included in the average amount outstanding until transferred to real
estate acquired in settlement of loans.
(2) Equals weighted average yield on total interest-earning assets less
weighted average rate on total interest-bearing liabilities.
(3) Equals annualized net interest income divided by the average balances of
total interest-earning assets.
-29-
<PAGE>
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.
-30-
<PAGE>
VOLUME AND RATE CHANGES IN NET INTEREST INCOME
----------------------------------------------
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended June 30, 1996
Compared to
Three Months Ended June 30, 1995
Increase (Decrease)
Due to Change in (1)
--------------------------------------
Total
Volume Rate Change
----------- --------- ----------
<S> <C> <C> <C>
Interest income:
Loans (2) $ (37,332) $ 40,164 $ 2,832
Mortgage-backed securities (3,242) (494) (3,736)
Securities purchased under agreements
to resell and federal funds sold 2,944 (670) 2,274
Trading securities 276 (71) 205
Investment securities 14 11 25
Other interest-earning assets 487 6 493
----------- --------- ----------
Total interest income (36,853) 38,946 2,093
----------- --------- ----------
Interest expense:
Deposit accounts 4,666 (4,391) 275
Borrowings (13,255) 7,104 (6,151)
----------- --------- ----------
Total interest expense (8,589) 2,713 (5,876)
----------- --------- ----------
Increase (decrease) in
net interest income $ (28,264) $ 36,233 $ 7,969
=========== ========= ==========
</TABLE>
- --------------------------------------------------------------------------------
(1) The net change attributable to the combined impact of volume and rate has
been allocated in proportion to the absolute value of the change due to
volume and the change due to rate.
(2) Includes loans held for sale and/or securitization.
-31-
<PAGE>
Interest income in the 1996 quarter increased $2.1 million or (2.2%) from the
level in the 1995 quarter primarily as a result of higher average yields earned
by the Bank on its loan portfolio. Higher average balances of securities
purchased under agreements to resell and federal funds sold also contributed to
the increase in interest income. Lower average balances of loans receivable and
mortgage-backed securities partially offset the effect on interest income of the
higher average yields and higher average balances.
The Bank's net yield on interest-earning assets increased to 5.25% in the 1996
quarter from 4.17% in the 1995 quarter. The increase primarily reflected the
upward adjustment of interest rates on certain of the Bank's adjustable-rate
products to reflect the expiration of introductory rates on certain products and
higher yields on credit card and automobile loans.
Interest income on loans, the largest category of interest-earning assets,
increased by $2.8 million (or 3.6%) from the 1995 quarter primarily because of
higher average yields.
The average yield on the loan portfolio in the 1996 quarter increased by 148
basis points (to 11.27% from 9.79%) from the average yield in the 1995 quarter
which contributed to a $40.2 million increase in interest income earned on
loans, shown in the table above. The higher yields were primarily due to
increases in the average yield on credit card loans from 15.41% to 19.92% and on
automobile loans from 6.78% to 11.63%. The increase in the average yield on
credit card loans was primarily a result of the expiration of promotional
introductory rates and the increase in the average yield on automobile loans was
primarily due to higher yielding nonprime loans originated by one of the Bank's
operating subsidiaries.
Lower average balances on the loan portfolio, which partially offset the effect
of the higher average yields, contributed to a decline of $37.4 million in
interest income earned on loans, shown in the table above. Average balances of
credit card receivables, automobile loans, and home equity credit line loans
decreased $237.4 million (or 20.6%), $117.1 million (or 33.8%) and $43.1 million
(or 33.0%), respectively, from the 1995 quarter as a result of the increased
securitization and sale activity by the Bank over the preceding twelve month
period. Higher average balances of consumer loans other than automobile loans,
principally home improvement loans, partially offset the lower average balances
discussed above. An increase of $96.5 million (or 89.9%) in the average
balances of other consumer loans, due largely to an increase in the origination
volume of home improvement loans, resulted in an increase of $2.8 million (or
82.2%) in interest income from these assets.
Interest income on mortgage-backed securities decreased $3.7 million (or 24.6%)
primarily because of lower average balances. The reduced mortgage-backed
securities balances in the 1996 quarter reflected the effects of scheduled
principal paydowns and unscheduled principal prepayments which was partially
offset by the purchase of $135.1 million of mortgage-backed securities in the
1996 quarter.
-32-
<PAGE>
Other interest income increased $2.8 million (or 140.3%) in the 1996 quarter
primarily as a result of higher average balances on securities purchased under
agreements to resell and federal funds sold which increased $178.5 million (or
340.6%), and, to a lesser extent, higher average balances and higher average
yields on other interest-earning assets.
Interest expense decreased $5.9 million (or 11.5%) for the 1996 quarter
primarily because of a decrease of $392.6 million (or 57.3%) in the average
balances of the Bank's borrowings. The decline in the average balances of
borrowings resulted in a decrease of $6.2 million in interest expense for the
1996 quarter for such liabilities. The decrease in interest paid on borrowings
is primarily due to a $4.5 million and a $1.3 million decrease in interest
expense on securities sold under repurchase agreements and Federal Home Loan
Bank advances, respectively, resulting from lower average balances of such
borrowings. The positive effect of the lower average balances was partially
offset by an increase in the average borrowing rate (to 7.47% from 6.78%).
The decrease in interest expense on borrowings was partially offset by a $0.3
million increase in interest expense on deposits, the largest category of
interest-bearing liabilities. A $4.7 million increase in interest expense on
deposits, shown in the table above and primarily due to higher average balances
of such deposits, was partially offset by a $4.4 million decrease in interest
expense on deposits, shown in the table above, as a result of a decline in the
average rates on deposits (to 3.85% from 3.95%).
PROVISION FOR LOAN LOSSES. The Bank's provision for loan losses increased to
$30.1 million in the 1996 quarter from $13.6 million in the 1995 quarter. The
$16.5 million increase was primarily attributable to increases of $9.7 million
in the provision for losses on credit card loans, $1.0 million in the provision
for losses on consumer loans and the establishment of a $6.0 million unallocated
provision for losses on loans. These increases were partially offset by a $0.2
million decrease in the provision for losses on real estate loans. The higher
provisions on credit card and consumer loans resulted from increased charge-offs
of such loans over the prior quarter and an increase in the reserve percentages
to reflect this recent trend. See "Financial Condition - Asset Quality -
Allowances for Losses."
OTHER INCOME. The increase in other (non-interest) income to $96.9 million in
the 1996 quarter from $68.1 million in the 1995 quarter was primarily
attributable to increases in credit card fees, loan and deposit ser vicing
fees, gain on sales of loans and other income. The positive effect of these
items on other income was partially offset by an increase in loss on real estate
held for investment or sale.
Credit card fees, consisting primarily of membership fees, late charges, cash
advance charges and overlimit fees increased to $7.9 million in the 1996 quarter
from $2.5 million in the 1995 quarter. The $5.4 million (or 215.3%) increase
was primarily attributable to the impact of recent changes in the fee structure
for the Bank's credit card program.
An increase of $13.3 million in excess spread income and $5.1 million of
servicing fees earned by the Bank for servicing its portfolios of securitized
credit card loans contributed to an increase of $19.8 million (or 34.1%) in loan
and deposit servicing fees. Such excess spread income 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 $1.6
million increase in mortgage loan servicing fee income resulting from the
acquisition of servicing rights and
-33-
<PAGE>
retention of servicing rights related to loans sold as part of the Bank's
mortgage banking operations.
Gain on sales of loans increased $7.4 million primarily as a result of a $2.7
million and a $9.5 million gain on the securitization and sale of $227.7 million
of automobile loans and $153.5 million of home loans in the 1996 quarter,
respectively, compared to a $4.0 million gain on the securitization and sale of
$252.2 million of automobile loans in the 1995 quarter.
Other income increased $6.7 million primarily because of the establishment of a
valuation allowance on an office building, which offset other income, during the
1995 quarter. A $6.2 million valuation allowance, previously established as an
allowance against an REI property, was transferred with such property to
property and equipment.
The $11.0 million increase in loss on real estate held for investment or sale
was primarily attributable to a decrease of $5.6 million in the gain recorded on
sales of the Bank's REO properties, an increase of $5.0 million in the provision
for losses on such assets and a decrease of $0.4 million in the operating income
generated by the REO properties. See "Financial Condition - Asset Quality -
Allowance for Losses."
OPERATING EXPENSES. Operating expenses for the 1996 quarter increased $12.6
million (or 16.4%) from the level in the 1995 quarter, largely as a result of
the Bank's credit card lending program. The main components of the higher
operating expenses were increases in salaries and employee benefits, loan and
marketing expenses. The $4.5 million increase in salaries and employee benefits
resulted primarily from the addition of staff to the Bank's credit card,
consumer lending and branch operations. The $3.5 million increase in loan
expenses was primarily attributable to an increase in the amortization of
capitalized mortgage servicing rights, which resulted from acquisitions of
single-family residential mortgage servicing rights in recent periods, and a
$1.1 million valuation allowance against its mortgage servicing rights recorded
during the 1996 quarter. The $2.8 million increase in marketing expenses was
principally attributable to a $2.1 million increase in marketing expenses
associated with the credit card portfolio as the Bank continues to focus on
increased originations of such loans.
-34-
<PAGE>
RESULTS OF OPERATIONS
NINE MONTHS ENDED JUNE 30, 1996 COMPARED TO NINE MONTHS ENDED JUNE 30, 1995
OVERVIEW. The Bank recorded pre-tax income of $67.6 million and net income of
$39.8 million for the nine months ended June 30, 1996 (the "1996 period"),
compared to pre-tax income of $41.4 million and net income of $27.9 million for
the nine months ended June 30, 1995 (the "1995 period"). The increase in income
for the 1996 period was primarily attributable to a $75.9 million increase in
other (non-interest) income resulting primarily from an increase in loan and
deposit servicing fees and a $14.2 million increase in net interest income
before the provision for loan losses. These increases were partially offset by
a $38.7 million increase in operating expenses and a $35.0 million increase in
the provision for loan losses.
NET INTEREST INCOME. Net interest income, before the provision for loan losses,
increased $14.2 million (or 10.9%) in the 1996 period. The Bank would have
recorded interest income of $6.1 million for the 1996 period if the Bank's non-
accrual assets and restructured loans had been current in accordance with their
original terms. Interest income of $0.7 million was actually recorded on non-
accrual assets and restructured loans for the 1996 period. 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.
-35-
<PAGE>
NET INTEREST MARGIN ANALYSIS
----------------------------
(DOLLARS IN THOUSANDS)
================================================================================
<TABLE>
<CAPTION>
Nine Months Ended June 30,
------------------------------------------------------------------------
1996 1995
---------------------------------- ------------------------------------
Average Yield/ Average Yield/
Balances Interest Rate Balances Interest Rate
------------ ----------- ------- ------------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans receivable, net (1) $ 2,875,952 $ 231,571 10.74% $ 2,992,253 $ 216,720 9.66%
Mortgage-backed securities 803,789 36,966 6.13 1,002,104 46,257 6.15
Securities purchased under agreements
to resell and federal funds sold 221,557 9,144 5.50 60,974 2,590 5.66
Trading securities 12,367 640 6.90 3,597 220 8.15
Investment securities 4,782 171 4.77 4,401 146 4.42
Other interest-earning assets 166,874 5,637 4.50 123,730 4,293 4.63
------------ ----------- ------------- ----------
Total 4,085,321 284,129 9.27 4,187,059 270,226 8.61
----------- ------- ---------- -------
Noninterest-earning assets:
Cash 160,496 128,581
Real estate held for investment or sale 169,164 310,757
Property and equipment, net 188,078 146,390
Cost in excess of net assets acquired, net 43,148 47,216
Other assets 240,153 146,209
------------ ------------
Total assets $ 4,886,360 $ 4,966,212
============ ============
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits $ 914,928 17,781 2.59 $ 874,404 17,756 2.71
Savings deposits 939,103 23,758 3.37 1,081,504 27,063 3.34
Time deposits 1,279,248 53,172 5.54 942,173 34,920 4.94
Money market deposits 985,186 28,622 3.87 1,095,108 32,518 3.96
------------ ----------- ------------- ----------
Total deposits 4,118,465 123,333 3.99 3,993,189 112,257 3.75
Borrowings 306,371 17,137 7.46 548,146 28,480 6.93
------------ ----------- ------------- ----------
Total 4,424,836 140,470 4.23 4,541,335 140,737 4.13
----------- ------- ---------- -------
Noninterest-bearing items:
Noninterest-bearing deposits 71,332 70,973
Other liabilities 55,699 60,620
Stockholders' equity 334,493 293,284
------------ ------------
Total liabilities and stockholders'
equity $ 4,886,360 $ 4,966,212
============ ============
Net interest income $ 143,659 $ 129,489
=========== ==========
Net interest spread (2) 5.04% 4.48%
======= =======
Net yield on interest-earning assets (3) 4.69% 4.12%
======= =======
Interest-earning assets to interest-bearing
liabilities 92.33% 92.20%
======= =======
</TABLE>
- --------------------------------------------------------------------------------
(1) Includes loans held for sale and/or securitization. Interest on non-
accruing loans has been included only to the extent reflected in the
Condensed Consolidated Statements of Operations; however, the loan balance
is included in the average amount outstanding until transferred to real
estate acquired in settlement of loans.
(2) Equals weighted average yield on total interest-earning assets less
weighted average rate on total interest-bearing liabilities.
(3) Equals annualized net interest income divided by the average balances of
total interest-earning assets.
-36-
<PAGE>
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.
-37-
<PAGE>
VOLUME AND RATE CHANGES IN NET INTEREST INCOME
----------------------------------------------
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended June 30, 1996
Compared to
Nine Months Ended June 30, 1995
Increase (Decrease)
Due to Change in (1)
---------------------------------------------------
Total
Volume Rate Change
------------ --------- ------------
<S> <C> <C> <C>
Interest income:
Loans (2) $ (12,842) $ 27,693 $ 14,851
Mortgage-backed securities (9,141) (150) (9,291)
Securities purchased under agreements
to resell and federal funds sold 6,677 (123) 6,554
Trading securities 480 (60) 420
Investment securities 13 12 25
Other interest-earning assets 1,542 (198) 1,344
------------- ------------ ------------
Total interest income (13,271) 27,174 13,903
------------- ------------ ------------
Interest expense:
Deposit accounts 3,643 7,433 11,076
Borrowings (14,619) 3,276 (11,343)
------------- ------------ ------------
Total interest expense (10,976) 10,709 (267)
------------- ------------ ------------
Increase (decrease) in
net interest income $ (2,295) $ 16,465 $ 14,170
============= ============ ============
</TABLE>
- --------------------------------------------------------------------------------
(1) The net change attributable to the combined impact of volume and rate has
been allocated in proportion to the absolute value of the change due to
volume and the change due to rate.
(2) Includes loans held for sale and/or securitization.
-38-
<PAGE>
Interest income in the 1996 period increased $13.9 million (or 5.1%) from the
level in the 1995 period primarily as a result of higher average yields earned
by the Bank on its loan portfolio. Higher average balances of securities
purchased under agreements to resell and federal funds sold also contributed to
the increase in interest income. The effect on interest income of higher
average yields and higher average balances was offset in part by lower average
balances of loans receivable and mortgage-backed securities.
The Bank's net yield on interest-earning assets increased to 4.69% in the 1996
period from 4.12% in the 1995 period. The increase primarily reflected the
upward adjustment of interest rates on certain of the Bank's adjustable-rate
products to reflect the expiration of introductory rates on certain products
(principally credit card loans) and higher yields on other consumer loans. The
positive effect of the increase on the Bank's net yield was offset in part by
increased interest rates on the Bank's interest-bearing liabilities.
Interest income on loans, the largest category of interest-earning assets,
increased by $14.9 million (or 6.9%) from the 1995 period primarily because of
higher average yields on the loan portfolio, which were partially offset by
lower average balances. The average yield on the loan portfolio in the 1996
period increased by 108 basis points (to 10.74% from 9.66%) from the average
yield in the 1995 period. The higher yields were primarily due to increases in
the average yield on credit card loans from 14.81% to 18.23% and on automobile
loans from 7.35% to 11.02%. The increase in the yield on credit card loans was
primarily a result of the expiration of promotional introductory rates and was
primarily responsible for a $23.3 million (or 21.2%) increase in interest income
from credit card receivables. The increase in the yield on automobile loans was
primarily due to higher yields earned on loans originated by one of the Bank's
operating subsidiaries. Higher average balances of consumer loans other than
automobile loans, which increased $102.8 million (or 115.6%), also contributed
to the increase in interest income on loans. The increased average balances of
other consumer loans resulted primarily from the higher origination volume of
home improvement loans during the 1996 period, and was largely responsible for a
$9.4 million (or 113.3%) increase in interest income on other consumer loans.
The effect on interest income of higher average yields and higher average
balances of certain consumer loans was offset in part by a $139.3 million
decrease in the average balances of automobile loan receivables due to the
securitization and sale of such loans in the amount of $247.6 million and $227.7
million in the December 1995 quarter and the June 1996 quarter, respectively.
Interest income on real estate loans decreased $2.3 million primarily as a
result of a $55.3 million decrease in the average balances of such loans, which
was partially offset by an increase in the average yield to 7.31% from 7.25%.
Interest income on mortgage-backed securities decreased $9.3 million (or 20.1%)
primarily because of lower average balances. The reduced mortgage-backed
securities balances in the 1996 period reflected the effects of scheduled
principal paydowns and unscheduled principal prepayments. The negative effect
of the lower average balances was compounded by a decrease in the average
interest rates on these securities to 6.13% from 6.15%.
-39-
<PAGE>
Other interest income increased $7.9 million (or 114.8%) in the 1996 period
primarily as a result of higher average balances on securities purchased under
agreements to resell and federal funds sold which increased by $160.6 million
(or 263.4%) and, to a lesser extent, higher average balances on other interest-
earning assets. Higher average yields on such interest-earning assets also
contributed to the increased interest income for the current period.
Interest expense decreased $0.3 million for the 1996 period primarily because of
a decrease of $241.8 million (or 44.1%) in the average balances of the Bank's
borrowings, which resulted in an $11.3 million decrease in interest expense for
the 1996 period for such liabilities. The decrease in interest expense on
borrowings is primarily a result of an $8.2 million, a $1.7 million and a $1.3
million decrease in interest expense on securities sold under repurchase
agreements, Federal Home Loan Bank ("FHLB") advances and bonds payable,
respectively. The decrease in interest expense on securities sold under
repurchase agreements was primarily a result of a $186.3 million decrease in the
average balances of such liabilities as the Bank's deposit base has increased in
recent periods. A $33.5 million decline in the average balances of FHLB
advances contributed to the $1.7 million decrease in the interest expense on
such liabilities. The decrease in interest expense on bonds payable was due to
the assumption of bonds payable in April 1995 by the purchaser of two
residential apartment buildings that were securing the bonds. The positive
effect of such lower average balances was offset in part by an increase in the
average borrowing rate (to 7.46% from 6.93%).
The decrease in interest expense on borrowings was partially offset by an $11.1
million increase in interest expense on deposits, the largest category of
interest-bearing liabilities. Interest expense on deposits increased primarily
as a result of an increase in average rates (to 3.99% from 3.75%), which
reflected a shift in the composition of the Bank's deposits to higher yielding
certificates of deposit and, to a lesser extent, an increase in average deposit
balances of $125.3 million.
PROVISION FOR LOAN LOSSES. The Bank's provision for loan losses increased to
$70.8 million in the 1996 period from $35.8 million in the 1995 period. The
$35.0 million increase was primarily attributable to increases of $26.1 million
in the provision for losses on credit card loans, $0.5 million in the provision
for losses real estate loans, $2.4 million in the provision for losses on other
consumer loans and the establishment of a $6.0 million unallocated provision for
losses on loans. The higher provisions on credit card and other consumer loans
resulted from increased origination volume and increased charge-offs of such
loans over the prior period and increased reserve percentages to reflect this
recent trend. See "Financial Condition - Asset Quality - Allowances for
Losses."
OTHER INCOME. The increase in other (non-interest) income to $252.5 million in
the 1996 period from $166.7 million in the 1995 period was primarily
attributable to increases in credit card fees, loan and deposit servicing fees,
gain on sales of loans and other income. The positive effect of these items on
other income was partially offset by an increase in loss on real estate held for
investment or sale.
Credit card fees, consisting primarily of membership fees, late charges, cash
advance charges and overlimit fees, increased to $18.7 million in the 1996
period from $9.2 million in the 1995 period. The $9.5 million (or 103.1%)
increase was primarily attributable to the initial impact of recent changes in
the fee structure for the Bank's credit card program.
-40-
<PAGE>
An increase of $49.9 million in excess spread income and $17.6 million of
servicing fees earned by the Bank for servicing its portfolios of securitized
credit card loans contributed to an increase of $75.9 million (or 52.3%) in loan
and deposit servicing fees. Such excess spread income 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 $3.6
million increase in mortgage loan servicing fee income as the Bank increased the
size of its loan servicing portfolio.
Gain on sales of loans increased by $12.4 million primarily from gains of $7.3
million and $9.5 million on the securitization and sale of $475.3 million of
automobile loan receivables and $153.5 million of home loan receivables,
respectively, during the 1996 period.
Other income increased $8.6 million primarily because of the establishment of a
valuation allowance on an office building which offset other income during the
1995 period. A $6.2 million valuation allowance, previously established as an
allowance against an REI property, was transferred with such property to
property and equipment.
The $22.2 million increase in loss on real estate held for investment or sale
was primarily attributable to a decrease of $4.5 million in the equity earnings
in partnership income, a decrease of $11.2 million in the gain recorded on sales
of the Bank's REO properties, a decrease of $2.4 million in the operating income
generated by the REO properties, and an increase of $4.1 million in the
provision for losses on such assets. See "Financial Condition - Asset Quality -
Allowance for Losses."
OPERATING EXPENSES. Operating expenses for the 1996 period increased $38.7
million (or 17.7%) from the level in the 1995 period, largely as a result of the
continued expansion of the Bank's credit card lending program. The main
components of the higher operating expenses were increases in salaries and
employee benefits, loan, data processing and other operating expenses. The
$14.6 million increase in salaries and employee benefits resulted primarily from
the addition of staff to the Bank's credit card, consumer lending and branch
operations. The $9.5 million increase in loan expenses was primarily
attributable to an increase in the amortization of capitalized mortgage
servicing rights, which resulted from acquisitions of single-family residential
mortgage servicing rights in recent periods, and a $1.8 million valuation
allowance against mortgage servicing rights. The $5.6 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 the 1996 period. The $4.8 million increase in other operating expenses
resulted primarily from an increases in credit card fraud losses,
telecommunications expenses and other expenses recorded during the current
period. During the 1996 period, management changed its policy regarding the
recognition of fraud losses, which had the effect of increasing such losses by
$3.6 million.
-41-
<PAGE>
PART II. OTHER INFORMATION
ITEM 6A. EXHIBITS
Exhibits required by Item 601 of Regulation S-K are set forth below.
<TABLE>
<CAPTION>
Exhibit
No. Exhibit
- ------- -------
<S> <C>
11 Computation of Earnings Per Share Included in Part I, Item 1 of
this report
</TABLE>
-42-
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 563g.18 of the Rules and Regulations for
Savings Associations, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
CHEVY CHASE BANK, F.S.B.
August 8, 1996 By: /s/ ALEXANDER R. M. BOYLE
------------------------------
Alexander R. M. Boyle
Vice Chairman of the Board
August 8, 1996 By: /s/ STEPHEN R. HALPIN, JR.
----------------------------------
Stephen R. Halpin, Jr.
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
August 8, 1996 By: /s/ JOEL A. FRIEDMAN
------------------------------------
Joel A. Friedman
Senior Vice President and Controller
(Principal Accounting Officer)
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES OTHER THAN THE SECURITIES TO WHICH IT RELATES OR AN OFFER TO SELL
OR A SOLICITATION OF AN OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN
WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE FACTS SET FORTH IN THIS
PROSPECTUS OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary......................................................... 1
Risk Factors............................................................... 9
The Company................................................................ 16
Use of Proceeds............................................................ 17
Capitalization............................................................. 18
Business and Strategy...................................................... 19
Management................................................................. 33
Certain Transactions Constituting the Formation............................ 36
Description of Series A Preferred Shares................................... 39
Description of Capital Stock............................................... 44
Federal Income Tax Considerations.......................................... 47
ERISA Considerations....................................................... 56
Certain Information Regarding the Bank..................................... 58
Underwriting............................................................... 72
Experts.................................................................... 73
Ratings.................................................................... 73
Certain Legal Matters...................................................... 73
Available Information...................................................... 73
Glossary................................................................... 74
Financial Statement........................................................ F-1
Annex I--Offering Circular for Bank
Preferred Shares.......................................................... OC-1
</TABLE>
----------------
THROUGH AND INCLUDING , 1996 (THE 25TH DAY AFTER THE COMMENCEMENT OF THE
OFFERING), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES,
WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER
A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
3,000,000 SHARES
CHEVY CHASE PREFERRED CAPITAL CORPORATION
% NONCUMULATIVE
EXCHANGEABLE
PREFERRED STOCK, SERIES A
(LIQUIDATION PREFERENCE $50.00 PER SHARE)
EXCHANGEABLE INTO PREFERRED STOCK
OF
CHEVY CHASE BANK, F.S.B.
----------------
PROSPECTUS
----------------
MERRILL LYNCH & CO.
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
SMITH BARNEY INC.
, 1996
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II. INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 30. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
<TABLE>
<S> <C>
Registration Fee............................................ $ 45,455
NYSE Listing Fee............................................ $ *
Printing and Engraving Expenses............................. $ 75,000
Legal Fees and Expenses..................................... $ *
Accounting Fees and Expenses................................ $ 50,000
Rating Agency Fees..........................................
Blue Sky Fees and Expenses.................................. $ 20,000
Financial Advisory Fee...................................... $ *
Miscellaneous............................................... $ *
-----------
Total................................................... $375,000.00
===========
</TABLE>
- --------
* To be completed by amendment.
ITEM 31. SALES TO SPECIAL PARTIES.
See response to Item 32 below.
ITEM 32. RECENT SALES OF UNREGISTERED SECURITIES.
In connection with the formation of the Company, the Company has issued 100
shares of Common Stock, par value $1.00 per share, to Chevy Chase Bank, F.S.B.
for $1,000. The description of these transactions in the Prospectus under the
heading "Certain Transactions Constituting The Formation" is incorporated
herein by reference. These shares of Common Stock were issued in reliance upon
the exemption from registration under Section 4(2) of the Securities Act.
ITEM 33. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Company's Articles of Incorporation provide that the liability of the
directors and officers of the Company for money damages shall be eliminated to
the maximum extent permitted by Maryland law. Under current Maryland law, the
directors are liable to the Company or its stockholders for money damages only
for liability resulting from (i) acts or omissions committed in bad faith
involving active and deliberate dishonesty established by a final judgment or
(ii) actual receipt of an improper benefit or profit in money, property or
services. The Articles of Incorporation also provide that no amendment thereto
may limit or eliminate this limitation of liability with respect to events
occurring prior to the effective date of such amendment. The Company's
Articles of Incorporation and Bylaws require it to indemnify its directors and
officers to the fullest extent permitted by Maryland law. Under current
Maryland law, the Company will indemnify (a) any director or officer who has
been successful, on the merits or otherwise, in the defense of a proceeding to
which he was made a party by reason of his service in that capacity, against
reasonable expense incurred by him in connection with the proceeding and (b)
any present or former director or officer against any claim or liability
unless it is established that (i) his act or omission was committed in bad
faith or was the result of active and deliberate dishonesty; (ii) he actually
received an improper personal benefit in money, property or services; or (iii)
in the case of a criminal proceeding, he had reasonable cause to believe that
his act or omission was unlawful. In addition, the Company's Bylaws require it
to pay or reimburse, in advance of the final disposition of a proceeding,
reasonable expenses incurred by a present or former director or officer made a
party to a proceeding by reason of his status as a director or officer,
provided that the Company shall have received (i) a written affirmation by the
director or officer of his good faith belief that he has met the standard of
conduct necessary for indemnification by the Company as authorized by the
Bylaws and (ii) a written undertaking by or on his behalf to repay the amount
paid or reimbursed by the Company if it shall ultimately be determined that
the standard of conduct was not met. The Company's Bylaws also (i) permit the
Company to provide indemnification, payment or reimbursement of expenses to
any employee or agent of the Company in such
II-1
<PAGE>
capacity; (ii) provide that any indemnification, payment or reimbursement of
the expenses permitted by the Bylaws shall be furnished in accordance with the
procedures provided for indemnification and payment or reimbursement of
expenses under Section 2-418 of the MGCL for directors of Maryland
corporations; and (iii) permit the Company to provide such other and further
indemnification or payment or reimbursement of expenses as may be permitted by
the MGCL for directors of Maryland corporations.
The Company expects to purchase an insurance policy that purports to insure
officers and directors of the Company against certain liabilities incurred by
them in the discharge of their official functions.
The Underwriting Agreement to be filed as Exhibit 1 to this Registration
Statement will provide for reciprocal indemnification by the Underwriters of
the Company, the Bank and its directors, officers and controlling persons, and
by the Company and the Bank of the Underwriters, and their respective
directors, officers and controlling persons, against certain liabilities under
the Securities Act.
ITEM 34. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
ITEM 35. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements
Not applicable.
(b) Exhibits
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<C> <S>
--Form of Underwriting Agreement between the Company, the Bank
1 and the Underwriters
3(a)(i)* --Articles of Incorporation of the Company
3(a)(ii) --Form of Articles of Amendment and Restatement of the Company
--Form of Articles Supplementary establishing the Series A
3(a)(iii) Preferred Shares
3(b) --Bylaws of the Company
--Specimen of certificate representing Series A Preferred
4** Shares
5 --Form of Opinion of Shaw, Pittman, Potts & Trowbridge, counsel
to the Company, relating to Series A Preferred Shares
8 --Form of Opinion of Shaw, Pittman, Potts & Trowbridge, counsel
to the Company, relating to certain tax matters
10(a) --Form of Residential Mortgage Loan Purchase Agreement
10(b) --Form of Mortgage Loan Servicing Agreement
10(c) --Form of Advisory Agreement between the Company and the Bank
--Consent of Arthur Andersen LLP with respect to the Bank's
23(a)* Financial Statements
--Consent of Shaw, Pittman, Potts & Trowbridge (included in
23(b) Exhibit 5)
--Consent of Arthur Andersen LLP with respect to the Company's
23(c) Financial Statements
--Power of Attorney (included on the signature page to this
24 Registration Statement)
99(a) --Consent of John J. O'Connor III
99(b) --Consent of N. Alexander MacColl, Jr.
</TABLE>
- --------
* Previously filed
** To be filed by amendment
II-2
<PAGE>
ITEM 36. UNDERTAKINGS.
The undersigned Registrant hereby undertakes to provide to the Underwriters,
at the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Act") may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the provisions described
under Item 33 above, or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred or
paid by a director, officer, or controlling person of the Registrant in the
successful defense of any action, suit or proceeding), is asserted by such
director, officer, or controlling person in connection with the securities
registered, the registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the
final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Act, the
information omitted from the form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in the form
of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Act, each
post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration Statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
CERTIFIES THAT IT HAS REASONABLE GROUNDS TO BELIEVE THAT IT MEETS ALL OF THE
REQUIREMENTS FOR FILING ON FORM S-11 AND HAS DULY CAUSED THIS REGISTRATION
STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY
AUTHORIZED, IN CHEVY CHASE, MARYLAND, ON NOVEMBER 14, 1996.
Chevy Chase Preferred Capital
Corporation (Issuer)
/s/ B. Francis Saul II
By: _________________________________
B. Francis Saul II
Chairman of the Board, President
and Chief Executive Officer
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Stephen R. Halpin, Jr. and Alexander R. M.
Boyle, and each of them, his true and lawful attorney-in-fact and agents, with
full power of substitution and resubstitution, for and in his name, place and
stead, in any and all capacities to sign any or all amendments (including
post-effective amendments) to this Registration Statement and any or all other
documents in connection therewith, and to file the same, with all exhibits
thereto, with the Securities and Exchange Commission granting unto said
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as might or could be done in person, hereby ratifying and confirming
all said attorneys-in-fact and agents or any of them, or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED ON NOVEMBER 14, 1996 BY THE FOLLOWING
PERSONS IN THE CAPACITIES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE
<S> <C>
Director
/s/ Alexander R. M. Boyle
- -------------------------------------
ALEXANDER R. M. BOYLE
Senior Vice
/s/ Joel A. Friedman President and
- ------------------------------------- Controller
JOEL A. FRIEDMAN (Principal
Accounting Officer)
Executive Vice
/s/ Stephen R. Halpin, Jr. President, Chief
- ------------------------------------- Financial Officer,
STEPHEN R. HALPIN, JR. Treasurer and
Director (Principal
Financial Officer)
Executive Vice
/s/ Leslie A. Nicholson President, General
- ------------------------------------- Counsel and
LESLIE A. NICHOLSON Director
/s/ B. Francis Saul II Chairman of the
- ------------------------------------- Board and President
B. FRANCIS SAUL II and Chief Executive
Officer (Principal
Executive Officer)
</TABLE>
II-4
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<C> <S>
--Form of Underwriting Agreement between the Company, the Bank
1 and the Underwriters
3(a)(i)* --Articles of Incorporation of the Company
3(a)(ii) --Form of Articles of Amendment and Restatement of the Company
--Form of Articles Supplementary establishing the Series A
3(a)(iii) Preferred Shares
3(b) --Bylaws of the Company
--Specimen of certificate representing Series A Preferred
4** Shares
5 --Form of opinion of Shaw, Pittman, Potts & Trowbridge, counsel
to the Company, relating to Series A Preferred Shares
8 --Form of opinion of Shaw, Pittman, Potts & Trowbridge, counsel
to the Company, relating to certain tax matters
10(a) --Form of Residential Mortgage Loan Purchase Agreement
10(b) --Form of Mortgage Loan Servicing Agreement
10(c) --Form of Advisory Agreement between the Company and the Bank
--Consent of Arthur Andersen LLP with respect to the Bank's
23(a)* Financial Statements
--Consent of Shaw, Pittman, Potts & Trowbridge (included in
23(b) Exhibit 5)
--Consent of Arthur Andersen LLP with respect to the Company's
23(c) Financial Statements
--Power of Attorney (included on the signature page to this
24 Registration Statement)
99(a) --Consent of John J. O'Connor III
99(b) --Consent of N. Alexander MacColl, Jr.
</TABLE>
- --------
* Previously filed
** To be filed by amendment
II-5
<PAGE>
Exhibit 1
Draft of November 13, 1996
CHEVY CHASE PREFERRED CAPITAL CORPORATION
(a Maryland corporation)
3,000,000 Shares
% Noncumulative Exchangeable Preferred Stock, Series A
---
PURCHASE AGREEMENT
------------------
November , 1996
--
MERRILL LYNCH & CO.
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
SMITH BARNEY INC.
as Representatives of the several Underwriters
c/o Merrill Lynch & Co.
Merrill Lynch, Pierce, Fenner & Smith
Incorporated
North Tower
World Financial Center
New York, New York 10281-1209
Ladies and Gentlemen:
Chevy Chase Preferred Capital Corporation, a Maryland corporation (the
"Company"), and Chevy Chase Bank, F.S.B., a federally chartered and federally
insured stock savings bank (the "Bank"), hereby confirm their agreement with
Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch") and each of the other Underwriters named in Schedule A hereto
(collectively, the "Underwriters," which term shall also include any underwriter
substituted as hereinafter provided in Section 10 hereof), for whom Merrill
Lynch, Friedman, Billings, Ramsey & Co., Inc. and Smith Barney Inc. are acting
as representatives (in such capacity, the "Representatives"), with respect to
the issue and sale by the Company and the purchase by the Underwriters, acting
severally and not jointly, of the respective numbers of shares of the Company's
__% Noncumulative Exchangeable Preferred Stock, Series A (the "Series A
Preferred Shares") set forth in said Schedule A, and with respect to the grant
by the Company to the Underwriters, acting severally and not jointly, of the
option described in Section 2(b) hereof to purchase all or any part of 300,000
-------
additional shares of such preferred stock to cover over-allotments, if any. The
aforesaid
<PAGE>
3,000,000 shares of Series A Preferred Shares (the "Initial Securities") to be
purchased by the Underwriters and all or any part of the 300,000 shares of
Series A Preferred Shares subject to the option described in Section 2(b) hereof
(the "Option Securities") are hereinafter called, collectively, the
"Securities." Each share of the Series A Preferred Shares is exchangeable, on
the terms set forth in the certificate of designation for the Series A Preferred
Shares (the "Certificate of Designation"), into one share of the Bank's __%
Noncumulative Preferred Stock, Series B (the "Bank Preferred Shares").
The Company understands that the Underwriters propose to make a public
offering of the Securities as soon as the Representatives deem such offering
advisable after this Agreement has been executed and delivered.
The Company has filed with the Securities and Exchange Commission (the
"Commission") a registration statement on Form S-11 (No. 333-10495) covering the
registration of the Securities under the Securities Act of 1933, as amended (the
"1933 Act"), including the related preliminary prospectus or prospectuses.
Promptly after execution and delivery of this Agreement, the Company will either
(i) prepare and file a prospectus in accordance with the provisions of Rule 430A
("Rule 430A") of the rules and regulations of the Commission under the 1933 Act
(the "1933 Act Regulations") and paragraph (b) of Rule 424 ("Rule 424(b)") of
the 1933 Act Regulations or (ii) if the Company has elected to rely upon Rule
434 ("Rule 434") of the 1933 Act Regulations, prepare and file a term sheet (a
"Term Sheet") in accordance with the provisions of Rule 434 and Rule 424(b).
The information included in such prospectus or in such Term Sheet, as the case
may be, that was omitted from such registration statement at the time it became
effective but that is deemed to be part of such registration statement at the
time it became effective (a) pursuant to paragraph (b) of Rule 430A is referred
to as "Rule 430A Information" or (b) pursuant to paragraph (d) of Rule 434 is
referred to as "Rule 434 Information." Each prospectus used before such
registration statement became effective, and any prospectus that omitted, as
applicable, the Rule 430A Information or the Rule 434 Information, that was used
after such effectiveness and prior to the execution and delivery of this
Agreement, is herein called a "preliminary prospectus." Such registration
statement, including the exhibits thereto and schedules thereto at the time it
became effective and including the Rule 430A Information and the Rule 434
Information, as applicable, is herein called the "Registration Statement." Any
registration statement filed pursuant to Rule 462(b) of the 1933 Act Regulations
is herein referred to as the "Rule 462(b) Registration Statement," and after
such filing the term "Registration Statement" shall include the Rule 462(b)
Registration Statement. The final prospectus in the form first furnished to the
Underwriters for use in connection with the offering of the Securities is herein
called the "Prospectus." If Rule 434 is relied on, the term "Prospectus" shall
refer to the preliminary prospectus dated _____, 1996 together with the Term
Sheet and all references in this Agreement to the date of the Prospectus shall
mean the date of the Term Sheet. For purposes of this Agreement, all references
to the Registration Statement, any preliminary prospectus, the Prospectus or any
Term Sheet or any amendment or supplement to any of the foregoing shall be
deemed to include the copy filed with the Commission pursuant to its Electronic
Data Gathering, Analysis and Retrieval system ("EDGAR").
2
<PAGE>
The Bank has prepared and filed on October 3, 1996 with the Office of
Thrift Supervision (the "OTS") a preliminary offering circular under cover of
Form OC (Docket No. 08145), also filed with the Commission as an attachment to
the Registration Statement, for the registration of the Bank Preferred Shares
pursuant to 12 C.F.R. (S) 563g of the rules and regulations of the OTS (all of
the rules and regulations of the OTS set forth in Chapter V of Title 12 of the
Code of Federal Regulations, including, without limitation, 12 C.F.R. (S) 563g,
and the rules and regulations of the Commission made applicable to the offering
circular by the rules and regulations of the OTS, are hereinafter collectively
referred to as the "OTS Rules and Regulations"). The Bank will promptly prepare
and file an offering circular (which includes the information (the "Pricing
Information") excluded from the preliminary offering circular in reliance upon
12 C.F.R. S 563g.2(c)(2) of the OTS Rules and Regulations and 17 C.F.R. (S) 230-
430A of the 1933 Act Regulations) in accordance with the provisions of Rule
424(b). Each offering circular used before the time such offering circular is
declared effective by the OTS and any offering circular that omits the Pricing
Information that is used after such effectiveness and prior to the date hereof
is herein called a "preliminary offering circular." Such filing under cover of
Form OC, and the offering circular constituting a part thereof, as amended at
the time the offering circular becomes effective under the OTS Rules and
Regulations (and including the Pricing Information), including all documents
incorporated by reference therein, are hereinafter referred to as the "Form OC"
and the "Offering Circular," respectively, except that if any amended or
supplemented offering circular shall be provided to the Underwriters by the Bank
for use in connection with the offering of the Bank Preferred Shares which
differs from the Offering Circular at the time it becomes effective (whether or
not such revised offering circular is required to be filed by the Bank pursuant
to the Rules and Regulations (including Rule 424(b)), the term "Of fering
Circular" shall refer to such newly amended or supplemented offering circular
from and after the time it is first provided to the Underwriters for such use.
SECTION 1. Representations and Warranties.
------------------------------
(a) Representations and Warranties by the Company. The Company represents
and warrants to each Underwriter as of the date hereof, as of the Closing Time
referred to in Section 2(c) hereof, and as of each Date of Delivery (if any)
referred to in Section 2(b) hereof, and agrees with each Underwriter, as
follows:
(i) Compliance with Registration Requirements. Each of the
-----------------------------------------
Registration Statement and any Rule 462(b) Registration Statement has become
effective under the 1933 Act and no stop order suspending the effectiveness of
the Registration Statement or any Rule 462(b) Registration Statement has been
issued under the 1933 Act and no proceedings for that purpose have been
instituted or are pending or, to the knowledge of the Company, are contemplated
by the Commission, and any request on the part of the Commission for additional
information has been complied with.
At the respective times the Registration Statement, any Rule 462(b)
Registration Statement and any post-effective amendments thereto became
effective and at the Closing Time (and, if any Option Securities are purchased,
at the Date of Delivery), the Registration
3
<PAGE>
Statement, the Rule 462(b) Registration Statement and any amendments and
supplements thereto complied and will comply in all material respects with the
requirements of the 1933 Act and the 1933 Act Regulations and did not and will
not contain an untrue statement of a material fact or omit to state a material
fact required to be stated therein or necessary to make the statements therein
not misleading. Neither the Prospectus nor any amendments or supplements
thereto, at the time the Prospectus or any such amendment or supplement was
issued and at the Closing Time (and, if any Option Securities are purchased, at
the Date of Delivery), included or will include an untrue statement of a
material fact or omitted or will omit to state a material fact necessary in
order to make the statements therein, in the light of the circumstances under
which they were made, not misleading. If Rule 434 is used, the Company will
comply with the requirements of Rule 434 and the Prospectus shall not be
"materially different", as such term is used in Rule 434, from the prospectus
included in the Registration Statement at the time it became effective. The
representations and warranties in this subsection shall not apply to statements
in or omissions from the Registration Statement or Prospectus made in reliance
upon and in conformity with information furnished to the Company in writing by
any Underwriter through Merrill Lynch expressly for use in the Registration
Statement or Prospectus.
Each preliminary prospectus and the prospectus filed as part of the
Registration Statement as originally filed or as part of any amendment thereto,
or filed pursuant to Rule 424 under the 1933 Act, complied when so filed in all
material respects with the 1933 Act Regulations and each preliminary prospectus
and the Prospectus delivered to the Underwriters for use in connection with this
offering was identical to the electronically transmitted copies thereof filed
with the Commission pursuant to EDGAR, except to the extent permitted by
Regulation S-T.
(ii) Independent Accountants. Arthur Andersen LLP, the accountants
-----------------------
who certified the financial statements included in the Registration Statement,
are independent public accountants as required by the 1933 Act and the 1933 Act
Regulations.
(iii) No Material Adverse Change in Business. Since the respective
--------------------------------------
dates as of which information is given in the Registration Statement and the
Prospectus, except as otherwise stated therein, (A) there has been no material
adverse change in the condition, financial or otherwise, or in the earnings,
business affairs or business prospects of the Company, whether or not arising in
the ordinary course of business (a "Material Adverse Effect"), (B) there have
been no transactions entered into by the Company, other than those in the
ordinary course of business, which are material with respect to the Company, and
(C) there has been no dividend or distribution of any kind declared, paid or
made by the Company on any class of its capital stock.
(iv) Good Standing of the Company. The Company has been duly
----------------------------
organized and is validly existing as a corporation in good standing under the
laws of the State of Maryland and has corporate power and authority to own,
lease and operate its properties and to conduct
4
<PAGE>
its business as described in the Prospectus and to enter into and perform its
obligations under this Agreement; and the Company is duly qualified as a foreign
corporation to transact business and is in good standing in each other
jurisdiction in which such qualification is required, whether by reason of the
ownership or leasing of property or the conduct of business, except where the
failure so to qualify or to be in good standing would not result in a Material
Adverse Effect.
(v) No Subsidiaries. The Company has no subsidiaries.
---------------
(vi) Capitalization. The authorized, issued and outstanding capital
--------------
stock of the Company is as set forth in the Prospectus in the column entitled
"Actual" under the caption "Capitalization" (except for subsequent issuances, if
any, pursuant to this Agreement). The shares of issued and outstanding capital
stock of the Company have been duly authorized and validly issued and are fully
paid and non-assessable; none of the outstanding shares of capital stock of the
Company was issued in violation of the preemptive or other similar rights of any
securityholder of the Company.
(vii) Authorization of Agreement. This Agreement has been duly
--------------------------
authorized, executed and delivered by the Company.
(viii) Authorization and Description of Common Stock. The common
---------------------------------------------
stock of the Company, par value $0.01 per share (the "Common Stock"), conforms
to all statements relating thereto contained or incorporated by reference in the
Prospectus and such description conforms to the rights set forth in the
instruments defining the same. All of the outstanding shares of Common Stock
have been duly authorized and validly issued, are fully paid and nonassessable,
and are owned by the Bank free and clear of any liens, charges or encumbrances.
(ix) Authorization and Description of Securities. The Securities
-------------------------------------------
have been duly authorized for issuance and sale to the Underwriters pursuant to
this Agreement and, when issued and delivered by the Company pursuant to this
Agreement against payment of the consideration set forth herein, will be validly
issued and fully paid and non-assessable; the Securities conform to the
statements relating thereto contained in the Prospectus and such description
conforms to the provisions of the Certificate of Designation; the relative
rights, preferences, interests and powers of the Securities are as set forth in
the Certificate of Designation relating thereto; no holder of the Securities
will be subject to personal liability by reason of being such a holder; and the
issuance of the Securities is not subject to the preemptive or other similar
rights of any securityholder of the Company.
(x) Absence of Defaults and Conflicts. The Company is not in
---------------------------------
violation of its charter or by-laws or in default in the performance or
observance of any obligation, agreement, covenant or condition contained in any
contract, indenture, mortgage, deed of trust, loan or credit agreement, note,
lease or other agreement or instrument to which the
5
<PAGE>
Company or any of its subsidiaries is a party or by which it or any of
them may be bound, or to which any of the property or assets of the Company is
subject (collectively, "Agreements and Instruments") except for such defaults
that would not result in a Material Adverse Effect; and the execution, delivery
and performance of this Agreement and the consummation of the transactions
contemplated herein and in the Registration Statement (including the issuance
and sale of the Securities and the use of the proceeds from the sale of the
Securities as described in the Prospectus under the caption "Use of Proceeds")
and compliance by the Company with its obligations hereunder have been duly
authorized by all necessary corporate action and do not and will not, whether
with or without the giving of notice or passage of time or both, conflict with
or constitute a breach of, or default or Repayment Event (as defined below)
under, or result in the creation or imposition of any lien, charge or
encumbrance upon any property or assets of the Company or any subsidiary
pursuant to, the Agreements and Instruments (except for such conflicts, breaches
or defaults or liens, charges or encumbrances that would not result in a
Material Adverse Effect), nor will such action result in any violation of the
provisions of the charter or by-laws of the Company or any subsidiary or any
applicable law, statute, rule, regulation, judgment, order, writ or decree of
any government, government instrumentality or court, domestic or foreign, having
jurisdiction over the Company or any of its assets, properties or operations.
As used herein, a "Repayment Event" means any event or condition which gives the
holder of any note, debenture or other evidence of indebtedness (or any person
acting on such holder's behalf) the right to require the repurchase, redemption
or repayment of all or a portion of such indebtedness by the Company.
(xi) Absence of Proceedings. There is no action, suit, proceeding,
----------------------
inquiry or investigation before or brought by any court or governmental agency
or body, domestic or foreign, now pending, or, to the knowledge of the Company,
threatened, against or affecting the Company, which is required to be disclosed
in the Registration Statement (other than as disclosed therein), or which might
reasonably be expected to result in a Material Adverse Effect, or which might
reasonably be expected to materially and adversely affect the properties or
assets thereof or the consummation of the transactions contemplated in this
Agreement or the performance by the Company of its obligations hereunder; the
aggregate of all pending legal or governmental proceedings to which the Company
is a party or of which any of their respective property or assets is the subject
which are not described in the Registration Statement, including ordinary
routine litigation incidental to the business, could not reasonably be expected
to result in a Material Adverse Effect.
(xii) Authorization of Other Agreements. Each of the agreements
---------------------------------
listed in Schedule C hereto has been duly authorized, executed and delivered by
the Company and constitutes a valid and legally binding obligation of the
Company and is enforceable in accordance with its terms, subject to bankruptcy,
insolvency, reorganization, moratorium and similar laws of general applicability
relating to or affecting the enforcement of creditors' rights.
6
<PAGE>
(xiii) Accuracy of Exhibits. There are no contracts or documents
--------------------
which are required to be described in the Registration Statement or the
Prospectus or to be filed as exhibits thereto which have not been so described
and filed as required.
(xiv) Absence of Further Requirements. No filing with, or
-------------------------------
authorization, approval, consent, license, order, registration, qualification or
decree of, any court or governmental authority or agency is necessary or
required for the performance by the Company of its obligations hereunder, in
connection with the offering, issuance or sale of the Securities hereunder or
the consummation of the transactions contemplated by this Agreement, except such
as have been already obtained or as may be required under the 1933 Act or the
1933 Act Regulations or state securities laws or the OTS approval referred to in
Section 1(b)(xiii) hereof [and the filing of the Certificate of Designation in
the State of Maryland].
(xv) Possession of Licenses and Permits. The Company possesses
----------------------------------
such permits, licenses, approvals, consents and other authorizations
(collectively, "Governmental Licenses") issued by the appropriate federal,
state, local or foreign regulatory agencies or bodies necessary to conduct the
business now operated by it; the Company is in compliance with the terms and
conditions of all such Governmental Licenses, except where the failure so to
comply would not, singly or in the aggregate, have a Material Adverse Effect;
all of the Governmental Licenses are valid and in full force and effect, except
when the invalidity of such Governmental Licenses or the failure of such
Governmental Licenses to be in full force and effect would not have a Material
Adverse Effect; and neither the Company nor any of its subsidiaries has received
any notice of proceedings relating to the revocation or modification of any such
Governmental Licenses which, singly or in the aggregate, if the subject of an
unfavorable decision, ruling or finding, would result in a Material Adverse
Effect.
(xvi) Investment Company Act. The Company is not, and upon the
----------------------
issuance and sale of the Securities as herein contemplated and the application
of the net proceeds therefrom as described in the Prospectus will not be, an
"investment company" or an entity "controlled" by an "investment company" as
such terms are defined in the Investment Company Act of 1940, as amended (the
"1940 Act").
(xvii) Registration Rights. There are no persons with registration
-------------------
rights or other similar rights to have any securities registered pursuant to the
Registration Statement or otherwise registered by the Company under the 1933
Act.
(xviii)The Company is organized and carries on its business so as to
qualify as "real estate investment trust" (a "REIT") under Sections 856 through
860 of the Internal Revenue Code of 1986, as amended (the "Code"), and no
transaction or other event has occurred which would cause the Company not to
enable it to qualify as a REIT for its current taxable year or for future
taxable years.
7
<PAGE>
(b) Representations and Warranties by the Bank. The Bank represents and
warrants to each Underwriter as of the date hereof, as of the Closing Time
referred to in Section 2(c) hereof, and as of each Date of Delivery (if any)
referred to in Section 2(b) hereof, and agrees with each Underwriter, as
follows:
(i) Compliance with Requirements. The Form OC and the Offering
----------------------------
Circular, at the respective times the Form OC and any post-effective
amendments thereto became effective, at the date hereof and at all times
subsequent thereto up to the Closing Time (and, if any Option Securities
are purchased, at the Date of Delivery), complied and will comply in all
material respects with the requirements of the OTS Rules and Regulations.
The Form OC, at the respective times the Form OC and any post-effective
amendments thereto became effective, and at the date hereof, did not or
will not contain an untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein, in the light of the circumstances under which they
were made, not misleading. The Offering Circular, at the respective times
the Form OC and any post-effective amendments thereto became effective, at
the date hereof and at all times subsequent thereto up to the Closing Time
(and, if any Option Securities are purchased, at the Date of Delivery),
did not and will not include an untrue statement of a material fact or
omit to state a material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were made, not
misleading; provided, however, that the representations and warranties in
this paragraph (b)(i) shall not apply to statements in or omissions from
the Form OC or the Offering Circular made in reliance upon and in
conformity with information furnished to the Bank in writing by any
Underwriter through Merrill Lynch expressly for use therein.
(ii) Incorporated Documents. The documents incorporated or deemed
----------------------
to be incorporated by reference in the Form OC and the Offering Circular,
at the time they were or hereafter are filed with the OTS, complied and
will comply in all material respects with the requirements of the OTS
Rules and Regulations, and, when read together with the other information
in the Offering Circular, at the time the Form OC became effective, at the
time the Offering Circular was issued and at the Closing Time (and if any
Option Securities are purchased, at the Date of Delivery), did not and
will not contain an untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein not misleading.
(iii) Independent Accountants. Arthur Andersen LLP, the accountants
-----------------------
who have certified the financial statements included in the Offering
Circular, are and were at all relevant times, with respect to the Bank and
its subsidiaries, independent public accountants within the meaning of
Rule 1.01 of the Code of Professional Ethics of the American Institute of
Certified Public Accountants.
(iv) Financial Statements. The consolidated financial statements
--------------------
and the related notes thereto included in the Offering Circular present
fairly the financial position of the
8
<PAGE>
Bank and its subsidiaries as of the latest respective dates of such
financial statements, and the results of operations of the Bank and its
subsidiaries for the respective periods covered thereby. Such statements
and related notes have been prepared in accordance with generally accepted
accounting principles applied on a consistent basis throughout the periods
involved. The tables included in the Offering Circular present fairly the
information purported to be shown thereby at the respective dates thereof
and for the respective periods covered thereby and conform in all material
respects with the OTS Rules and Regulations.
(v) No Material Adverse Change in Business. Since the respective
--------------------------------------
dates as of which information is given in the Form OC and the Offering
Circular, except as otherwise stated therein, (A) there has been no
material adverse change in the condition, financial or otherwise, or in
the earnings, business affairs or business prospects of the Bank and its
subsidiaries considered as one enterprise, whether or not arising in the
ordinary course of business, (B) there have been no transactions entered
into by the Bank or any of its sub sidiaries, other than those in the
ordinary course of business, which are material with respect to the Bank
and its subsidiaries considered as one enterprise and (C) there has been
no dividend or distribution of any kind declared, paid or made by the Bank
on any class of its capital stock except as descibed in the Offering
Circular.
(vi) Good Standing of the Bank. The Bank has been duly organized
-------------------------
and is validly existing as a federally chartered savings bank organized in
stock form under the laws of the United States of America with full power
(corporate and other) and authority to own, lease and operate its
properties and to conduct its business as described in the Offering
Circular. The Bank is duly qualified as a foreign corporation to transact
business in all places where such qualification is necessary or, to the
extent not so qualified, where the failure to obtain such qualification
would not have a material adverse effect on the condition (financial or
otherwise), earnings, business affairs or business prospects of the Bank
and its subsidiaries, considered as one enterprise. The Bank is a member
in good standing of the Federal Home Loan Bank of Atlanta, and the Bank's
deposit accounts are insured by the Federal Deposit Insurance Corporation
(the "FDIC") to the fullest extent provided under applicable law and the
OTS Rules and Regulations, and no proceedings for the termination or
revocation of such insurance are pending or, to the knowledge of the Bank,
threatened.
(vii) Good Standing of the Subsidiaries. The Bank does not own or
---------------------------------
control, directly or indirectly, any corporation, association (other than
homeowners' associations formed by certain of the Bank's subsidiaries in
connection with the Bank's planned unit developments) or other entity
other than the Company and the subsidiaries listed in Exhibit 21.1 to the
Form OC. Each subsidiary of the Bank has been duly incorporated and is
validly existing as a corporation in good standing under the laws of the
jurisdiction of its incorporation, has full power (corporate and other)
and authority to own, lease and operate its properties and conduct its
business as described in the Offering Circular (or, if not so described,
as presently conducted), and is duly qualified as a foreign corporation to
transact business and is in good standing in all places where such
qualification or good standing is necessary or to the extent
9
<PAGE>
not so qualified or not in good standing, where the failure to obtain such
qualification or to be in good standing would not have a material adverse
effect on the condition (financial or otherwise), earnings, business
affairs or business prospects of the Bank and its subsidiaries, considered
as one enterprise; no proceeding has been instituted in any such
jurisdiction, revoking, limiting or curtailing, or seeking to revoke,
limit or curtail, such power and authority or qualification; the
activities of the subsidiaries of the Bank are permitted to subsidiaries
of a federally chartered savings bank under applicable law and the OTS
Rules and Regulations; all of the issued and outstanding capital stock of
each subsidiary of the Bank has been duly authorized and validly issued
and is fully paid and nonassessable and is owned, directly or through
other subsidiaries of the Bank, by the Bank; and all of the capital stock
of each subsidiary of the Bank that is owned by the Bank, directly or
through other subsidiaries of the Bank, is owned free and clear of any
pledge, lien, encumbrance, claim or equity.
(viii) Capitalization. All of the outstanding shares of common
--------------
stock of the Bank have been duly authorized and validly issued, are fully
paid and nonassessable, are owned as indicated in the Offering Circular
under the caption "Ownership of Capital Stock --Common Stock" and are
subject only to such pledges, liens, security interests, charges, claims,
equities and encumbrances of any kind to the extent set forth in the
Offering Circular under the caption "Ownership of Capital Stock -- Common
Stock." The authorized, issued and outstanding capital stock and any
outstanding short-term debt, long-term debt and capital lease obligations
of the Bank at June 30, 1996 are as set forth in the Offering Circular
under the caption "Capitalization," and any subsequent borrowings and
issuances have been made in the ordinary course of business.
(ix) Authorization of Agreement. This Agreement has been duly
--------------------------
authorized, executed and delivered by the Bank.
(x) Absence of Defaults and Conflicts. Neither the Bank nor any
---------------------------------
of its subsidiaries is in violation of its federal stock charter or
certificate of incorporation, as the case may be, or by-laws; nor is the
Bank or any of its subsidiaries in default in the performance or
observance of any obligation, agreement, covenant or condition contained
in any contract, indenture, mortgage, loan agreement, note, lease or other
agreement or instrument to which the Bank or any of its subsidiaries is a
party or by which it or any of them or any of their properties may be
bound, except for such defaults which would not, in the aggregate, have a
material adverse effect on the condition (financial or otherwise),
earnings, business affairs or business prospects of the Bank and its
subsidiaries, considered as one enterprise; and the execution and delivery
of this Agreement, the incurrence of the obligations herein set forth and
the consummation of the transactions herein contemplated have been duly
authorized by all necessary corporate action of the Bank and will not
result in any violation of the federal stock charter or by-laws of the
Bank or the certificate of incorporation or by-laws of any of its
subsidiaries, and do not and will not contravene or conflict with, or
constitute a default under, or result in the creation or imposition of any
lien, charge or encumbrance upon any
10
<PAGE>
property or assets of the Bank or any of its subsidiaries under, (A) any
contract, indenture, mortgage, loan agreement, note, lease or other
agreement or instrument to which the Bank or any of its subsidiaries is a
party or by which it or any of them or any of their properties may be
bound, except for breaches or defaults which would not, in the aggregate,
have a material adverse effect on the condition (financial to otherwise),
earnings, business affairs or business prospects of the Bank and its
subsidiaries, considered as one enterprise, (B) any existing applicable
law, rule or regulation or (C) any judgment, order or decree of, or
agreement with, any government or governmental instrumentality or court,
domestic or foreign, having jurisdiction over the Bank or any of its
subsidiaries or any of their respective properties.
(xi) Regulatory Compliance. Except as disclosed in the Offering
---------------------
Circular, the Bank and its subsidiaries are conducting their respective
businesses in compliance in all material respects with all laws, rules,
regulations, decisions, directives and orders (including, without
limitation, all regulations and orders of, or agreements with, the OTS and
the FDIC) applicable to them. There is no action, suit, investigation or
proceeding before or by any government, governmental instrumentality or
court, domestic or foreign, now pending or, to the knowledge of the Bank,
threatened against or affecting the Bank or any of its subsidiaries (A)
that is required to be disclosed in the Offering Circular and not
disclosed therein, (B) that could result in any material adverse change in
the condition (financial or otherwise), earnings, business affairs or
business prospects of the Bank and its subsidiaries, considered as one
enterprise, (C) that could materially and adversely affect the properties,
assets or leasehold interests thereof or (D) that could adversely affect
the consummation of the transactions contemplated in this Agreement. All
pending legal or governmental proceedings to which the Bank or any of its
subsidiaries is a party or of which any of their property is the subject,
which are not described in the Offering Circular, including ordinary
routine litigation incidental to their respective businesses, would not
have a material adverse effect on the condition (financial or otherwise),
earnings, business affairs or business prospects of the Bank and its
subsidiaries, considered as one enterprise.
(xii) Absence of Labor Dispute. No labor dispute with the employees
------------------------
of the Bank or any subsidiary exists or, to the knowledge of the Bank, is
imminent, and the Bank is not aware of any existing or imminent labor
disturbance by the employees of any of its or any subsidiary's principal
suppliers, manufacturers, customers or contractors, which, in either case,
may reasonably be expected to result in a material adverse change in the
condition (financial or otherwise), earnings, business affairs or business
prospects of the Bank and its subsidiaries, considered as one enterprise.
(xiii) Accuracy of Exhibits. There are no contracts or documents
--------------------
which are required to be described in the Registration Statement, the Form
OC, the Prospectus or the Offering Circular or to be filed as exhibits
thereto which have not been so described and filed as required.
11
<PAGE>
(xiv) Absence of Further Requirements. No filing with, or
-------------------------------
authorization, approval, consent, license, order, registration,
qualification or decree of, any court or governmental authority or agency
is necessary or required for the performance by the Bank of its
obligations hereunder, in connection with the offering, issuance or sale
of the Securities hereunder or the consummation of the transactions
contemplated by this Agreement, except such as have been already obtained
or as may be required under applicable law or the OTS Rules and
Regulations or state securities laws or the OTS approval referred to in
the next sentence. Without limiting the foregoing, (A) the Bank has
submitted an application to the OTS for approval by the OTS for the
inclusion of the minority interest represented by the Securities in the
Bank's regulatory capital pursuant to 12 C.F.R. (S) 563.81, which
application and notice, as originally filed and at the time of the filing
of any supplement or amendment to either thereto, were true and accurate
in all material respects and did not contain an untrue statement of a
material fact or omit to state any material fact necessary to make the
statements therein, in the light of the circumstances under which they
were made, not misleading and (B) the Bank will comply with the conditions
set forth in any approval of the OTS related to such application or notice
at the times required thereby. At or prior to the Closing Time, the Bank
will have received from the OTS approval for inclusion of the minority
interest represented by the Securities in the Bank's regulatory capital
pursuant to 12 C.F.R. (S) 563.81 and at the Closing Time (and, if any
Option Securities are purchased, at the Date of Delivery) such approval
shall continue to be in full force and effect.
(xv) Possession of Licenses and Permits. The Bank and its
----------------------------------
subsidiaries possess such permits, licenses, approvals, consents and other
authorizations (collectively, "Governmental Licenses") issued by the
appropriate federal, state, local or foreign regulatory agencies or bodies
necessary to conduct the business now operated by each of them; the Bank
and its subsidiaries are in compliance with the terms and conditions of
all such Governmental Li censes, except where the failure so to comply
would not, singly or in the aggregate, result in a material adverse change
in the condition (financial or otherwise), earnings, business affairs or
business prospects of the Bank and its subsidiaries, considered as one
enterprise; all of the Governmental Licenses are valid and in full force
and effect, except when the inval idity of such Governmental Licenses or
the failure of such Governmental Licenses to be in full force and effect
would not result in a material adverse change in the condition (financial
or otherwise), earnings, business affairs or business prospects of the
Bank and its subsidiaries, considered as one enterprise; and neither the
Bank nor any of its subsidiaries has received any notice of proceedings
relating to the revocation or modification of any such Governmental
Licenses which, singly or in the aggregate, if the subject of an
unfavorable decision, ruling or finding, would result in a material
adverse change in the condition (financial or otherwise), earnings,
business affairs or business prospects of the Bank and its subsidiaries,
considered as one enterprise.
(xvi) Title to Property. The Bank and its subsidiaries have good
-----------------
and marketable title to all real property owned by each of them and good
title to all other properties owned by them, in each case, free and clear
of all mortgages, pledges, liens, security interests, claims, restrictions
12
<PAGE>
or encumbrances of any kind except such as (a) relate to participating
interests held by third parties in certain real estate held by two of the
Bank's subsidiaries, (b) are described in the Prospectus or the Offering
Circular or (c) do not, singly or in the aggregate, materially affect the
value of such property and do not interfere with the use made and proposed
to be made of such property by the Bank or any of its subsidiaries; and
all of the leases and subleases material to the business of the Bank and
its subsidiaries, considered as one enterprise, and under which the Bank
or any of its subsidiaries holds properties described in the Prospectus or
the Offering Circular, are in full force and effect, and neither the Bank
nor any subsidiary has any notice of any material claim of any sort that
has been asserted by anyone adverse to the rights of the Bank or any
subsidiary under any of the leases or subleases mentioned above, or
affecting or questioning the rights of the Bank or such subsidiary to the
continued possession of the leased or subleased premises under any such
lease or sublease.
(xvii) Compliance with Cuba Act. The Bank has complied with, and
------------------------
is and will be in compliance with, the provisions of that certain Florida
act relating to disclosure of doing business with Cuba, codified as
Section 517.075 of the Florida statutes, and the rules and regulations
thereunder (collectively, the "Cuba Act") or is exempt therefrom.
(xviii)Registration Rights. There are no holders of securities of
-------------------
the Bank who by reason of the filing of the Offering Circular with the OTS
have the right to request the Bank to register under the Rules and
Regulations securities held by them.
(xix) Exemption. The Bank Preferred Shares are exempt securities
---------
under Section 3(a)(5) of the 1933 Act, and registration of the Bank
Preferred Shares under the 1933 Act is not required in connection with the
offer, sale, issuance or delivery of the Bank Preferred Shares as contem
plated herein.
(xx) Certificate of Designation. Prior to the Closing Time, the
--------------------------
Bank shall have filed a certificate of designation with the Maryland
Department of Assessments and Taxation providing for the issuance of the
Bank Preferred Shares.
(xxi) Authorization and Description of Bank Preferred Shares. The
------------------------------------------------------
Bank Preferred Shares have been duly authorized and, if and when issued
and delivered by the Bank pursuant to the terms and conditions set forth
in the Certificate of Designation, will be validly issued and fully paid
and non-assessable; the Bank Preferred Shares conform to the statements
relating thereto contained in the Offering Circular and such description
conforms to the rights set forth in the instruments defining the same; no
holder of the Bank Preferred Shares will be subject to personal liability
by reason of being such a holder; and the issuance of the Bank Preferred
Shares is not subject to the preemptive or other similar rights of any
securityholder of the Bank.
(xxii) Other Representations and Warranties. The representations
------------------------------------
and warranties of the Bank contained in the residential mortgage loan
purchase agreements between the Company and the Bank and affiliates of the
Bank, and the servicing agreements between the Company and the
13
<PAGE>
Bank and/or one or more affiliates of the Bank, are, as of the date hereof
and will be as of Closing Time (and, if any Option Securities are
purchased, as of the Date of Delivery), true and correct.
(c) Officer's Certificates. Any certificate signed by any officer of the
Company or the Bank or any of its subsidiaries delivered to the Representatives
or to counsel for the Underwriters shall be deemed a representation and warranty
by the Company or the Bank, as applicable, to each Underwriter as to the matters
covered thereby.
SECTION 2. Sale and Delivery to Underwriters; Closing.
------------------------------------------
(a) Initial Securities. On the basis of the representations and warranties
herein contained and subject to the terms and conditions herein set forth, the
Company agrees to sell to each Underwriter, severally and not jointly, and each
Underwriter, severally and not jointly, agrees to purchase from the Company, at
the price per share set forth in Schedule B, the number of Initial Securities
set forth in Schedule A opposite the name of such Underwriter, plus any
additional number of Initial Securities which such Underwriter may become
obligated to purchase pursuant to the provisions of Section 10 hereof.
(b) Option Securities. In addition, on the basis of the representations
and warranties herein contained and subject to the terms and conditions herein
set forth, the Company hereby grants an option to the Representatives, severally
and not jointly, to purchase up to an additional ____ shares of the Company's
Series A Preferred Shares at the price per share set forth in Schedule B. The
option hereby granted will expire 30 days after the date hereof and may be
exercised in whole or in part from time to time only for the purpose of covering
over-allotments which may be made in connection with the offering and
distribution of the Initial Securities upon notice by the Representatives to the
Company setting forth the number of Option Securities as to which the
Representatives are then exercising the option and the time and date of payment
and delivery for such Option Securities. Any such time and date of delivery (a
"Date of Delivery") shall be determined by the Representatives, but shall not be
later than seven full business days after the exercise of said option, nor in
any event prior to the Closing Time, as hereinafter defined. If the option is
exercised as to all or any portion of the Option Securities, each of the
Underwriters, acting severally and not jointly, will purchase that proportion of
the total number of Option Securities then being purchased which the number of
Initial Securities set forth in Schedule A opposite the name of such Underwriter
bears to the total number of Initial Securities, subject in each case to such
adjustments as the Representatives in their discretion shall make to eliminate
any sales or purchases of fractional shares.
(c) Payment. Payment of the purchase price for, and delivery of
certificates for, the Initial Securities shall be made at the offices of
Skadden, Arps, Slate, Meagher & Flom LLP at 919 Third Avenue, New York, New
York, or at such other place as shall be agreed upon by the Representatives and
the Company, at 9:00 A.M. (Eastern time) on the third (fourth, if the pricing
occurs after 4:30 P.M. (Eastern time) on any given day) business day after the
date hereof (unless postponed in accordance with the provisions of Section 10),
or such other time not later than ten business days after such date as shall
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<PAGE>
be agreed upon by the Representatives and the Company (such time and date of
payment and delivery being herein called "Closing Time").
In addition, in the event that any or all of the Option Securities are
purchased by the Underwriters, payment of the purchase price for, and delivery
of certificates for, such Option Securities shall be made at the above-mentioned
offices, or at such other place as shall be agreed upon by the Representatives
and the Company, on each Date of Delivery as specified in the notice from the
Representatives to the Company. Payment shall be made to the Company by wire
transfer of immediately available funds to a bank account designated by the
Company, against delivery to the Representatives for the respective accounts of
the Underwriters of certificates for the Securities to be purchased by them. It
is understood that each Underwriter has authorized the Representatives, for its
account, to accept delivery of, receipt for, and make payment of the purchase
price for, the Initial Securities and the Option Securities, if any, which it
has agreed to purchase. Merrill Lynch, individually and not as representative
of the Underwriters, may (but shall not be obligated to) make payment of the
purchase price for the Initial Securities or the Option Securities, if any, to
be purchased by any Underwriter whose funds have not been received by the
Closing Time or the relevant Date of Delivery, as the case may be, but such
payment shall not relieve such Underwriter from its obligations hereunder.
(d) Denominations; Registration. Certificates for the Initial Securities
and the Option Securities, if any, shall be in such denominations and registered
in such names as the Representatives may request in writing at least one full
business day before the Closing Time or the relevant Date of Delivery, as the
case may be. The certificates for the Initial Securities and the Option
Securities, if any, will be made available for examination and packaging by the
Representatives in The City of New York not later than 10:00 A.M. (Eastern time)
on the business day prior to the Closing Time or the relevant Date of Delivery,
as the case may be.
SECTION 3. Covenants.
---------
(1) The Company covenants with each Underwriter as follows:
(a) Compliance with Securities Regulations and Commission Requests.
The Company, subject to Section 3(b), will comply with the requirements of
Rule 430A or Rule 434, as applicable, and will notify the Representatives
immediately, and confirm the notice in writing, when any post-effective
amendment to the Registration Statement shall become effective, or any
supplement to the Prospectus or any amended Prospectus shall have been
filed, of the receipt of any comments from the Commission, of any request
by the Commission for any amendment to the Registration Statement or any
amendment or supplement to the Prospectus or for additional information,
and of the issuance by the Commission of any stop order suspending the
effectiveness of the Registration Statement or of any order preventing or
suspending the use of any preliminary prospectus, or of the suspension of
the qualification of the Securities for offering or sale in any
jurisdiction, or of the initiation or threatening of any proceedings for
any of such purposes. The Company will promptly effect the filings
necessary pursuant to Rule 424(b) and will take such steps as it deems
necessary to ascertain promptly
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whether the form of prospectus transmitted for filing under Rule 424(b)
was received for filing by the Commission and, in the event that it was
not, it will promptly file such prospectus. The Company will make every
reasonable effort to prevent the issuance of any stop order and, if any
stop order is issued, to obtain the lifting thereof at the earliest
possible moment.
(b) Filing of Amendments. The Company will give the Representatives
notice of its intention to file or prepare any amendment to the
Registration Statement (including any filing under Rule 462(b)), any Term
Sheet or any amendment, supplement or revision to either the prospectus
included in the Registration Statement at the time it became effective or
to the Prospectus, will furnish the Representatives with copies of any
such documents a reasonable amount of time prior to such proposed filing
or use, as the case may be, and will not file or use any such document to
which the Representatives or counsel for the Underwriters shall object.
(c) Delivery of Registration Statements. The Company has furnished or
will deliver to the Representatives and counsel for the Underwriters,
without charge, signed copies of the Registration Statement as originally
filed and of each amendment thereto (including exhibits filed therewith or
incorporated by reference therein) and signed copies of all consents and
certificates of experts, and will also deliver to the Representatives,
without charge, a conformed copy of the Registration Statement as
originally filed and of each amendment thereto (without exhibits) for each
of the Underwriters. The copies of the Registration Statement and each
amendment thereto furnished to the Underwriters will be identical to the
electronically transmitted copies thereof filed with the Commission
pursuant to EDGAR, except to the extent permitted by Regulation S-T.
(d) Delivery of Prospectuses. The Company has delivered to each
Underwriter, without charge, as many copies of each preliminary prospectus
as such Underwriter reasonably requested, and the Company hereby consents
to the use of such copies for purposes permitted by the 1933 Act. The
Company will furnish to each Underwriter, without charge, during the
period when the Prospectus is required to be delivered under the 1933 Act
or the Securities Exchange Act of 1934, as amended, (the "1934 Act"), such
number of copies of the Prospectus (as amended or supplemented) as such
Underwriter may reasonably request. The Prospectus and any amendments or
supplements thereto furnished to the Underwriters will be identical to the
electronically transmitted copies thereof filed with the Commission
pursuant to EDGAR, except to the extent permitted by Regulation S-T.
(e) Continued Compliance with Securities Laws. The Company will
comply with the 1933 Act and the 1933 Act Regulations so as to permit the
completion of the distribution of the Securities as contemplated in this
Agreement and in the Prospectus. If at any time when a prospectus is
required by the 1933 Act to be delivered in connection with sales of the
Securities, any event shall occur or condition shall exist as a result of
which it is necessary, in the opinion of counsel for the Underwriters or
for the Company, to amend the Registration Statement or amend or
supplement the Prospectus in order that the Prospectus will not include
any untrue statements of a material fact or omit to state a material fact
necessary in order to make the
16
<PAGE>
statements therein not misleading in the light of the circumstances
existing at the time it is delivered to a purchaser, or if it shall be
necessary, in the opinion of such counsel, at any such time to amend the
Registration Statement or amend or supplement the Prospectus in order to
comply with the requirements of the 1933 Act or the 1933 Act Regulations,
the Company will promptly prepare and file with the Commission, subject to
Section 3(b), such amendment or supplement as may be necessary to correct
such statement or omission or to make the Registration Statement or the
Prospectus comply with such requirements, and the Company will furnish to
the Underwriters such number of copies of such amendment or supplement as
the Underwriters may reasonably request.
(f) Blue Sky Qualifications. The Company will use its best efforts,
in cooperation with the Underwriters, to qualify the Securities for
offering and sale under the applicable securities laws of such states and
other jurisdictions as the Representatives may designate and to maintain
such qualifications in effect for a period of not less than one year from
the later of the effective date of the Registration Statement and any Rule
462(b) Registration Statement; provided, however, that the Company shall
-------- -------
not be obligated to file any general consent to service of process or to
qualify as a foreign corporation or as a dealer in securities in any
jurisdiction in which it is not so qualified or to subject itself to
taxation in respect of doing business in any jurisdiction in which it is
not otherwise so subject. In each jurisdiction in which the Securities
have been so qualified, the Company will file such statements and reports
as may be required by the laws of such jurisdiction to continue such
qualification in effect for a period of not less than one year from the
effective date of the Registration Statement and any Rule 462(b)
Registration Statement.
(g) Rule 158. The Company will timely file such reports pursuant to
the 1934 Act as are necessary in order to make generally available to its
securityholders as soon as practicable an earnings statement for the
purposes of, and to provide the benefits contemplated by, the last
paragraph of Section 11(a) of the 1933 Act.
(h) Use of Proceeds. The Company will use the net proceeds received
by it from the sale of the Securities in the manner specified in the
Prospectus under "Use of Proceeds".
(i) Listing. The Company will use its best efforts to effect the
listing of the Securities on the New York Stock Exchange.
(j) Reporting Requirements. The Company, during the period when the
Prospectus is required to be delivered under the 1933 Act or the 1934 Act,
will file all documents required to be filed with the Commission pursuant
to the 1934 Act within the time periods required by the 1934 Act and the
rules and regulations of the Commission thereunder.
(k) REIT Qualification. Except to the extent that a Tax Event (as
defined in the Prospectus) shall have occurred, the Company will, in a
timely manner, make the elections and take the procedural steps described
in the Prospectus under the heading "Federal Income Tax Considerations" to
meet the requirements to qualify, for its taxable year ending December 31,
17
<PAGE>
1996, as a REIT under the Code, as is in effect on the date hereof and use
every reasonable effort to do so.
(2) The Bank covenants with each Underwriter as follows:
(a) Compliance with Regulations and OTS Requests. The Bank will
notify the Underwriters immediately, and confirm the notice in writing,
(i) of the effectiveness of the Offering Circular and any amendment
thereto, (ii) of the receipt by the Bank or its counsel of any comments
from the OTS with respect to the offering of the Securities, (iii) of any
request to the Bank or its counsel by the OTS for any amendment or
supplement to the Offering Circular or for additional information and
(iv) of the issuance or initiation by the OTS or by any other state or
federal banking or securities regulatory authority of any stop order or
cease-and-desist proceeding to suspend the effectiveness of the Offering
Circular or interfering with the offering of the Securities, or of the
suspension of the qualification of the Securities for offering or sale in
any jurisdiction, or the initiation or threat of any other orders or
proceedings for any of such purposes. The Bank will make every reasonable
effort to prevent the issuance or initiation of any such stop orders or
cease-and-desist proceedings and, if any such stop orders or cease-and-
desist proceedings are issued or initiated, to obtain the lifting or
dismissal thereof at the earliest possible moment.
(b) Filing of Amendments. The Bank will give the Representatives
notice of its intention to file or prepare any amendment to the Offering
Circular (or to any preliminary offering circular, as the case may be) or
any amendment, supplement or revision to the Offering Circular, will
furnish the Representatives with copies of any such documents a reasonable
amount of time prior to such proposed filing or use, as the case may be,
and will not file or use any such document to which the Representatives or
counsel for the Underwriters shall object.
(c) Delivery of Form OC. The Bank has furnished or will deliver to
the Representatives and counsel for the Underwriters, without charge,
signed copies of the Form OC, as originally filed and of each amendment
thereto (including exhibits filed therewith or incorporated by reference
therein) and signed copies of all consents and certificates of experts,
and will also deliver to the Representatives, without charge, a conformed
copy of the Form OC, as originally filed and of each amendment thereto
(without exhibits) for each of the Underwriters.
(d) Continued Compliance with Laws. If any event shall occur as a
result of which it is necessary, in the opinion of counsel for the
Underwriters, to amend or supplement the Offering Circular in order to
make the Offering Circular not misleading in the light of the
circumstances existing at the time it is delivered to a purchaser, the
Bank will forthwith amend or supplement the Offering Circular by preparing
and furnishing to the Underwriters a reasonable number of copies of an
amendment or amendments of, or a supplement or supplements to, the
Offering Circular (in form and substance reasonably satisfactory to such
counsel) so that, as so amended or supplemented, the Offering Circular
will not contain an untrue statement of a material fact or omit to state a
material fact necessary in order to make the statements therein, in the
light of the
18
<PAGE>
circumstances existing at the time the Offering Circular is delivered to a
purchaser, not misleading, and the Bank will furnish to each Underwriter
such number of copies of such amendment or supplement as such Underwriter
shall reasonably request. For the purposes of this subsection, the Bank
shall furnish such information with respect to itself to the
Representatives, counsel for the Underwriters and counsel for the Bank, as
may be necessary for counsel for the Underwriters and counsel for the Bank
to be aware of and to consult with the Representatives and the Bank with
respect to the need to amend or supplement the Offering Circular and shall
furnish such further information as may from time to time be reasonably
requested.
(e) Earnings Reports. The Bank will timely file such reports in
connection with the Securities as are necessary in order to make generally
available as soon as practicable an earnings statement for the purposes
of, and to provide the benefits contemplated by, 12 C.F.R. (S) 563.81 or
12 C.F.R. (S) 563g.12.
(f) Reporting Requirements. The Bank, during the period when the
Offering Circular is required to be delivered under 12 C.F.R. (S) 563g,
will file all documents required to be filed with the OTS within the time
periods required by 12 C.F.R. (S) 563g and the rules and regulations of
the OTS thereunder.
SECTION 4. Payment of Expenses. (a) Expenses. The Company and the Bank,
-------------------
jointly and severally, covenant and agree with the several Underwriters to pay
or cause to be paid all expenses incident to the performance of their
obligations under this Agreement, including (i) the preparation, printing and
filing of the Registration Statement and the Form OC (including financial
statements and exhibits) as originally filed and of each amendment thereto, (ii)
the preparation, printing and delivery to the Underwriters of this Agreement,
any Agreement among Underwriters and such other documents as may be required in
connection with the offering, purchase, sale, issuance or delivery of the
Securities and the Bank Preferred Shares, (iii) the preparation, issuance and
delivery of the certificates for the Securities to the Underwriters, including
any stock or other transfer taxes and any stamp or other duties payable upon the
sale, issuance or delivery of the Securities to the Underwriters, (iv) the fees
and disbursements of the Company's counsel, accountants and other advisors, (v)
the qualification of the Securities under securities laws in accordance with the
provisions of Section 3(f) hereof, including filing fees and the reasonable fees
and disbursements of counsel for the Underwriters in connection therewith and in
connection with the preparation of the Blue Sky Survey and any supplement
thereto, (vi) the printing and delivery to the Underwriters of copies of each
preliminary prospectus, preliminary offering circular, any Term Sheets and of
the Prospectus and the Offering Circular and any amendments or supplements
thereto, (vii) the preparation, printing and delivery to the Underwriters of
copies of the Blue Sky Survey and any supplement thereto, (viii) the fees and
expenses of any transfer agent or registrar for the Securities or the Bank
Preferred Shares (ix) any fees charged by securities rating services for rating
the Securities, (x) the filing fees incident to, and the reasonable fees and
disbursements of counsel to the Underwriters in connection with, the review by
the National Association of Securities Dealers, Inc. (the "NASD") of the terms
of the sale of the Securities, and (xi) the fees and expenses incurred in
connection with the listing of the Securities on the New York Stock Exchange.
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<PAGE>
(b) Termination of Agreement. If this Agreement is terminated by the
Representatives in accordance with the provisions of Section 5 or
Section 9(a)(i) hereof, the Company shall reimburse the Underwriters for all of
their out-of-pocket expenses, including the reasonable fees and disbursements
of counsel forthe Underwriters.
SECTION 5. Conditions of Underwriters' Obligations. The obligations of
---------------------------------------
the several Underwriters hereunder are subject to the accuracy of the
representations and warranties of the Company and the Bank contained in Section
1 hereof or in certificates of any officer of the Company or the Bank delivered
pursuant to the provisions hereof, to the performance by each of the Company and
the Bank of their respective covenants and other obligations hereunder, and to
the following further conditions:
(a) Effectiveness of Registration Statement. The Registration
Statement, including any Rule 462(b) Registration Statement, has become
effective and at Closing Time (and, if any Option Securities are
purchased, at the Date of Delivery) no stop order suspending the
effectiveness of the Registration Statement shall have been issued under
the 1933 Act or proceedings therefor initiated or threatened by the
Commission, and any request on the part of the Commission for additional
information shall have been complied with to the reasonable satisfaction
of counsel to the Underwriters. A prospectus containing the Rule 430A
Information shall have been filed with the Commission in accordance with
Rule 424(b) (or a post-effective amendment providing such information
shall have been filed and declared effective in accordance with the
requirements of Rule 430A) or, if the Company has elected to rely upon
Rule 434, a Term Sheet shall have been filed with the Commission in
accordance with Rule 424(b).
(b) Effectiveness of Offering Circular. The Offering Circular has
become effective and at Closing Time (and, if any Option Securities are
purchased, at the Date of Delivery), no stop order or cease-and-desist
proceeding suspending the effectiveness of the Offering Circular or
interfering with the offering of the Securities or the Bank Preferred
Shares shall have been issued and no proceedings for purposes of issuing a
stop order or cease-and-desist proceedings shall have been instituted or
shall be pending or, to the knowledge of the Bank, shall be contemplated
by the OTS or by any other state or federal banking or securities
regulatory authority. Any request on the part of the OTS for additional
information or for inclusion of additional infor mation in the Form OC
shall have been complied with to the reasonable satisfaction of counsel
for the Underwriters.
(c) Opinion of Counsel for Company. At Closing Time, the
Representatives shall have received the favorable opinions, dated as of
Closing Time, of Shaw, Pittman, Potts & Trowbridge, counsel for the
Company, in form and substance satisfactory to counsel for the
Underwriters, together with signed or reproduced copies of each such
letter for each of the other Underwriters to the effect set forth in
Exhibits A-1 and A-2 hereto and to such further effect as counsel to the
Underwriters may reasonably request.
(d) Opinions of Counsel for Bank. At Closing Time, the
Representatives shall have received [(A)] the favorable opinions, dated as
of Closing Time, of Shaw, Pittman, Potts &
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<PAGE>
Trowbridge, counsel for the Bank to the effect set forth in Exhibits B-1
and B-2 hereto, in form and substance satisfactory to counsel for the
Underwriters[, and (B) the favorable opinion, dated as of Closing Time, of
internal counsel for the Bank, in form and substance satisfactory to
counsel for the Underwriters,] together with signed or reproduced copies
of [each] such opinion for each of the other Underwriters. Such opinion[s]
shall be to such further effect with respect to other legal matters
relating to this Agreement and the sale of the Securities pursuant to this
Agreement as counsel for the Underwriters may reasonably request.
The opinions required by Sections 5(c) and 5(d) may be limited to New York
State, Maryland State, District of Columbia and federal law. In giving such
opinions, such counsel may rely, as to all matters governed by the laws of
jurisdictions other than the laws of the State of New York, the State of
Maryland and the District of Columbia and the federal law of the United States,
upon opinions of other counsel, who shall be counsel satisfactory to counsel for
the Underwriters, in which case each applicable opinion shall state that they
believe the Underwriters and they are entitled to so rely.
(e) Opinion of Counsel for Underwriters. At Closing Time, the
Representatives shall have received the favorable opinion, dated as of
Closing Time, of Skadden, Arps, Slate, Meagher & Flom LLP, counsel for the
Underwriters, together with signed or reproduced copies of such letter for
each of the other Underwriters with respect to the matters set forth in
clauses (iv), (v), (vi) and (xiii), (xiv) of Exhibits A and B-1 hereto. In
giving such opinion such counsel may rely, as to all matters governed by
the laws of jurisdictions other than the law of the State of New York and
the federal law of the United States, upon the opinions of counsel
satisfactory to the Representatives. Such counsel may also state that,
insofar as such opinion involves factual matters, they have relied, to the
extent they deem proper, upon certificates of officers of the Company and
its subsidiaries and certificates of public officials.
(f) Officers' Certificate. At Closing Time, there shall not have
been, since the date hereof or since the respective dates as of which
information is given in the Prospectus or the Offering Circular, any
material adverse change in the condition, financial or otherwise, or in
the earnings, business affairs or business prospects of the Company or the
Bank and its subsidiaries considered as one enterprise, whether or not
arising in the ordinary course of business, and the Representatives shall
have received a certificate of the President or a Vice President of each
of the Company and the Bank and of the chief financial or chief accounting
officer of each of the Company and the Bank, dated as of Closing Time, to
the effect that (i) there has been no such material adverse change,
(ii) the representations and warranties in Sections 1(a) and 1(b) hereof
are true and correct with the same force and effect as though expressly
made at and as of Closing Time, (iii) the Company and the Bank have
complied with all agreements and satisfied all conditions on its part to
be performed or satisfied at or prior to Closing Time, (iv) no stop order
suspending the effectiveness of the Registration Statement has been issued
and no proceedings for that purpose have been instituted or are pending or
are contemplated by the Commission, and (v) no stop order suspending the
effectiveness of the Offering Circular has been issued and no proceedings
for that purpose have been instituted or are pending or are contemplated
by the OTS.
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(g) Accountants' Comfort Letter. At the time of the execution of this
Agreement, the Representatives shall have received from Arthur Anderson
LLP a letter dated such date, in form and substance satisfactory to the
Representatives, together with signed or reproduced copies of such letter
for each of the other Underwriters containing statements and information
of the type ordinarily included in accountants' "comfort letters" to
underwriters with respect to the financial statements and certain
financial information contained in the Registration Statement and the
Prospectus.
(h) Bring-down Comfort Letter. At Closing Time, the Representatives
shall have received from Arthur Anderson LLP a letter, dated as of Closing
Time, to the effect that they reaffirm the statements made in the letter
furnished pursuant to subsection (e) of this Section, except that the
specified date referred to shall be a date not more than three business
days prior to Closing Time.
(i) Maintenance of Rating. At Closing Time, the Securities shall be
rated "B" by Moody's Investors Service and "B" by Standard & Poor's
Ratings Services, a division of McGraw-Hill, Inc and the Company shall
have delivered to the Representatives a letter dated the Closing Time,
from each such rating agency, or other evidence satisfactory to the
Representatives, confirming that the Securities have such ratings; and
since the date of this Agreement, there shall not have occurred a
downgrading in the rating assigned to the Securities or any of the
Company's or the Bank's securities by any "nationally recognized
statistical rating agency," as that term is defined by the Commission for
purposes of Rule 436(g)(2) under the 1933 Act, and no such organization
shall have publicly announced that it has under surveillance or review its
rating of the Securities or any of the Company's or the Bank's securities.
(j) Approval of Listing. At Closing Time, the Securities shall have
been approved for listing on the New York Stock Exchange, subject only to
official notice of issuance.
(k) No Objection. The NASD has confirmed that it has not raised any
objection with respect to the fairness and reasonableness of the
underwriting terms and arrangements.
(l) Other Conditions. At Closing Time (and, if any Option Securities
are purchased, at the Date of Delivery), (A) there shall not have occurred
any change from the date hereof in the number of shares of common stock of
the Bank, directly or indirectly, legally or beneficially, owned, held or
controlled by Mr. B. Francis Saul II, (B) there shall not have been, since
the latest respective dates as of which information is given in the most
recent financial statements of B. F. Saul Real Estate Investment Trust
(the "Trust") and B. F. Saul Company ("Saul Company") furnished to the
Underwriters, any material adverse change or development in the condition
(financial or otherwise), earnings, business affairs or business prospects
of the Trust and its subsidiaries, considered as one enterprise, or of the
Saul Company and its subsidiaries, considered as one enterprise, whether
or not arising in the ordinary course of business, (C) no action, suit or
proceeding before or by any government, governmental instrumentality or
court, domestic or foreign, that has not been disclosed in the Offering
Circular, the financial statements referred to
22
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in clause (B) above or in a written notice addressed to the
Representatives prior to the date hereof, shall be pending against the
Trust, Saul Company or any of the subsidiaries of either of them that
could result in any material adverse change in the condition (financial or
otherwise), earnings, business affairs or business prospects of the Trust
and its subsidiaries, considered as one enterprise, or of the Saul Company
and its subsidiaries, considered as one enterprise, whether or not arising
in the ordinary course of business, (D) no event of default shall exist
under any contract, indenture, mortgage, loan agreement, note, lease or
other agreement or instrument constituting indebtedness of the Trust, Saul
Company or any of the subsidiaries of either of them, nor shall the Trust,
Saul Company or any of such subsidiaries be in default in the performance
or observance of any obligation, agreement, covenant or condition
contained in any contract, indenture, mortgage, loan agreement, note,
lease or other agreement or instrument to which the Trust, Saul Company or
any of such subsidiaries is a party or by which it or any of them or any
of their properties may be bound, except for such defaults that have been
disclosed in the Offering Circular, the financial statements referred to
in clause (B) above or in a written notice addressed to the
Representatives prior to the date hereof or that would not, in the
aggregate, have a material adverse effect on the condition (financial or
otherwise), earnings, business affairs or business prospects of the Trust
and its subsidiaries, considered as one enterprise, or of the Saul Company
and its subsidiaries, considered as one enterprise, and (E) the execution
and delivery of this Agreement by the Bank and the incurrence of the
obligations herein set forth and the consummation of the transactions
herein contemplated will not result in any violation of, and do not and
will not contravene or conflict with, or constitute a default under, or
result in the creation or imposition of any lien, charge or encumbrance
upon any property or assets of the Trust, the Saul Company or any of the
subsidiaries of either of them under (1) any contract, indenture,
mortgage, loan agreement, note, lease or other agreement or instrument to
which the Trust, Saul Company or any of such subsidiaries is a party or by
which any of their respective properties may be bound, (2) any existing
applicable law, rule or regulation applicable to the Trust, the Saul
Company or any of such subsidiaries or (3) any judgment, order or decree
of, or agreement with, any government or governmental instrumentality or
court, domestic or foreign, having jurisdiction over the Trust, the Saul
Company or any of such subsidiaries or any of their respective properties.
(m) Conditions to Purchase of Option Securities. In the event that
the Underwriters exercise their option provided in Section 2(b) hereof to
purchase all or any portion of the Option Securities, the representations
and warranties of each of the Company and the Bank contained herein and
the statements in any certificates furnished by each of the Company or the
Bank or any subsidiary hereunder shall be true and correct as of each Date
of Delivery and, at the relevant Date of Delivery, the Representatives
shall have received:
(i) Officers' Certificate. A certificate, dated such Date of
---------------------
Delivery, of the President or a Vice President of each of the Company
and the Bank and of the chief financial or chief accounting officer
of each of the Company and the Bank confirming that the certificate
delivered at the Closing Time pursuant to Section 5(f) hereof remains
true and correct as of such Date of Delivery.
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(ii) Opinions of Counsel for Company. The favorable opinions of
-------------------------------
Shaw, Pittman, Potts & Trowbridge, counsel for the Company, in form
and substance satisfactory to counsel for the Underwriters, dated
such Date of Delivery, relating to the Option Securities to be
purchased on such Date of Delivery and otherwise to the same effect
as the opinion required by Section 5(c) hereof.
(iii) Opinions of Counsel for Bank. The favorable opinions of Shaw,
----------------------------
Pittman, Potts & Trowbridge, counsel for the Bank, and of internal
counsel for the Bank, in form and substance satisfactory to counsel
for the Underwriters, each dated such Date of Delivery, relating to
the Option Securities to be purchased on such Date of Delivery and
otherwise to the same effect as the opinions required by Section 5(d)
hereof.
(iv) Opinion of Counsel for Underwriters. The favorable opinion
-----------------------------------
of Skadden, Arps, Slate, Meagher & Flom LLP, counsel for the
Underwriters, dated such Date of Delivery, relating to the Option
Securities to be purchased on such Date of Delivery and otherwise to
the same effect as the opinion required by Section 5(e) hereof.
(v) Bring-down Comfort Letter. A letter from Arthur Anderson LLP,
-------------------------
in form and substance satisfactory to the Representatives and dated
such Date of Delivery, substantially in the same form and substance
as the letter furnished to the Representatives pursuant to Section
5(h) hereof, except that the "specified date" in the letter furnished
pursuant to this paragraph shall be a date not more than five days
prior to such Date of Delivery.
(vi) No Downgrading. Subsequent to the date of this Agreement, no
--------------
downgrading shall have occurred in the rating accorded the Securities
or of any of the Company's or the Bank's other securities by any
"nationally recognized statistical rating organization", as that term
is defined by the Commission for purposes of Rule 436(g)(2) under the
1933 Act, and no such organization shall have publicly announced that
it has under surveillance or review its ratings of any of the
Company's or the Bank's securities.
(n) Additional Documents. At Closing Time and at each Date of
Delivery counsel for the Underwriters shall have been furnished with such
documents and opinions as they may require for the purpose of enabling
them to pass upon the issuance and sale of the Securities as herein
contemplated, or in order to evidence the accuracy of any of the
representations or warranties, or the fulfillment of any of the
conditions, herein contained; and all proceedings taken by the Company and
the Bank in connection with the issuance and sale of the Securities as
herein contemplated shall be satisfactory in form and substance to the
Representatives and counsel for the Underwriters.
(o) Termination of Agreement. If any condition specified in this
Section shall not have been fulfilled when and as required to be
fulfilled, this Agreement, or, in the case of any condition to the
purchase of Option Securities on a Date of Delivery which is after the
Closing
24
<PAGE>
Time, the obligations of the several Underwriters to purchase the relevant
Option Securities, may be terminated by the Representatives by notice to
the Company at any time at or prior to Closing Time or such Date of
Delivery, as the case may be, and such termination shall be without
liability of any party to any other party except as provided in Section 4
and except that Sections 1, 6, 7, and 8 shall survive any such termination
and remain in full force and effect.
SECTION 6. Indemnification.
---------------
(a) Indemnification of Underwriters. The Company and the Bank,
jointly and severally, agree to indemnify and hold harmless each Underwriter and
each person, if any, who controls any Underwriter within the meaning of Section
15 of the 1933 Act or Section 20 of the 1934 Act as follows:
(i) against any and all loss, liability, claim, damage and expense
whatsoever, as incurred, arising out of any untrue statement or alleged
untrue statement of a material fact contained in the Registration
Statement or the Form OC (or any amendment thereto), including the Rule
430A Information and the Rule 434 Information, if applicable, or the
omission or alleged omission therefrom of a material fact required to be
stated therein or necessary to make the statements therein not misleading
or arising out of any untrue statement or alleged untrue statement of a
material fact included in any preliminary prospectus, any preliminary
offering circular, the Prospectus or the Offering Circular (or any
amendment or supplement thereto), or the omission or alleged omission
therefrom of a material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were made, not
misleading;
(ii) against any and all loss, liability, claim, damage and expense
whatsoever, as incurred, to the extent of the aggregate amount paid in
settlement of any litigation, or any investigation or proceeding by any
governmental agency or body, commenced or threatened, or of any claim
whatsoever based upon any such untrue statement or omission, or any such
alleged untrue statement or omission; provided that (subject to Section
6(d) below) any such settlement is effected with the written consent of
the Company and the Bank; and
(iii) against any and all expense whatsoever, as incurred (including
the fees and disbursements of counsel chosen by Merrill Lynch), reasonably
incurred in investigating, preparing or defending against any litigation,
or any investigation or proceeding by any governmental agency or body,
commenced or threatened, or any claim whatsoever based upon any such
untrue statement or omission, or any such alleged untrue statement or
omission, to the extent that any such expense is not paid under (i) or
(ii) above;
provided, however, that this indemnity agreement shall not apply to any loss,
- -------- -------
liability, claim, damage or expense to the extent arising out of any untrue
statement or omission or alleged untrue statement or omission made in reliance
upon and in conformity with written information furnished to the Company or the
Bank by any Underwriter through Merrill Lynch expressly for use in the
Registration Statement
25
<PAGE>
or the Form OC (or any amendment thereto), including the Rule 430A Information
and the Rule 434 Information, if applicable, or any preliminary prospectus, any
preliminary offering circular, the Prospectus or the Offering Circular (or any
amendment or supplement thereto).
(b) Indemnification of Company, Bank, Directors and Officers. Each
Underwriter severally agrees to indemnify and hold harmless the Company and the
Bank, their respective directors, each officer of the Company who signed the
Registration Statement, each officer of the Bank who signed the Form OC, and
each person, if any, who controls the Company or the Bank within the meaning of
Section 15 of the 1933 Act or Section 20 of the 1934 Act against any and all
loss, liability, claim, damage and expense described in the indemnity contained
in subsection (a) of this Section, as incurred, but only with respect to untrue
statements or omissions, or alleged untrue statements or omissions, made in the
Registration Statement or the Form OC (or any amendment thereto), including the
Rule 430A Information and the Rule 434 Information, if applicable, or any
preliminary prospectus, any preliminary offering circular, the Prospectus or the
Offering Circular (or any amendment or supplement thereto) in reliance upon and
in conformity with written information furnished to the Company or the Bank by
such Underwriter through Merrill Lynch expressly for use in the Registration
Statement or the Form OC (or any amendment thereto) or such preliminary
prospectus, preliminary offering circular, the Prospectus or the Offering
Circular (or any amendment or supplement thereto).
(c) Actions against Parties; Notification. Each indemnified party shall
give notice as promptly as reasonably practicable to each indemnifying party of
any action commenced against it in respect of which indemnity may be sought
hereunder, but failure to so notify an indemnifying party shall not relieve such
indemnifying party from any liability hereunder to the extent it is not
materially prejudiced as a result thereof and in any event shall not relieve it
from any liability which it may have otherwise than on account of this indemnity
agreement. In the case of parties indemnified pursuant to Section 6(a) above,
counsel to the indemnified parties shall be selected by Merrill Lynch, and, in
the case of parties indemnified pursuant to Section 6(b) above, counsel to the
indemnified parties shall be selected by the Company or the Bank. An
indemnifying party may participate at its own expense in the defense of any such
action; provided, however, that counsel to the indemnifying party shall not
-------- -------
(except with the consent of the indemnified party) also be counsel to the
indemnified party. In no event shall the indemnifying parties be liable for
fees and expenses of more than one counsel (in addition to any local counsel)
separate from their own counsel for all indemnified parties in connection with
any one action or separate but similar or related actions in the same
jurisdiction arising out of the same general allegations or circumstances. No
indemnifying party shall, without the prior written consent of the indemnified
parties, settle or compromise or consent to the entry of any judgment with
respect to any litigation, or any investigation or proceeding by any
governmental agency or body, commenced or threatened, or any claim whatsoever in
respect of which indemnification or contribution could be sought under this
Section 6 or Section 7 hereof (whether or not the indemnified parties are actual
or potential parties thereto), unless such settlement, compromise or consent (i)
includes an unconditional release of each indemnified party from all liability
arising out of such litigation, investigation, proceeding or claim and (ii) does
not include a statement as to or an admission of fault, culpability or a failure
to act by or on behalf of any indemnified party.
26
<PAGE>
(d) Settlement without Consent if Failure to Reimburse. If at any time an
indemnified party shall have requested an indemnifying party to reimburse the
indemnified party for fees and expenses of counsel, such indemnifying party
agrees that it shall be liable for any settlement of the nature contemplated by
Section 6(a)(ii) effected without its written consent if (i) such settlement is
entered into more than 45 days after receipt by such indemnifying party of the
aforesaid request, (ii) such indemnifying party shall have received notice of
the terms of such settlement at least 30 days prior to such settlement being
entered into and (iii) such indemnifying party shall not have reimbursed such
indemnified party in accordance with such request prior to the date of such
settlement.
SECTION 7. Contribution. If the indemnification provided for in Section 6
------------
hereof is for any reason unavailable to or insufficient to hold harmless an
indemnified party in respect of any losses, liabilities, claims, damages or
expenses referred to therein, then each indemnifying party shall contribute to
the aggregate amount of such losses, liabilities, claims, damages and expenses
incurred by such indemnified party, as incurred, (i) in such proportion as is
appropriate to reflect the relative benefits received by the Company and the
Bank on the one hand and the Underwriters on the other hand from the offering of
the Securities pursuant to this Agreement or (ii) if the allocation provided by
clause (i) is not permitted by applicable law, in such proportion as is
appropriate to reflect not only the relative benefits referred to in clause (i)
above but also the relative fault of the Company and the Bank on the one hand
and of the Underwriters on the other hand in connection with the statements or
omissions which resulted in such losses, liabilities, claims, damages or
expenses, as well as any other relevant equitable considerations.
The relative benefits received by the Company and the Bank on the one hand
and the Underwriters on the other hand in connection with the offering of the
Securities pursuant to this Agreement shall be deemed to be in the same
respective proportions as the total net proceeds from the offering of the
Securities pursuant to this Agreement (before deducting expenses) received by
the Company and the total underwriting discount received by the Underwriters, in
each case as set forth on the cover of the Prospectus, or, if Rule 434 is used,
the corresponding location on the Term Sheet, bear to the aggregate initial
public offering price of the Securities as set forth on such cover.
The relative fault of the Company and the Bank on the one hand and the
Underwriters on the other hand shall be determined by reference to, among other
things, whether any such untrue or alleged untrue statement of a material fact
or omission or alleged omission to state a material fact relates to information
supplied by the Company or the Bank or by the Underwriters and the parties'
relative intent, knowledge, access to information and opportunity to correct or
prevent such statement or omission.
The Company, the Bank and the Underwriters agree that it would not be just
and equitable if contribution pursuant to this Section 7 were determined by pro
rata allocation (even if the Underwriters were treated as one entity for such
purpose) or by any other method of allocation which does not take account of the
equitable considerations referred to above in this Section 7. The aggregate
amount of losses, liabilities, claims, damages and expenses incurred by an
indemnified party and referred to above in this Section 7 shall be deemed to
include any legal or other expenses reasonably incurred by such indemnified
party in investigating, preparing or defending against any litigation, or any
investigation or
27
<PAGE>
proceeding by any governmental agency or body, commenced or threatened, or any
claim whatsoever based upon any such untrue or alleged untrue statement or
omission or alleged omission.
Notwithstanding the provisions of this Section 7, no Underwriter shall be
required to contribute any amount in excess of the amount by which the total
price at which the Securities underwritten by it and distributed to the public
were offered to the public exceeds the amount of any damages which such
Underwriter has otherwise been required to pay by reason of such untrue or
alleged untrue statement or omission or alleged omission.
No person guilty of fraudulent misrepresentation (within the meaning of
Section 11(f) of the 1933 Act) shall be entitled to contribution from any person
who was not guilty of such fraudulent misrepresentation.
For purposes of this Section 7, each person, if any, who controls an
Underwriter within the meaning of Section 15 of the 1933 Act or Section 20 of
the 1934 Act shall have the same rights to contribution as such Underwriter, and
each director of the Company or the Bank, each officer of the Company who signed
the Registration Statement, each officer of the Bank who signed Form OC and each
person, if any, who controls the Company or the Bank within the meaning of
Section 15 of the 1933 Act or Section 20 of the 1934 Act shall have the same
rights to contribution as the Company or the Bank, as applicable. The
Underwriters' respective obligations to contribute pursuant to this Section 7
are several in proportion to the number of Initial Securities set forth opposite
their respective names in Schedule A hereto and not joint.
SECTION 8. Representations, Warranties and Agreements to Survive Delivery.
--------------------------------------------------------------
All representations, warranties and agreements contained in this Agreement or in
certificates of officers of the Company or the Bank or any of its subsidiaries
submitted pursuant hereto, shall remain operative and in full force and effect,
regardless of any investigation made by or on behalf of any Underwriter or
controlling person, or by or on behalf of the Company or the Bank, and shall
survive delivery of the Securities to the Underwriters.
SECTION 9. Termination of Agreement.
------------------------
(a) Termination; General. The Representatives may terminate this
Agreement, by notice to the Company, at any time at or prior to Closing Time (i)
if there has been, since the time of execution of this Agreement or since the
respective dates as of which information is given in the Prospectus or the
Offering Circular, any material adverse change in the condition, financial or
otherwise, or in the earnings, business affairs or business prospects of the
Company or the Bank and its subsidiaries considered as one enterprise, whether
or not arising in the ordinary course of business, or (ii) if there has occurred
any material adverse change in the financial markets in the United States, any
outbreak of hostilities or escalation thereof or other calamity or crisis or any
change or development involving a prospective change in national or
international political, financial or economic conditions, in each case the
effect of which is such as to make it, in the judgment of the Representatives,
impracticable to market the Securities or to enforce contracts for the sale of
the Securities, or (iii) if trading in any securities of
28
<PAGE>
the Company has been suspended or materially limited by the Commission or the
New York Stock Exchange, or if trading generally on the American Stock Exchange
or the New York Stock Exchange or in the Nasdaq National Market has been
suspended or materially limited, or minimum or maximum prices for trading have
been fixed, or maximum ranges for prices have been required, by any of said
exchanges or by such system or by order of the Commission, the National
Association of Securities Dealers, Inc. or any other governmental authority, or
(iv) if a banking moratorium has been declared by either Federal or New York
authorities.
(b) Liabilities. If this Agreement is terminated pursuant to this
Section, such termination shall be without liability of any party to any other
party except as provided in Section 4 hereof, and provided further that Sections
1, 6, 7, and 8 shall survive such termination and remain in full force and
effect.
SECTION 10. Default by One or More of the Underwriters. If one or more of
------------------------------------------
the Underwriters shall fail at Closing Time or a Date of Delivery to purchase
the Securities which it or they are obligated to purchase under this Agreement
(the "Defaulted Securities"), the Representatives shall have the right, within
24 hours thereafter, to make arrangements for one or more of the non-defaulting
Underwriters, or any other underwriters, to purchase all, but not less than all,
of the Defaulted Securities in such amounts as may be agreed upon and upon the
terms herein set forth; if, however, the Representatives shall not have
completed such arrangements within such 24-hour period, then:
(a) if the number of Defaulted Securities does not exceed 10% of
the number of Securities to be purchased on such date, each of the non-
defaulting Underwriters shall be obligated, severally and not jointly, to
purchase the full amount thereof in the proportions that their respective
underwriting obligations hereunder bear to the underwriting obligations of
all non-defaulting Underwriters, or
(b) if the number of Defaulted Securities exceeds 10% of the
number of Securities to be purchased on such date, this Agreement or, with
respect to any Date of Delivery which occurs after the Closing Time, the
obligation of the Underwriters to purchase and of the Company to sell the
Option Securities to be purchased and sold on such Date of Delivery shall
terminate without liability on the part of any non-defaulting Underwriter.
No action taken pursuant to this Section shall relieve any defaulting
Underwriter from liability in respect of its default.
In the event of any such default which does not result in a termination of
this Agreement or, in the case of a Date of Delivery which is after the Closing
Time, which does not result in a termination of the obligation of the
Underwriters to purchase and the Company to sell the relevant Option Securities,
as the case may be, either the Representatives or the Company shall have the
right to postpone Closing Time or the relevant Date of Delivery, as the case may
be, for a period not exceeding seven days in order to effect any required
changes in the Registration Statement or Prospectus or in any other documents or
29
<PAGE>
arrangements. As used herein, the term "Underwriter" includes any person
substituted for an Underwriter under this Section 10.
SECTION 11. Notices. All notices and other communications hereunder shall
-------
be in writing and shall be deemed to have been duly given if mailed or
transmitted by any standard form of telecommunication. Notices to the
Underwriters shall be directed to Merrill Lynch at North Tower, World Financial
Center, New York, New York 10281-1201, attention of ____________; notices to the
Company shall be directed to it at 8401 Connecticut Avenue, Chevy Chase,
Maryland 20815, attention of Stephen R. Halpin, Jr.; and notices to the Bank
shall be directed to it at 8251 Greensboro Drive, McLean, Virginia, attention of
Stephen R. Halpin Jr.
SECTION 12. Parties. This Agreement shall each inure to the benefit of
-------
and be binding upon the Underwriters, the Company and the Bank and their
respective successors. Nothing expressed or mentioned in this Agreement is
intended or shall be construed to give any person, firm or corporation, other
than the Underwriters, the Company and the Bank and their respective successors
and the controlling persons and officers and directors referred to in Sections 6
and 7 and their heirs and legal representatives, any legal or equitable right,
remedy or claim under or in respect of this Agreement or any provision herein
contained. This Agreement and all conditions and provisions hereof are intended
to be for the sole and exclusive benefit of the Underwriters, the Company and
the Bank and their respective successors, and said controlling persons and
officers and directors and their heirs and legal representatives, and for the
benefit of no other person, firm or corporation. No purchaser of Securities from
any Underwriter shall be deemed to be a successor by reason merely of such
purchase.
SECTION 13. GOVERNING LAW AND TIME. THIS AGREEMENT SHALL BE GOVERNED BY
----------------------
AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. EXCEPT AS
OTHERWISE SET FORTH HEREIN, SPECIFIED TIMES OF DAY REFER TO NEW YORK CITY TIME.
SECTION 14. Effect of Headings. The Article and Section headings herein
------------------
are for convenience only and shall not affect the construction hereof.
30
<PAGE>
If the foregoing is in accordance with your understanding of our agreement,
please sign and return to each of the Company and the Bank a counterpart hereof,
whereupon this instrument, along with all counterparts, will become a binding
agreement between the Underwriters and the Company and the Bank in accordance
with its terms.
Very truly yours,
CHEVY CHASE PREFERRED CAPITAL
CORPORATION
By_____________________________
Title:
CHEVY CHASE BANK, F.S.B.
By______________________________
Title:
CONFIRMED AND ACCEPTED,
as of the date first above written:
MERRILL LYNCH & CO.
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
SMITH BARNEY INC.
By: MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
By_____________________________________________
Authorized Signatory
For themselves and as Representatives of the other Underwriters named in
Schedule A hereto.
31
<PAGE>
SCHEDULE A
<TABLE>
<CAPTION>
Underwriters Number of
------------ Initial
Securities
----------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated
Friedman, Billings, Ramsey & Co., Inc.
Smith Barney Inc.
________
Total................................... 10,000,000
==========
</TABLE>
Sch A - 1
<PAGE>
SCHEDULE B
CHEVY CHASE PREFERRED CAPITAL CORPORATION
10,000,000 Shares
___% Noncumulative Exchangeable Preferred Stock, Series A
1. The initial public offering price per share for the Securities,
determined as provided in said Section 2, shall be $25.00.
2. The purchase price per share for the Securities to be paid by the
several Underwriters shall be $____, being an amount equal to the initial public
offering price set forth above less $___ per share; provided that the purchase
price per share for any Option Securities purchased upon the exercise of the
over-allotment option described in Section 2(b) shall be reduced by an amount
per share equal to any dividends or distributions declared by the Company and
payable on the Initial Securities but not payable on the Option Securities.
3. The dividend rate on the Securities will be ___% per annum.
Sch B - 1
<PAGE>
SCHEDULE C
[LIST OF OTHER AGREEMENTS ENTERED INTO BY THE COMPANY]
Sch C-1
<PAGE>
EXHIBIT 3(a)(ii)
ARTICLES OF AMENDMENT AND RESTATEMENT
OF
CHEVY CHASE PREFERRED CAPITAL CORPORATION
CHEVY CHASE PREFERRED CAPITAL CORPORATION, a Maryland corporation having
its principal office in the State of Maryland at 8401 Connecticut Avenue, Chevy
Chase, Maryland 20815 (hereinafter, the "Corporation"), hereby certifies to the
Department of Assessments and Taxation of the State of Maryland, that:
FIRST: The Corporation desires to amend and restate its charter as
currently in effect.
SECOND: The provisions of the charter which are now in effect and as
amended hereby, stated in accordance with the Maryland General Corporation Law
(the "Charter"), are as follows:
FIRST AMENDED AND RESTATED
ARTICLES OF INCORPORATION
OF
CHEVY CHASE PREFERRED CAPITAL CORPORATION
__________________________________
ARTICLE I
NAME
The name of the Corporation is Chevy Chase Preferred Capital Corporation.
ARTICLE II
DURATION
The duration of the Corporation is perpetual.
<PAGE>
ARTICLE III
PURPOSES AND POWERS
The purposes for which the Corporation is formed are to conduct any
business for which corporations may be organized under the laws of the State of
Maryland including, but not limited to, the following: (i) to acquire, hold,
own, develop, construct, improve, maintain, operate, sell, lease, transfer,
encumber, convey, exchange and otherwise dispose of or deal with real and
personal property directly or through one or more subsidiaries or affiliates;
(ii) to enter into any partnership, joint venture or other similar arrangement
to engage in any of the foregoing; and (iii) in general, to possess and exercise
all the purposes, powers, rights and privileges granted to, or conferred upon
corporations by the laws of the State of Maryland now or hereafter in force, and
to exercise any powers suitable, convenient or proper for the accomplishment of
any of the purposes herein enumerated, implied or incidental to the powers or
purposes herein specified, or which at any time may appear conducive to or
expedient for the accomplishment of any such purposes.
The foregoing shall, except where otherwise expressed, in no way be limited
or restricted by reference to or inference from the terms of any other clause of
this or any other provision of this Charter or of any amendment hereto or
restatement hereof, and shall each be regarded as independent, and construed as
powers as well as purposes.
ARTICLE IV
PRINCIPAL OFFICE AND RESIDENT AGENT
The post office address of the principal office of the Corporation in the
State of Maryland is 8401 Connecticut Avenue, Chevy Chase, Maryland 20815. The
name and address of the resident agent of the Corporation is The Corporation
Trust Incorporated, 32 South Street, Baltimore, Maryland 21202. Said resident
agent is a Maryland corporation.
ARTICLE V
AUTHORIZED STOCK
SECTION 5.1 Total Capitalization.
The total number of shares of all classes of capital stock that the
Corporation has authority to issue is Twenty Million One Thousand (20,001,000)
shares, consisting of (i) Ten Million (10,000,000) shares of preferred stock,
par value $5.00 per share (the "Preferred Stock"); (ii) One Thousand (1,000)
shares of common stock, par value $1.00 per share (the "Common Stock"); and
-2-
<PAGE>
(iii) Ten Million (10,000,000) shares of excess stock, par value $5.00 per share
(the "Excess Stock"). The aggregate par value of all of the authorized shares
of all classes of capital stock having par value is Thirty Million One Thousand
Dollars ($30,001,000).
SECTION 5.2. Preferred Stock.
The Preferred Stock may be issued from time to time in one or more series
as authorized by the Board of Directors. Prior to the issuance of shares of
each such series, the Board of Directors, by resolution, shall fix the number of
shares to be included in each series and the terms, rights, restrictions and
qualifications of the shares of each series. The authority of the Board of
Directors with respect to each series shall include, but not be limited to,
determination of the following:
(i) The designation of the series, which may be by distinguishing
number, letter or title.
(ii) The dividend rate on the shares of the series, if any, whether
any dividends shall be cumulative and, if so, from which date
or dates, and the relative rights of priority, if any, of
payment of dividends on shares of the series.
(iii) The redemption rights, including conditions and the price or
prices, if any, for shares of the series.
(iv) The terms and amounts of any sinking fund for the purchase or
redemption of shares of the series.
(v) The rights of the shares of the series in the event of any
voluntary or involuntary liquidation, dissolution or winding up
of the affairs of the Corporation, and the relative rights of
priority, if any, of payment of shares of the series.
(vi) Whether the shares of the series shall be convertible into
shares of any other class or series, or any other security, of
the Corporation or any other corporation or other entity, and,
if so, the specification of such other class or series of such
other security, the conversion price or prices or rate or
rates, any adjustments thereof, the date or dates on which such
shares shall be convertible and all other terms and conditions
upon which such conversion may be made.
(vii) Restrictions on the issuance or reissuance of shares of the
same series or of any other class or series.
(viii) The voting rights, if any, of the holders of shares of the
series; provided, however, that in no event shall any holder of
shares of
-3-
<PAGE>
Preferred Stock be entitled to more than one vote for each
share of such Preferred Stock held by it.
(ix) Any other relative rights, preferences and limitations on that
series.
Subject to the express provisions of any other series of Preferred Stock
then outstanding, and notwithstanding any other provision of this Charter, the
Board of Directors may increase or decrease (but not below the number of shares
of such series then outstanding) the number of shares, or alter the designation
or classify or reclassify any unissued shares of a particular series of
Preferred Stock, by fixing or altering, in one or more respects, from time to
time before issuing the shares, the terms, rights, restrictions and
qualifications of the shares of any such series of Preferred Stock.
SECTION 5.3 Common Stock.
(A) Common Stock Subject to Terms of Preferred Stock. Notwithstanding
------------------------------------------------
any other provision of this Charter, the Common Stock shall be subject to the
express terms of any series of Preferred Stock.
(B) Dividend Rights. The holders of shares of Common Stock shall be
---------------
entitled to receive such dividends as may be declared by the Board of Directors
of the Corporation out of funds legally available therefor.
(C) Balancing Distributions. The Board of Directors is authorized to
-----------------------
establish procedures for (i) regularly determining the value of the Common Stock
relative to the value of the Corporation and (ii) distributing cash or property
to the holders of Common Stock at times when it is determined that the value of
the Common Stock exceeds 52 percent of the value of the Corporation.
Distributions made under such procedures ("Balancing Distributions") shall be in
an amount sufficient to reduce the value of the Common Stock to less than 52
percent of the value of the Corporation, but shall not be in an amount that will
reduce the value of the Common Stock to less than 50 percent of the value of the
Corporation.
(D) Rights Upon Liquidation. In the event of any voluntary or
-----------------------
involuntary liquidation, dissolution or winding up, or any distribution of the
assets of the Corporation, the aggregate assets available for distribution to
holders of shares of the Common Stock shall be determined in accordance with
applicable law. Each holder of shares of Common Stock shall be entitled to
receive, ratably with each other holder of shares of Common Stock, that portion
of such aggregate assets available for distribution as the number of shares of
the outstanding Common Stock held by such holder bears to the total number of
shares of outstanding Common Stock then outstanding.
(E) Voting Rights. Except as may be provided in this Charter, and
-------------
subject to the express terms of any series of Preferred Stock, the holders of
shares of the Common Stock shall have the exclusive right to vote on all matters
(as to which a common stockholder shall be entitled to vote pursuant to
applicable law) at all meetings of the stockholders of the Corporation, and
-4-
<PAGE>
shall be entitled to one (1) vote for each share of the Common Stock entitled to
vote at such meeting.
SECTION 5.4 Restrictions on Ownership, Transfer, Acquisition and
Redemption of Shares.
(A) Definitions. For purposes of Sections 5.4 and 5.5 hereof, the
-----------
following terms shall have the following meanings:
"Acquire" shall mean the acquisition of Beneficial Ownership of
shares of Preferred Stock by any means, including, without limitation, the
exercise of any rights under any option, warrant, convertible security, pledge
or other security interest or similar right to acquire shares, but shall not
include the acquisition of any such rights unless, as a result, the acquirer
would be considered a Beneficial Owner. The terms "Acquires" and "Acquisition"
shall have correlative meanings.
"Beneficial Ownership" shall mean ownership of shares of Preferred
Stock by an Individual, either directly or constructively through the
application of Section 544 of the Code, as modified by Section 856(h)(1)(B) of
the Code. The terms "Beneficial Owner," "Beneficially Own," "Beneficially Owns"
and "Beneficially Owned" shall have correlative meanings.
"Beneficiary" shall mean a beneficiary of the Trust as determined
pursuant to paragraph (E) of Section 5.5.
"Board of Directors" shall mean the Board of Directors of the
Corporation.
"Bylaws" shall mean the Bylaws of the Corporation, as the same are in
effect from time to time.
"Closing Price" on any day shall mean the last sale price, regular
way on such day, or, if no such sale takes place on that day, the average of the
closing bid and asked prices, regular way, in either case as reported on the
principal consolidated transaction reporting system with respect to securities
listed or admitted to trading on the New York Stock Exchange, or if the affected
series of Preferred Stock is not so listed or admitted to trading, as reported
in the principal consolidated transaction reporting system with respect to
securities listed on the principal national securities exchange (including the
National Market System of the National Association of Securities Dealers, Inc.
Automated Quotation System) on which the affected series of Preferred Stock is
listed or admitted to trading or, if the affected series of Preferred Stock is
not so listed or admitted to trading, the last quoted price or, if not quoted,
the average of the high bid and low asked prices in the over-the-counter market,
as reported by the National Association of Securities Dealers, Inc. Automated
Quotation System or, if such system is no longer in use, the principal automated
quotation system then in use or, if the affected series of Preferred Stock is
not so quoted by any such system, the average of the closing bid and asked
prices as furnished by a professional market maker selected by the Board of
Directors making a market in the affected series of Preferred Stock, or, if
there is no such market maker or such closing prices otherwise are
-5-
<PAGE>
not available, the fair market value of the affected series of Preferred Stock
as of such day, as determined by the Board of Directors in its discretion.
"Code" shall mean the Internal Revenue Code of 1986, as amended from
time to time, or any successor statute thereto. Reference to any provision of
the Code shall mean such provision as in effect from time to time, as the same
may be amended, and any successor provision thereto, as interpreted by any
applicable regulations as in effect from time to time.
"Excess Stock" shall have the meaning set forth in paragraph (C) of
this Section 5.4.
"Individual" shall mean a natural person or any entity considered an
individual for purposes of Section 542(a)(2) of the Code.
"Initial Public Offering" shall mean the closing of the sale of shares
of Preferred Stock pursuant to the Corporation's first effective registration
statement for such Preferred Stock, filed under the Securities Act of 1933, as
amended.
"Market Price" on any day shall mean the average of the Closing Prices
for the ten (10) consecutive Trading Days immediately preceding such day (or
those days during such 10-day period for which Closing Prices are available).
"Person" shall mean an individual, corporation, partnership, estate,
trust (including a trust qualified under Section 401(a) or 501(c)(17) of the
Code), a portion of a trust permanently set aside for or to be used exclusively
for the purposes described in Section 642(c) of the Code, association, private
foundation within the meaning of Section 509(a) of the Code, joint stock company
or other entity, or a group as that term is used for purposes of Section
13(d)(3) of the Securities Exchange Act of 1934, as amended; but does not
include an underwriter which participated in a public offering of Preferred
Stock for a period of sixty (60) days following the purchase by such underwriter
of such Preferred Stock therein, provided that the foregoing exclusion shall
apply only if the ownership of such Preferred Stock by an underwriter or
underwriters participating in a public offering would not cause the Corporation
to fail to qualify as a REIT by reason of being "closely held" within the
meaning of Section 856(a) of the Code or otherwise cause the Corporation to
fail to qualify as a REIT.
"Preferred Stock Ownership Limit" shall mean 1.0 percent of the
outstanding shares of a particular series of Preferred Stock of the Corporation,
subject to adjustment pursuant to paragraph (J) of this Section 5.4 (but not
more than 2.0 percent of the outstanding shares of Preferred Stock, as so
adjusted) and to the limitations contained in paragraph (K) of this Section 5.4.
"Purported Beneficial Holder" shall mean, with respect to any event or
transaction other than a purported Transfer or Acquisition which results in
Excess Stock, the Person for whom the applicable Purported Record Holder held
the shares of Preferred Stock that were, pursuant to paragraph (C) of this
Section 5.4, automatically exchanged for Excess Stock
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<PAGE>
upon the occurrence of such event or transaction. The Purported Beneficial
Holder and the Purported Record Holder may be the same Person.
"Purported Beneficial Transferee" shall mean, with respect to any
purported Transfer or Acquisition which results in Excess Stock, the purported
beneficial transferee for whom the Purported Record Transferee would have
acquired shares of Preferred Stock if such Transfer or Acquisition had been
valid under paragraph (B) of this Section 5.4. The Purported Beneficial
Transferee and the Purported Record Transferee may be the same Person.
"Purported Record Holder" shall mean, with respect to any event or
transaction other than a purported Transfer or Acquisition which results in
Excess Stock, the record holder of the shares of Preferred Stock that were,
pursuant to paragraph (C) of this Section 5.4, automatically exchanged for
Excess Stock upon the occurrence of such an event or transaction. The Purported
Record Holder and the Purported Beneficial Holder may be the same Person.
"Purported Record Transferee" shall mean, with respect to any
purported Transfer or Acquisition which results in Excess Stock, the record
holder of the Preferred Stock if such Transfer had been valid under
paragraph (B) of this Section 5.4. The Purported Record Transferee and the
Purported Beneficial Transferee may be the same Person.
"REIT" shall mean a real estate investment trust under Sections 856
through 860 of the Code.
"Restriction Termination Date" shall mean the first day after the date
of the Initial Public Offering on which the Board of Directors and the
stockholders of the Corporation determine that it is no longer in the best
interests of the Corporation to attempt, or continue, to qualify as a REIT.
"Saul Family Member" shall mean B.F. Saul II, Theresa Gardner Lyons
and Andrew Joseph Poljevka and, with respect to any of them, any sibling
(whether by the whole or half blood), spouse, ancestor or lineal descendant
thereof (provided that in the event the definition of "Family" pursuant to
Section 544(a)(2) of the Code shall be amended, the foregoing shall be deemed to
be similarly amended), as well as any entities owned or controlled by such
individuals.
"Trading Day" shall mean a day on which the principal national
securities exchange on which the affected series of Preferred Stock is listed or
admitted to trading is open for the transaction of business or, if the affected
series of Preferred Stock is not listed or admitted to trading, shall mean any
day other than a Saturday, Sunday or other day on which banking institutions in
the State of New York are authorized or obligated by law or executive order to
close.
"Transfer" shall mean any sale, transfer, gift, hypothecation,
assignment, devise or other disposition of a direct or indirect interest in
Preferred Stock or the right to vote or receive dividends on Preferred Stock
(including (i) the granting of any option (including any option to acquire an
option or any series of such options) or entering into any agreement for the
-7-
<PAGE>
sale, transfer or other disposition of Preferred Stock or the right to vote or
receive dividends on Preferred Stock or (ii) the sale, transfer, assignment or
other disposition of any securities or rights convertible into or exchangeable
for Preferred Stock, whether voluntary or involuntary, of record, constructively
or beneficially, and whether by operation of law or otherwise. The terms
"Transfers," "Transferred" and "Transferable" shall have correlative meanings.
"Trust" shall mean the trust created pursuant to paragraph (A) of
Section 5.5.
"Trustee" shall mean the Corporation as trustee for the Trust, and any
successor trustee appointed by the Corporation.
(B) Ownership and Transfer Limitations.
----------------------------------
(1) Notwithstanding any other provision of this Charter, except as
provided in paragraph (I) of this Section 5.4 and Section 5.6, from the date of
the Initial Public Offering and prior to the Restriction Termination Date, no
Individual shall Beneficially Own shares of Preferred Stock in excess of the
Preferred Stock Ownership Limit, and no Individual shall Beneficially Own shares
of Preferred Stock in an amount that (in combination with the Beneficial
Ownership of the Common Stock and the other shares of Preferred Stock) would
cause the Corporation to fail to qualify as a REIT by reason of being "closely
held" within the meaning of Section 856(h) of the Code or otherwise.
(2) Notwithstanding any other provision of this Charter, except as
provided in paragraph (I) of this Section 5.4 and Section 5.6, from the date of
the Initial Public Offering and prior to the Restriction Termination Date, any
Transfer, Acquisition, change in the capital structure of the Corporation, or
other purported change in Beneficial Ownership of Preferred Stock or other event
or transaction that, if effective, would result in any Individual Beneficially
Owning Preferred Stock in excess of the Preferred Stock Ownership Limit shall be
void ab initio as to the Transfer, Acquisition, change in the capital structure
-- ------
of the Corporation, or other purported change in Beneficial Ownership or other
event or transaction with respect to that number of shares of Preferred Stock
which would otherwise be Beneficially Owned by such Individual in excess of the
Preferred Stock Ownership Limit, and none of the Purported Beneficial
Transferee, the Purported Record Transferee, the Purported Beneficial Holder or
the Purported Record Holder, as applicable, shall acquire any rights in that
number of shares of Preferred Stock.
(3) Notwithstanding any other provision of this Charter, except as
provided in Section 5.6, from the date of the Initial Public Offering and prior
to the Restriction Termination Date, any Transfer, Acquisition, change in the
capital structure of the Corporation, or other purported change in Beneficial
Ownership (including actual ownership) of shares of Preferred Stock or other
event or transaction that, if effective, would result in the Preferred Stock
being actually owned by fewer than one hundred (100) Persons (determined without
reference to any rules of attribution) shall be void ab initio as to the
-- ------
Transfer, Acquisition, change in the capital structure of the Corporation, or
other purported change in Beneficial Ownership (including actual ownership) or
other event or transaction with respect to that number of shares of Preferred
Stock which otherwise would be owned by the transferee, and the intended
transferee or subsequent
-8-
<PAGE>
owner (including a Beneficial Owner) shall acquire no rights in that number of
shares of Preferred Stock.
(4) Notwithstanding any other provision of this Charter, except as
provided in Section 5.6, from the date of the Initial Public Offering and prior
to the Restriction Termination Date, any Transfer, Acquisition, change in the
capital structure of the Corporation, or other purported change in Beneficial
Ownership of shares of Preferred Stock or other event or transaction that, if
effective, would cause the Corporation to fail to qualify as a REIT by reason of
being "closely held" within the meaning of Section 856(h) of the Code or
otherwise, directly or indirectly, would cause the Corporation to fail to
qualify as a REIT shall be void ab initio as to the Transfer, Acquisition,
-- ------
change in the capital structure of the Corporation, or other purported change in
Beneficial Ownership or other event or transaction with respect to that number
of shares of Preferred Stock which would cause the Corporation to be "closely
held" within the meaning of Section 856(h) of the Code or otherwise, directly or
indirectly, would cause the Corporation to fail to qualify as a REIT, and none
of the Purported Beneficial Transferee, the Purported Record Transferee, the
Purported Beneficial Holder or the Purported Record Holder shall acquire any
rights in that number of shares of Preferred Stock.
(5) Notwithstanding any other provision of this Charter, except as
provided in Section 5.6, from the date of the Initial Public Offering and prior
to the Restriction Termination Date, any Transfer, Acquisition, change in the
capital structure of the Corporation, or other purported change in Beneficial
Ownership of Preferred Stock or other event or transaction that, if effective,
would result in any Saul Family Member Beneficially Owning any Preferred Stock
shall be void ab initio as to the Transfer, Acquisition, change in the capital
-- ------
structure of the Corporation, or other purported change in Beneficial Ownership
or other event or transaction with respect to that number of shares of Preferred
Stock which would otherwise be Beneficially Owned by such Saul Family Member,
and no Saul Family Member shall acquire any rights in that number of shares of
Preferred Stock.
(C) Exchange for Excess Stock.
-------------------------
(1) If, notwithstanding the other provisions contained in this
Article V, at any time after the date of the Initial Public Offering and prior
to the Restriction Termination Date, there is a purported Transfer, Acquisition,
change in the capital structure of the Corporation, or other purported change in
the Beneficial Ownership of Preferred Stock or other event or transaction such
that (i) any Individual would Beneficially Own Preferred Stock in excess of the
Preferred Stock Ownership Limit, then, except as otherwise provided in
paragraph (I) of this Section 5.4, such number of shares of Preferred Stock
(rounded up to the next whole number of shares) in excess of the Preferred Stock
Ownership Limit (whether such Preferred Stock is actually held by the Beneficial
Owner or by some other Person) automatically shall be exchanged for an equal
number of shares of Excess Stock having terms, rights, restrictions and
qualifications identical thereto, except to the extent that this Article V
requires different terms. Such exchange shall be effective as of the close of
business on the business day next preceding the date of the purported Transfer,
Acquisition, change in capital structure, or other purported change in
Beneficial Ownership of Preferred Stock or other event or transaction.
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<PAGE>
(2) If, notwithstanding the other provisions contained in this
Article V, at any time after the date of the Initial Public Offering and prior
to the Restriction Termination Date, the Beneficial Ownership of the Common
Stock and Preferred Stock is such that the Corporation would (but for this
subparagraph) fail to qualify as a REIT by reason of being "closely held" within
the meaning of Section 856(h) of the Code, then shares of Preferred Stock in an
amount sufficient to prevent the Corporation from being "closely held" (rounded
up to the next whole number of shares) shall be exchanged for an equal number of
shares of Excess Stock having terms, rights, restrictions and qualifications
identical thereto, except to the extent that this Article V requires different
terms. The shares of Preferred Stock automatically exchanged for Excess Stock
under this subparagraph shall be chosen on a share-by-share basis and shall be
those shares Beneficially Owned by the Beneficial Owner or Owners of the largest
number of shares of Preferred Stock at the time of the exchange, after giving
effect to any prior exchanges of shares of Preferred Stock for shares of Excess
Stock under this subparagraph. If more than one Individual Beneficially Owns the
same number of Preferred Stock, after giving effect to any prior exchanges of
shares of Preferred Stock for shares of Excess Stock under this subparagraph,
and such number of shares is the largest number of shares of Preferred Stock
Beneficially Owned by any Individual, then the shares Preferred Stock exchanged
under this subparagraph shall be chosen on an alternating share-by-share basis
from each of the largest Beneficial Owners of the Preferred Stock. An automatic
exchange under this subparagraph shall be effective as of the close of business
on the business day next preceding the date that the Corporation would otherwise
fail to qualify as a REIT by reason of being "closely held" within the meaning
of Section 856(h) of the Code. Notwithstanding the above, if the Beneficial
Ownership of the Common Stock is such that all of the shares of Preferred Stock
would otherwise be exchanged for shares of Excess Stock under this subparagraph,
then this subparagraph shall not apply and none of the shares of Preferred Stock
will be exchanged for shares of Excess Stock.
(3) If, notwithstanding the other provisions contained in this
Article V, at any time after the date of the Initial Public Offering and prior
to the Restriction Termination Date, there is a purported Transfer, Acquisition,
change in the capital structure of the Corporation, or other purported change in
Beneficial Ownership of Preferred Stock or other event or transaction which, if
effective, would result in a violation of any of the restrictions described in
subparagraphs (2), (3), (4) and (5) of paragraph (B) of this Section 5.4 or,
directly or indirectly, would for any reason cause the Corporation to fail to
qualify as a REIT, then the number of shares of Preferred Stock (rounded up to
the next whole number of shares) being Transferred or Acquired or which are
otherwise affected by the change in capital structure or other purported change
in Beneficial Ownership or other event or transaction and which would result in
a violation of any of the restrictions described in subparagraphs (2), (3), (4)
and (5) of paragraph (B) of this Section 5.4 or, directly or indirectly, would
for any reason cause the Corporation to fail to qualify as a REIT, automatically
shall be exchanged for an equal number of shares of Excess Stock having terms,
rights, restrictions and qualifications identical thereto, except to the extent
that this Article V requires different terms. Such exchange shall be effective
as of the close of business on the business day next preceding the date of the
purported Transfer, Acquisition, change in capital structure, or other purported
change in Beneficial Ownership or other event or transaction.
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<PAGE>
(D) Remedies For Breach. If the Board of Directors or its designee
-------------------
shall at any time determine in good faith that a Transfer, Acquisition, or
change in the capital structure of the Corporation or other purported change in
Beneficial Ownership or other event or transaction has taken place in violation
of paragraph (B) of this Section 5.4 or that a Person intends to Acquire or has
attempted to Acquire ownership of any shares of Preferred Stock and such
acquisition would result in an Individual Beneficially Owning any shares of
Preferred Stock in violation of paragraph (B) of this Section 5.4, the Board of
Directors or its designee shall take such action as it deems advisable to refuse
to give effect to or to prevent such Transfer, Acquisition, or change in the
capital structure of the Corporation, or other attempt to Acquire Beneficial
Ownership of any shares of Preferred Stock or other event or transaction,
including, but not limited to, refusing to give effect thereto on the books of
the Corporation or instituting injunctive proceedings with respect thereto;
provided, however, that any Transfer, Acquisition, change in the capital
structure of the Corporation, attempted Transfer, or other attempt to Acquire
Beneficial Ownership of any shares of Preferred Stock or event or transaction in
violation of subparagraphs (2), (3), (4) or (5) of paragraph (B) of this
Section 5.4 (as applicable) shall be void ab initio and, where applicable,
-- ------
automatically shall result in the exchange described in paragraph (C) of this
Section 5.4, irrespective of any action (or inaction) by the Board of Directors
or its designee.
(E) Notice of Restricted Transfer. Any Person who Acquires or attempts
-----------------------------
to Acquire ownership of any shares of Preferred Stock when such acquisition
would result in an Individual Beneficially Owning shares of Preferred Stock in
violation of paragraph (B) of this Section 5.4 and any Person who owns Excess
Stock as a transferee of shares of Preferred Stock resulting in an exchange for
Excess Stock, pursuant to paragraph (C) of this Section 5.4, or otherwise,
immediately shall give written notice to the Corporation, or, in the event of a
proposed or attempted Transfer or Acquisition or purported change in Beneficial
Ownership, shall give at least fifteen (15) days prior written notice to the
Corporation, of such event and shall promptly provide to the Corporation such
other information as the Corporation, in its sole discretion, may request in
order to determine the effect, if any, of such Transfer, attempted Transfer,
Acquisition, attempted Acquisition or other purported change in Beneficial
Ownership on the Corporation's status as a REIT.
(F) Owners Required To Provide Information. From the date of the
--------------------------------------
Initial Public Offering and prior to the Restriction Termination Date:
(1) Every Beneficial Owner of more than 0.5 percent, or such lower
percentage or percentages as determined pursuant to regulations under the Code
or as may be requested by the Board of Directors in its sole discretion, of the
outstanding shares of any series of Preferred Stock of the Corporation annually
shall, no later than January 31 of each calendar year, give written notice to
the Corporation stating (i) the name and address of such Beneficial Owner; (ii)
the number of shares of each series of Preferred Stock Beneficially Owned; and
(iii) a description of how such shares are held. Each such Beneficial Owner
promptly shall provide to the Corporation such additional information as the
Corporation, in its sole discretion, may request in order to determine the
effect, if any, of such Beneficial Ownership on the Corporation's status
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<PAGE>
as a REIT and to ensure compliance with the Preferred Stock Ownership Limit and
other restrictions set forth herein.
(2) Each Individual who is a Beneficial Owner of Preferred Stock and
each Person (including the stockholder of record) who is holding Preferred Stock
for a Beneficial Owner promptly shall provide to the Corporation such
information as the Corporation, in its sole discretion, may request in order to
determine the Corporation's status as a REIT, to comply with the requirements of
any taxing authority or other governmental agency, to determine any such
compliance or to ensure compliance with the Preferred Stock Ownership Limit and
other restrictions set forth herein.
(G) Remedies Not Limited. Nothing contained in this Article V except
--------------------
Section 5.6 shall limit the scope or application of the provisions of this
Section 5.4, the ability of the Corporation to implement or enforce compliance
with the terms thereof or the authority of the Board of Directors to take any
such other action or actions as it may deem necessary or advisable to protect
the Corporation and the interests of its stockholders by preservation of the
Corporation's status as a REIT and to ensure compliance with the Preferred Stock
Ownership Limit and other restrictions set forth herein, including, without
limitation, refusal to give effect to a transaction on the books of the
Corporation.
(H) Ambiguity. In the case of ambiguity in the application of any of
---------
the provisions of this Section 5.4, including any definition contained in
paragraph (A) hereof, the Board of Directors shall have the power and authority,
in its sole discretion, to determine the application of the provisions of this
Section 5.4 with respect to any situation, based on the facts known to it.
(I) Exceptions. The Board of Directors, upon receipt of a ruling from
----------
the Internal Revenue Service, an opinion of counsel, or other evidence
satisfactory to the Board of Directors, in its sole discretion, in each case to
the effect that the restrictions contained in subparagraph (4) of paragraph (B)
of this Section 5.4 will not be violated, may waive or change, in whole or in
part, the application of the Preferred Stock Ownership Limit with respect to any
Person that is not an Individual. In connection with any such waiver or change,
the Board of Directors may require such representations and undertakings from
such Person or affiliates and may impose such other conditions, as the Board
deems necessary, advisable or prudent, in its sole discretion, to determine the
effect, if any, of the proposed transaction or ownership of Preferred Stock on
the Corporation's status as a REIT.
(J) Increase in Preferred Stock Ownership Limit. Subject to the
-------------------------------------------
limitations contained in paragraph (K) of this Section 5.4, the Board of
Directors may from time to time increase the Preferred Stock Ownership Limit.
(K) Limitations on Modifications.
----------------------------
(l) The Preferred Stock Ownership Limit may not be increased and no
additional ownership limitations may be created if, after giving effect to such
increase or creation, the Corporation would be "closely held" within the meaning
of Section 856(h) of the Code
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<PAGE>
(assuming ownership of shares of Preferred Stock by all Beneficial Owners of
such stock equal to the greatest of (i) their actual ownership, (ii) their
Beneficial Ownership, or (iii) the Preferred Stock Ownership Limit, and assuming
the Beneficial Ownership of all of the shares of Common Stock in equal amounts
by three Individuals).
(2) Prior to any modification of the Preferred Stock Ownership Limit
with respect to any Person, the Board of Directors may require such opinions of
counsel, affidavits, undertakings or agreements as it may deem necessary,
advisable or prudent, in its sole discretion, in order to determine or ensure
the Corporation's status as a REIT.
(3) The Preferred Stock Ownership Limit may not be increased to a
percentage that is greater than 2.0 percent.
(L) Legend. Each certificate for shares of Preferred Stock shall bear
------
substantially the following legend:
"The securities represented by this certificate are subject to
restrictions on transfer and ownership for the purpose of maintenance of
the Corporation's status as a real estate investment trust (a "REIT")
under Sections 856 through 860 of the Internal Revenue Code of 1986, as
amended (the "Code"). Except as otherwise provided pursuant to the
Charter of the Corporation, no Individual may (i) Beneficially Own
shares of Preferred Stock of the Corporation in excess of 1.0 percent
(or such greater percent as may be determined by the Board of Directors
of the Corporation) of the outstanding shares of such Preferred Stock;
or (ii) Beneficially Own Preferred Stock (of any series) which would
result in the Corporation being "closely held" under Section 856(h) of
the Code or which otherwise would cause the Corporation to fail to
qualify as a REIT. Any Person that has ownership, or who Acquires or
attempts to Acquire ownership of Preferred Stock where such ownership or
Acquisition of ownership of Preferred Stock would result in an
Individual having Beneficial Ownership, or Acquiring Beneficial
Ownership of Preferred Stock in excess of the above limitations and any
Person who owns Excess Stock as a transferee of shares of Preferred
Stock resulting in an exchange for Excess Stock (as described below)
immediately must notify the Corporation in writing or, in the event of a
proposed or attempted Transfer or Acquisition or purported change in
Beneficial Ownership, must give written notice to the Corporation at
least fifteen (15) days prior to the proposed or attempted transfer,
transaction or other event. Any Transfer or Acquisition of shares of
Preferred Stock or other event which results in violation of the
ownership or transfer limitations set forth in the Company's Charter
shall be void ab initio and the Purported Beneficial and Record
----------
Transferee shall not have or acquire any rights in such shares of
Preferred Stock. If the transfer and ownership limitations referred to
herein are violated, the shares of Preferred Stock represented hereby
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<PAGE>
automatically will be exchanged for shares of Excess Stock to the extent
of violation of such limitations, and such shares of Excess Stock will
be held in trust by the Corporation, all as provided by the Charter of
the Corporation. All defined terms used in this legend have the
meanings identified in the Corporation's Charter, as the same may be
amended from time to time, a copy of which, including the restrictions
on transfer, will be sent without charge to each stockholder who so
requests."
SECTION 5.5 Excess Stock.
(A) Ownership In Trust. Upon any purported Transfer, Acquisition,
------------------
change in the capital structure of the Corporation, or other purported change in
Beneficial Ownership or event or transaction that results in Excess Stock
pursuant to paragraph (C) of Section 5.4, such Excess Stock shall be deemed to
have been transferred to the Corporation, as Trustee of a Trust for the benefit
of such Beneficiary or Beneficiaries to whom an interest in such Excess Stock
may later be transferred pursuant to paragraph (E) of this Section 5.5. Shares
of Excess Stock so held in trust shall be issued and outstanding stock of the
Corporation. The Purported Record Transferee (or Purported Record Holder) shall
have no rights in such Excess Stock except the right to designate a transferee
of such Excess Stock upon the terms specified in paragraph (E) of this
Section 5.5. The Purported Beneficial Transferee (or Purported Beneficial
Holder) shall have no rights in such Excess Stock except as provided in
paragraphs (C) and (E) of this Section 5.5.
(B) Dividend Rights. Excess Stock shall not be entitled to any
---------------
dividends or distributions (except as provided in Paragraph (C) of this Section
5.5). Any dividend or distribution paid prior to the discovery by the
Corporation that the shares of Preferred Stock have been exchanged for Excess
Stock shall be repaid to the Corporation upon demand, and any dividend or
distribution declared but unpaid at the time of such discovery shall be void ab
--
initio with respect to such shares of Excess Stock.
- ------
(C) Rights Upon Liquidation. Except as provided below, in the event of
-----------------------
any voluntary or involuntary liquidation, dissolution or winding up, or any
other distribution of the assets, of the Corporation, each holder of shares of
Excess Stock resulting from the exchange of Preferred Stock of any specified
series shall be entitled to receive, ratably with each other holder of shares of
Excess Stock resulting from the exchange of shares of Preferred Stock of such
series and each holder of shares of Preferred Stock of such series, such accrued
and unpaid dividends, liquidation preferences and other preferential payments,
if any, as are due to holders of shares of Preferred Stock of such series. In
the event that holders of shares of any series of Preferred Stock are entitled
to participate in the Corporation's distribution of its residual assets, each
holder of shares of Excess Stock resulting from the exchange of
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<PAGE>
Preferred Stock of any such series shall be entitled to participate, ratably
with (i) each other holder of shares of Excess Stock resulting from the exchange
of shares of Preferred Stock of all series entitled to so participate; (ii) each
holder of shares of Preferred Stock of all series entitled to so participate;
and (iii) each holder of shares of Common Stock, that portion of the aggregate
assets available for distribution (determined in accordance with applicable law)
as the number of shares of such Excess Stock held by such holder bears to the
total number of (i) outstanding shares of Excess Stock resulting from the
exchange of Preferred Stock of all series entitled to so participate;
(ii) outstanding shares of Preferred Stock of all series entitled to so
participate; and (iii) outstanding shares of Common Stock. The Corporation, as
holder of the Excess Stock in trust, or, if the Corporation shall have been
dissolved, any trustee appointed by the Corporation prior to its dissolution,
shall distribute ratably to the Beneficiaries of the Trust, when determined, any
such assets received in respect of the Excess Stock in any liquidation,
dissolution or winding up, or any distribution of the assets, of the
Corporation. Anything to the contrary herein notwithstanding, in no event shall
the amount payable to a holder with respect to shares of Excess Stock resulting
from the exchange of shares of Preferred Stock exceed (i) the price per share
such holder paid for the Preferred Stock in the purported Transfer, Acquisition,
change in capital structure, or other transaction or event that resulted in the
Excess Stock or (ii) if the holder did not give full value for such Excess Stock
(as through a gift, devise or other event or transaction, including an
application of subparagraph (2) of paragraph (C) of Section 5.4), a price per
share equal to the Market Price for the shares of Preferred Stock on the date of
the purported Transfer, Acquisition, change in capital structure or other
transaction or event that resulted in such Excess Stock. Any amount available
for distribution in excess of the foregoing limitations shall be paid ratably to
the holders of shares of Preferred Stock and Excess Stock resulting from the
exchange of Preferred Stock to the extent permitted by the foregoing
limitations.
(D) Voting Rights. The holders of shares of Excess Stock shall not be
-------------
entitled to vote on any matters (except as required by the Maryland General
Corporation Law as in effect from time to time or any successor statute thereto
(the "MGCL")).
(E) Restrictions on Transfer; Designation of Beneficiary.
----------------------------------------------------
(1) Excess Stock shall not be Transferable. The Purported Record
--------------------------------------
Transferee (or Purported Record Holder) may freely designate a Beneficiary of
its interest in the Trust (representing the number of shares of Excess Stock
held by the Trust attributable to the purported Transfer that resulted in the
Excess Stock), if (i) the shares of Excess Stock held in the Trust would not be
Excess Stock in the hands of such Beneficiary and (ii) the Purported Beneficial
Transferee (or Purported Beneficial Holder) does not receive a price for
designating such Beneficiary that reflects a price per share for such Excess
Stock that exceeds (x) the price per share such Purported Beneficial Transferee
(or Purported Beneficial Holder) paid for the Preferred Stock in the purported
Transfer, Acquisition, change in capital structure, or other transaction or
event that resulted in the Excess Stock or (y) if the Purported Beneficial
Transferee (or Purported Beneficial Holder) did not give value for such shares
of Excess Stock in the purported Transfer, Acquisition, change in capital
structure, or other transaction or event (including an application of
subparagraph (2) of paragraph (C) of Section 5.4) that resulted in the Excess
Stock, a price per share equal to the Market Price for the shares of Preferred
Stock on the date of the purported Transfer, Acquisition, change in capital
structure, or other transaction or event that resulted in the Excess Stock.
Upon such Transfer of an interest in the Trust, the corresponding shares of
Excess Stock in the Trust automatically shall be exchanged for an equal number
of shares of Preferred Stock and such shares of Preferred Stock shall be
transferred of record to the Beneficiary of the interest in the Trust designated
by the Purported Record Transferee (or Purported Record Holder), as described
above, if such Preferred Stock would not
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<PAGE>
be Excess Stock in the hands of such Beneficiary. Prior to any Transfer of any
interest in the Trust, the Purported Record Transferee (or Purported Record
Holder) must give written notice to the Corporation of the intended Transfer and
the Corporation must have waived in writing its purchase rights under
paragraph (F) of this Section 5.5.
(2) Notwithstanding the foregoing, if a Purported Beneficial
Transferee (or Purported Beneficial Holder) receives a price for designating a
Beneficiary of an interest in the Trust that exceeds the amounts allowable under
subparagraph (1) of this paragraph (E), such Purported Beneficial Transferee (or
Purported Beneficial Holder) shall pay, or cause the Beneficiary of the interest
in the Trust to pay, such excess in full to the Corporation.
(3) If any of the Transfer restrictions set forth in this paragraph
(E) or any application thereof is determined to be void, invalid or
unenforceable by any court having jurisdiction over the issue, the Purported
Record Transferee (or Purported Record Holder) may be deemed, at the option of
the Corporation, to have acted as the agent of the Corporation in acquiring the
Excess Stock as to which such restrictions would otherwise, by their terms,
apply, and to hold such Excess Stock on behalf of the Corporation.
(F) Purchase Right in Excess Stock. Shares of Excess Stock shall be
------------------------------
deemed to have been offered for sale to the Corporation or its designee at a
price per share equal to the lesser of (i) the price per share in the
transaction that created such Excess Stock (or, in the case of a devise or gift
or event other than a Transfer or Acquisition which results in the issuance of
Excess Shares, including an application of subparagraph (2) of paragraph (C) of
Section 5.4, the Market Price at the time of the issuance of such Excess Shares)
or (ii) the Market Price of the Preferred Stock exchanged for such Excess Stock
on the date the Corporation or its designee accepts such offer. The Corporation
and its assignees shall have the right to accept such offer for a period of
ninety (90) days after the later of (i) the date of the purported Transfer,
Acquisition, change in capital structure of the Corporation, or purported change
in Beneficial Ownership or other event or transaction which resulted in such
Excess Stock and (ii) the date on which the Board of Directors determines in
good faith that a Transfer, Acquisition, change in capital structure of the
Corporation, or purported change in Beneficial Ownership or other event or
transaction resulting in Excess Stock has occurred, if the Corporation does not
receive a notice pursuant to paragraph (E) of Section 5.4, but in no event later
than a permitted Transfer pursuant to, and in compliance with, the terms of
paragraph (E) of this Section 5.5.
(G) Remedies Not Limited. Nothing contained in this Article V except
--------------------
Section 5.6 shall limit the scope or application of the provisions of this
Section 5.5, the ability of the Corporation to implement or enforce compliance
with the terms hereof or the authority of the Board of Directors to take any
such other action or actions as it may deem necessary or advisable to protect
the Corporation and the interests of its stockholders by preservation of the
Corporation's status as a REIT and to ensure compliance with the applicable
Ownership Limits and the other restrictions set forth herein, including, without
limitation, refusal to give effect to a transaction on the books of the
Corporation.
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<PAGE>
SECTION 5.6 Settlements.
Nothing in Sections 5.4 and 5.5 hereof shall preclude the settlement of any
transaction with respect to the Preferred Stock entered into through the
facilities of the New York Stock Exchange.
SECTION 5.7 Issuance of Rights to Purchase Securities and Other
Property.
Subject to the rights of the Holders of any series of Preferred Stock, the
Board of Directors is hereby authorized to create and to authorize and direct
the issuance (on either a pro rata or non-pro rata basis) by the Corporation of
rights, options or warrants for the purchase of shares of Common Stock or
Preferred Stock of the Corporation, other securities of the Corporation, or
shares or other securities of any successor in interest of the Corporation (a
"Successor"), at such times, in such amounts, to such persons, for such
consideration (if any), with such form and content (including without limitation
the consideration for which any shares of Common Stock or Preferred Stock of the
Corporation, other securities of the Corporation, or shares or other securities
of any Successor are to be issued) and upon such terms and conditions as it may,
from time to time, determine, subject only to the restrictions, limitations,
conditions and requirements imposed by the MGCL, other applicable laws and this
Charter. Without limiting the generality of the foregoing, the authority
granted hereby includes the authority to adopt a "rights plan" or similar plan
that treats stockholders in a discriminatory or non pro rata manner, based upon
the number of shares owned thereby or otherwise.
SECTION 5.8 Severability.
If any provision of this Article V or any application of any such provision
is determined to be void, invalid or unenforceable by any court having
jurisdiction over the issue, the validity and enforceability of the remainder of
this Article V shall not be affected and other applications of such provision
shall be affected only to the extent necessary to comply with the determination
of such court.
SECTION 5.9 Waiver.
The Corporation shall have authority at any time to waive the requirements
that Excess Stock be issued or be deemed outstanding in accordance with this
Article V if the Corporation determines, based on opinion of nationally
recognized tax counsel, that the issuance of such Excess Stock or the fact that
such Excess Stock is deemed to be outstanding, would jeopardize the status of
the Corporation as a REIT (as that term is defined in paragraph (A) of Section
5.4 hereof).
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<PAGE>
ARTICLE VI
BOARD OF DIRECTORS
The number of directors shall be no less than three (3), unless a lesser
number is permitted pursuant to the terms of the MGCL, nor more than eleven
(11). Subject to the foregoing, to Section 3.2 of the Bylaws and to the express
rights of the holders of any series of Preferred Stock to elect additional
directors under specified circumstances, the number of directors of the
Corporation shall be fixed by the Bylaws of the Corporation and may be increased
or deceased from time to time in such a manner as may be prescribed by the
Bylaws.
ARTICLE VII
MATTERS RELATING TO THE POWERS OF THE
CORPORATION AND ITS DIRECTORS AND STOCKHOLDERS
The following provisions are hereby adopted for the purpose of defining,
limiting and regulating the powers of the corporation and of the directors and
stockholders thereof:
SECTION 7.1 Matters Relating to the Corporation.
(A) Business Combinations. Notwithstanding any other provision of this
---------------------
Charter or any contrary provision of law, Title 3, subtitle 6 of the MGCL shall
not apply to any "business combination" (as defined in Section 3-601(e) of the
MGCL) of the Corporation and any or all of B. Francis Saul II and lineal
descendants, Chevy Chase Bank, F.S.B., the B.F. Saul Company, the B.F. Saul Real
Estate Investment Trust, and any and all other entities whether currently
existing or formed in the future affiliated with any of the foregoing.
(B) Control Share Acquisitions. Notwithstanding any other provision of
--------------------------
this Charter or any contrary provision of law, Title 3, subtitle 7 of the MGCL
shall not apply to any acquisition of shares of stock of the Corporation by any
and all of the following persons or entities:
(1) B. Francis Saul II and lineal descendants, Chevy Chase Bank,
F.S.B., the B.F. Saul Company, the B.F. Saul Real Estate Investment Trust, and
any and all other entities whether currently existing or formed in the future
affiliated with any of the foregoing;
(2) Directors, officers and employees of the Corporation and of any
partnership in which the Corporation is a general partner; and
(3) Any persons authorized by resolution of the board of directors of
the Corporation, in its discretion.
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<PAGE>
SECTION 7.2 Matters Relating to the Board of Directors.
(A) Authority as to Bylaws. Except as otherwise provided herein, in
----------------------
furtherance and not in limitation of the powers conferred by statute, the Board
of Directors is expressly authorized to make, alter, amend or repeal the Bylaws
of the Corporation and the Corporation may, in its Bylaws, confer powers on the
Board of Directors in addition to those contained herein or conferred by
applicable law.
(B) Authority as to Stock Issuances. The Board of Directors of the
-------------------------------
Corporation may authorize the issuance, from time to time, of shares of its
stock of any class or series, whether now or hereafter authorized, or securities
convertible into shares now or hereafter authorized, for such consideration as
the Board of Directors may deem advisable, subject to such restrictions or
limitations, if any, as may be set forth in the Charter or the Bylaws of the
Corporation or in the laws of the State of Maryland.
(C) Manner of Election. Unless and except to the extent that the Bylaws
------------------
of the Corporation shall so require, the election of directors of the
Corporation need not be by written ballot.
(D) Voluntary Bankruptcy. The affirmative vote of at least two-thirds
--------------------
of the Board of Directors is required in order for the Corporation to file a
voluntary petition of bankruptcy.
(E) Reserved Powers of Board. The enumeration and definition of
------------------------
particular powers of the Board of Directors included in this Article VII shall
in no way be limited or restricted by reference to or inference from the terms
of any other clause of this or any other provision of the Charter of the
Corporation, or construed or deemed by inference or otherwise in any manner to
exclude or limit the powers conferred upon the Board of Directors under the laws
of the State of Maryland as now or hereafter in force.
(F) Alteration of Authority Granted to the Board of Directors. The
---------------------------------------------------------
affirmative vote of that proportion of the then-outstanding shares of Common
Stock and Preferred Stock entitled to vote (the "Voting Stock") necessary to
approve an amendment to this Charter pursuant to the MGCL, voting together as a
single class, shall be required to amend, repeal or adopt any provision
inconsistent with Section 7.2 of this Article VII.
(G) REIT Qualification. The Board of Directors shall use its best
------------------
efforts to cause the Corporation and its stockholders to qualify for U.S.
federal income tax treatment in accordance with the provisions of the Code
applicable to REITs (as those terms are defined in paragraph (A) of Section 5.4
hereof). In furtherance of the foregoing, the Board of Directors shall use its
best efforts to take such actions as are necessary, and may take such actions as
it deems desirable (in its sole discretion) to preserve the status of the
Corporation as a REIT; provided, however, that in the event that the Board of
Directors determines, in its sole discretion, that it no longer is in the best
interests of the Corporation to qualify as a REIT, the Board of Directors shall
take such actions as are required by the Code, the MGCL and other applicable
law, to cause the matter of termination of qualification as a REIT (as that term
is defined in
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<PAGE>
paragraph (A) of Section 5.4 hereof) to be submitted to a vote of the
stockholders of the Corporation pursuant to paragraph (A) of Section 7.3.
SECTION 7.3 Matters Relating to the Stockholders.
(A) Voting. Except as otherwise provided by this Charter, any matter
------
(other than the election of directors) submitted to the stockholders for a vote
shall be decided by a majority of the votes entitled to be cast on the matter,
including, if applicable, the majority of votes entitled to be cast by each
class of stock entitled to vote separately on the matter.
(B) Termination of REIT Status. Anything contained in this Charter to
--------------------------
the contrary notwithstanding, the affirmative vote of the holders of a majority
of the then-outstanding shares of Voting Stock, voting as a single class, and
the approval of the Board of Directors, shall be required to terminate
voluntarily the Corporation's status as a REIT (as that term is defined in
paragraph (A) of Section 5.4).
(C) No Preemptive Rights. Except as may be expressly provided with
--------------------
respect to any series of Preferred Stock, no holders of stock of the
Corporation, of whatever class or series, shall have any preferential right of
subscription for the purchase of any shares of stock of any class or series or
for the purchase of any securities convertible into shares of stock of any class
or series of the Corporation other than such rights, if any, as the Board of
Directors, in its sole discretion, may determine, and for such consideration as
the Board of Directors, in its sole discretion, may fix; and except as may be
expressly provided with respect to any series of Preferred Stock, any shares of
stock of any class or series of convertible securities which the Board of
Directors may determine to offer for subscription to the holders of stock may,
as the Board of Directors shall determine in its sole discretion, be offered to
holders of any then-existing class, classes or series of stock or other
securities to the exclusion of holders of any or all other then-existing classes
or series of securities.
(D) Authority as to Bylaws. Except as otherwise specifically required
----------------------
by the MGCL, and in addition to any affirmative vote of the holders of any
particular class or series of the Voting Stock required by the MGCL, this
charter or the Bylaws of the Corporation with respect to any series of Preferred
Stock the affirmative vote of that proportion of the voting power of the Voting
Stock necessary to approve an amendment to this Charter pursuant to the MGCL,
voting together as a single class, may alter, amend or repeal any provision of
the Bylaws.
ARTICLE VIII
DIRECTORS' LIABILITY
No director or officer of the Corporation shall be liable to the
Corporation or to its stockholders for money damages except (i) to the extent
that it is established that such director or officer actually received an
improper benefit or profit in money, property or services for the amount of the
benefit or profit in money, property or services actually received or (ii) to
the
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<PAGE>
extent that a judgment or other final adjudication adverse to such director
or officer is entered in a proceeding based on a finding in such proceeding that
such director's or officer's action, or failure to act, was the result of active
and deliberate dishonesty and was material to the cause of action adjudicated in
the proceeding. In addition to, and not in limitation of, the foregoing, to the
maximum extent that Maryland law in effect from time to time permits limitation
of the liability of directors and officers, no director or officer of the
Corporation shall be liable to the Corporation or its stockholders for money
damages. Neither the amendment nor repeal of this Article VIII, nor the
adoption or amendment of any provision of the Charter or Bylaws of the
Corporation inconsistent with this Article VIII, shall apply to or affect in any
respect the applicability of the preceding sentence with respect to any act or
failure to act which occurred prior to such amendment, repeal or adoption.
ARTICLE IX
INDEMNIFICATION
Each Person who is or was or who agrees to become a director or officer of
the Corporation, or each person who, while a director of the Corporation, is or
was serving or who agrees to serve, at the request of the Corporation, as a
director, officer, partner, joint venturer, employee or trustee of another
corporation, partnership, joint venture, trust, employee benefit plan or other
enterprise (including the heirs, executors, administrators or estate of such
person), shall be indemnified by the Corporation, and shall be entitled to have
paid on his behalf or be reimbursed for reasonable expenses in advance of final
disposition of a proceeding, in accordance with the Bylaws of the Corporation,
to the full extent permitted from time to time by the MGCL (but, in the case of
any amendment to the MGCL, only to the extent that such amendment permits the
Corporation to provide broader indemnification rights than said law permitted
the Corporation to provide prior to such amendment) or any other applicable laws
presently or hereafter in effect. The Corporation shall have the power, with
the approval of the Board of Directors, to provide such indemnification and
advancement of expenses to any employee or agent of the Corporation, in
accordance with the Bylaws of the Corporation. Without limiting the generality
or the effect of the foregoing, the Corporation may enter into one or more
agreements with any person which provide for indemnification greater or
different than that provided in this Article IX. Any amendment or repeal of
this Article IX shall not adversely affect any right or protection existing
hereunder immediately prior to such amendment or repeal and shall not adversely
affect any right or protection then existing pursuant to any such
indemnification agreement.
ARTICLE X
AMENDMENT
The Corporation reserves the right at any time and from time to time to
amend, alter, change or repeal any provision contained in its Charter and any
other provisions authorized by the laws of the State of Maryland at the time in
force may be added or inserted in the manner now or
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<PAGE>
hereafter prescribed herein or by applicable law, and all rights, preferences
and privileges of whatsoever nature conferred upon stockholders, directors or
any other persons whomsoever by and pursuant to this Charter in its present form
or as hereafter amended are granted subject to the rights reserved in this
Article XI; provided, however, that any amendment or repeal of Articles VIII or
IX of this Charter or this Article X shall not adversely affect any right or
protection existing hereunder immediately prior to such amendment or repeal.
***************
THIRD: This amendment and restatement of the Charter of the Corporation
has been duly advised by the Board of Directors and approved by the stockholders
of the Corporation as required by law.
FOURTH: The Corporation currently has authority to issue one hundred (100)
shares of capital stock, all of one class of common stock, par value $1.00 per
share. The number, classes, par values and preferences, rights, powers,
restrictions, limitations, qualifications, terms and conditions of the shares of
capital stock that the Corporation will have authority to issue upon
effectiveness of this amendment and restatement of its Charter are as set forth
in Article V of the foregoing amendment and restatement of such Charter.
FIFTH: The current address of the principal office of the Corporation in
the State of Maryland is as set forth in ARTICLE IV of the foregoing amendment
and restatement of the Charter of the Corporation.
SIXTH: The name and address of the Corporation's current resident agent is
as set forth in ARTICLE IV of the foregoing amendment and restatement of the
Charter of the Corporation.
SEVENTH: The number of directors of the Corporation currently is four and
the names of the directors currently in office are as follows:
Alexander R. M. Boyle Leslie A. Nicholson
Stephen R. Halpin, Jr. B. Francis Saul II
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<PAGE>
IN WITNESS WHEREOF, Chevy Chase Preferred Capital Corporation has caused
these Articles of Amendment and Restatement to be signed in its name and on its
behalf on this ______ day of __________, 1996, by its President and Chief
Executive Officer, who acknowledges that these Articles are the act of the
Corporation and that, to the best of his knowledge, information and belief, and
under penalties for perjury, all matters and facts contained in these Articles
are true in all material respects.
CHEVY CHASE PREFERRED CAPITAL
CORPORATION
By: __________________________________
B. Francis Saul II
President and Chief Executive Officer
[Seal]
Attested: _________________________
Mary Lou Hayes
Secretary
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<PAGE>
Exhibit 3(a)(iii)
ARTICLES SUPPLEMENTARY
OF
___% NONCUMULATIVE EXCHANGEABLE PREFERRED STOCK, SERIES A
OF
CHEVY CHASE PREFERRED CAPITAL CORPORATION
Pursuant to Section 2-208 of the
Maryland General Corporation Law
CHEVY CHASE PREFERRED CAPITAL CORPORATION, a corporation organized and
existing under the laws of the State of Maryland (the "Corporation"), HEREBY
CERTIFIES that the following resolution was duly adopted by the Board of
Directors of the Corporation on _________, 1996, pursuant to authority conferred
upon the Board of Directors by the provisions of the Articles of Amendment and
Restatement of the Corporation, which authorize the issuance and classification
of up to 10,000,000 shares of preferred stock, $5.00 par value per share (the
"Preferred Stock"):
RESOLVED that the issuance and classification of ____ shares
of ___% Noncumulative Exchangeable Preferred Stock, Series A, $5.00 par
value per share, of the Corporation is hereby authorized, and the
designation, preferences, conversion or other rights, voting powers,
restrictions, limitations as to dividends, qualifications, and terms
and conditions of all ______ shares of this Series, in addition to
those set forth in the Corporation's Articles of Amendment and
Restatement, as the same may be amended or restated from time to time,
are hereby fixed as follows:
1. Designation. The designation of this Series shall be
-----------
___% Noncumulative Exchangeable Preferred Stock, Series A (hereinafter
referred to as the "Series A Preferred Shares" or the "Series"), and
the number of Series A Preferred Shares constituting this Series shall
be _____. The Series A Preferred Shares shall have a liquidation
preference of $50.00 per share. The number of authorized Series A
Preferred Shares may be reduced by further resolution duly adopted by
the Board of Directors of the Corporation and by the filing of articles
pursuant to the provisions of the Maryland General Corporation Law
stating that such reduction has been so authorized. The number of
authorized shares of this Series shall not be increased.
2. Dividends. (a) Dividends on the Series A Preferred Shares
---------
shall be payable at a rate of _____% per annum of the liquidation
preference, if, when and as declared by the Board of Directors of the
Corporation out of assets of the Corporation legally available
therefor. If declared, dividends on the Series A Preferred Shares shall
be payable quarterly in arrears on January 15, April 15, July 15 and
October 15 of each year (a "Dividend Period"), commencing on January
15, 1997. Dividends will accrue from the first day of each Dividend
Period, whether or not declared or paid for the prior Dividend Period.
Each declared dividend shall be payable to holders of record of the
Series A Preferred Shares as they appear at the close of business on
the stock register of the
<PAGE>
Corporation on such record date, not exceeding 45 days preceding the
payment date thereof, as shall be fixed by the Board of Directors of
the Corporation.
(b) Dividends shall be noncumulative. If the Board of
Directors of the Corporation fails to declare a dividend on the Series
A Preferred Shares for a Dividend Period, then holders of the Series A
Preferred Shares will have no right to receive a dividend for that
Dividend Period, and the Corporation will have no obligation to pay a
dividend for that Dividend Period, whether or not dividends are
declared and paid for any future Dividend Period with respect to either
the Series A Preferred Shares or the common stock, par value $0.01 per
share, of the Corporation (the "Common Stock").
(c) If full dividends on the Series A Preferred Shares for any
Dividend Period shall not have been declared and paid, or declared and
a sum sufficient for the payment thereof shall not have been set apart
for such payments, no dividends shall be declared or paid or set aside
for payment and no other distribution (including any Balancing
Distribution authorized by the Corporation's Articles of Amendment and
Restatement) shall be declared or made or set aside for payment upon
the Common Stock or any other capital stock of the Company ranking
junior to or on a parity with the Series A Preferred Shares as to
dividends or amounts upon liquidation, nor shall any Common Stock or
any other capital stock of the Company ranking junior to or on a parity
with the Series A Preferred Shares as to dividends or amounts upon
liquidation be redeemed, purchased or otherwise acquired for any
consideration (or any monies to be paid to or made available for a
sinking fund for the redemption of any such stock) by the Company
(except by conversion into or exchange for other capital stock of the
Company ranking junior to the Series A Preferred Shares as to dividends
and amounts upon liquidation), until such time as dividends on all
outstanding Series A Preferred Shares have been (i) declared and paid
declared for three consecutive dividend periods and (ii) declared and
paid or declared and a sum sufficient for the payment thereof has been
set apart for payment for the fourth consecutive Dividend Period.
Notwithstanding the above, nothing in this subparagraph shall prevent
the Company from treating an amount consented to by the holder of the
Common Stock under the provisions of section 565 of the Internal
Revenue Code of 1986, as amended (the "Code"), as a dividend for
purposes of the dividends paid deduction under section 561 of the Code.
(d) When dividends are not paid in full (or a sum sufficient
for such full payment is not set apart) upon the Series A Preferred
Shares and the shares of any other series of capital stock ranking on a
parity as to dividends with the Series A Preferred Shares, all
dividends declared upon the Series A Preferred Shares and any other
series of capital stock ranking on a parity as to dividends with the
Series A Preferred Shares shall be declared pro rata so that the amount
of dividends declared per share on the Series A Preferred Shares and
such other series of capital stock shall in all cases bear to each
other the same ratio that full dividends, for the then-current Dividend
Period, per share on the Series A Preferred Shares (which shall not
include any accumulation in respect of unpaid dividends for prior
Dividend Periods) and full dividends, including required or permitted
accumulations, if any, on such other series of capital stock bear to
each other.
(e) Holders of the Series A Preferred Shares shall not be
entitled to any dividend, whether payable in cash, property or stock,
in excess of full dividends, as herein provided, on the Series A
Preferred Shares. No interest, or sum of money in lieu of
2
<PAGE>
interest, shall be payable in respect of any dividend payment or
payments on the Series A Preferred Shares which may be in arrears.
3. Redemption. (a) The Series A Preferred Shares are not
----------
redeemable prior to ___________, 2001, except upon the occurrence of a
Tax Event (as defined in paragraph (b) of this Section 3). The
Corporation, at its option, may redeem the Series A Preferred Shares,
in whole or in part, at any time or from time to time, on or after
___________, 2001, at a redemption price of $50.00 per share, plus
accrued and unpaid dividends thereon to the date fixed for redemption.
(b) The Corporation will have the right, at any time upon the
occurrence of a Tax Event and with the prior written approval of the
Office of Thrift Supervision (the "OTS"), to redeem the Series A
Preferred Shares, in whole, but not in part, at a redemption price of
$50.00 per share, plus the quarterly accrued and unpaid dividend
thereon to the date fixed for redemption. "Tax Event" means the receipt
by the Corporation of an opinion of a nationally recognized law firm
experienced in such matters to the effect that, as a result of (i) any
amendment to, clarification of, or change (including any announced
prospective change) in, the laws or treaties (or any regulations
thereunder) of the United States or any political subdivision or taxing
authority thereof or therein affecting taxation, (ii) any judicial
decision, official administrative pronouncement, published or private
ruling, regulatory procedure, notice or announcement (including any
notice or announcement of intent to adopt such procedures or
regulations) ("Administrative Action") or (iii) any amendment to,
clarification of, or change in the official position or the
interpretation of such Administrative Action or any interpretation or
pronouncement that provides for a position with respect to such
Administrative Action that differs from the theretofore generally
accepted position, in each case, by any legislative body, court,
governmental authority or regulatory body, irrespective of the manner
in which such amendment, clarification or change is made known, which
amendment, clarification or change is effective or such pronouncement
or decision is announced on or after the date of issuance of the Series
A Preferred Shares, there is more than an insubstantial risk that (a)
dividends paid or to be paid by the Corporation with respect to the
Common Stock and Preferred Stock are not, or will not be, fully
deductible by the Corporation for United States federal income tax
purposes or (b) the Corporation is, or will be, subject to more than a
de minimis amount of other taxes, duties or other governmental charges.
(c) In the event that fewer than all the outstanding Series A
Preferred Shares are to be redeemed, the number of Series A Preferred
Shares to be redeemed shall be determined by the Board of Directors of
the Corporation, and the shares to be redeemed shall be determined by
lot or pro rata as may be determined by the Board of Directors or by
any other method as may be determined by the Board of Directors in its
sole discretion to be equitable, provided that such method satisfies
any applicable requirements of any securities exchange on which the
Series A Preferred Shares are listed.
(d) In the event the Corporation shall redeem any of the
Series A Preferred Shares, notice of such redemption shall be given by
first-class mail, postage prepaid, mailed not less than 30 nor more
than 60 days prior to the redemption date, to each holder of record of
the Series A Preferred Shares to be redeemed, at such holder's address
as the same appears on the stock register of the Corporation. Each such
notice
3
<PAGE>
shall state: (i) the redemption date; (ii) the number of Series A
Preferred Shares to be redeemed and, if fewer than all the Series A
Preferred Shares held by such holder are to be redeemed, the number of
such shares to be redeemed from such holder; (iii) the redemption
price; and (iv) the place or places where certificates for such shares
are to be surrendered for payment of the redemption price.
(e) Notice having been mailed as aforesaid, from and after the
redemption date (unless default shall be made by the Corporation in
providing money for the payment of the redemption price), said Series A
Preferred Shares shall no longer be deemed to be outstanding, and all
rights of the holders thereof as stockholders of the Corporation
(except the right to receive from the Corporation the redemption price)
shall cease. Upon surrender in accordance with said notices of the
certificates for any Series A Preferred Shares so redeemed (properly
endorsed or assigned for transfer, if the Board of Directors of the
Corporation shall so require and the notice shall so state), such
shares shall be redeemed by the Corporation at the redemption price
aforesaid. In case fewer than all the Series A Preferred Shares
represented by any such certificate are redeemed, a new certificate
shall be issued representing the unredeemed Series A Preferred Shares
without cost to the holder thereof.
(f) Any Series A Preferred Shares, which shall at any time
have been redeemed, shall, after such redemption, have the status of
authorized but unissued shares of Preferred Stock, without designation
as to series until such shares are once more designated as part of a
particular series by the Board of Directors of the Corporation.
(g) Notwithstanding the foregoing provisions of this Section
3, unless full dividends on the Series A Preferred Shares have been or
contemporaneously are declared and paid or declared and a sum
sufficient for the payment thereof has been set apart for payment for
the then-current Dividend Period, no Series A Preferred Shares shall be
redeemed unless all outstanding Series A Preferred Shares are redeemed
and the Corporation shall not purchase or otherwise acquire any Series
A Preferred Shares; provided, however, that the Corporation may
purchase or acquire Series A Preferred Shares pursuant to a purchase or
exchange offer made on the same terms to holders of all outstanding
Series A Preferred Shares.
4. Automatic Exchange. (a) Subject to the terms and conditions
------------------
of this Section 4, each Series A Preferred Share will be exchanged
automatically (the "Automatic Exchange") for one share of ___%
Noncumulative Preferred Stock, Series B, $5.00 par value per share (a
"Bank Preferred Share"), of Chevy Chase Bank, F.S.B. (the "Bank"). The
issuance of the Bank Preferred Shares has been duly authorized by the
board of directors of the Bank. Prior to or contemporaneously with the
filing of these Articles Supplementary with the Maryland State
Department of Assessments and Taxation, the Bank shall file with the
OTS a Certificate of Designation establishing the Bank Preferred
Shares. The preferences, conversion or other rights, voting powers,
restrictions, limitations as to dividends, qualifications, and terms
and conditions of the Bank Preferred Shares shall be substantially
identical to the preferences, conversion or other rights, voting
powers, restrictions, limitations as to dividends, qualifications, and
terms and conditions of the Series A Preferred Shares established by
these Articles Supplementary.
(b) The Automatic Exchange will occur only if the appropriate
federal regulatory agency directs in writing (a "Directive") an
exchange of the Series A Preferred
4
<PAGE>
Shares for Bank Preferred Shares because (i) the Bank becomes
"undercapitalized" under prompt corrective action regulations, (ii) the
Bank is placed into conservatorship or receivership or (iii) the
appropriate federal regulatory agency, in its sole discretion,
anticipates the Bank becoming "undercapitalized" in the near term (the
"Exchange Event").
(c) Upon the Exchange Event, each holder of the Series A
Preferred Shares shall be unconditionally obligated to surrender to the
Bank the certificates representing each share of the Series A Preferred
Shares of such holder, and the Bank shall be unconditionally obligated
to issue to such holder in exchange for each such Series A Preferred
Share a certificate representing one Bank Preferred Share.
(d) The Automatic Exchange shall occur as of 8:00 a.m. Eastern
Time on the date for such exchange set forth in the Directive, or, if
such date is not set forth in the Directive, as of 8:00 a.m. on the
earliest possible date such exchange could occur consistent with the
Directive (the "Time of Exchange"), as evidenced by the issuance by the
Bank of a press release. As of the Time of Exchange, all of the Series
A Preferred Shares required to be exchanged will be deemed canceled
without any further action by the Corporation, all rights of the
holders of the Series A Preferred Shares as stockholders of the
Corporation shall cease, and such persons shall thereupon and
thereafter be deemed to be and shall be for all purposes the holders of
Bank Preferred Shares. Notice of the occurrence of the Exchange Event
shall be given by first-class mail, postage prepaid, mailed within 30
days of such event, to each holder of record of the Series A Preferred
Shares, at such holder's address as the same appears on the stock
register of the Corporation. Each such notice shall indicate the place
or places where certificates for the Series A Preferred Shares are to
be surrendered by the holders thereof, and the Bank shall deliver to
each such holder certificates for Bank Preferred Shares upon surrender
of certificates for the Series A Preferred Shares. Until such
replacement stock certificates are delivered (or in the event such
replacement certificates are not delivered), certificates previously
representing the Series A Preferred Shares shall be deemed for all
purposes to represent Bank Preferred Shares.
(e) Any Series A Preferred Shares purchased or redeemed by the
Corporation in accordance with Section 3 hereof prior to the Time of
Exchange shall not be deemed outstanding and shall not be subject to
the Automatic Exchange. In the event of the Automatic Exchange, any
accrued and unpaid dividends on the Series A Preferred Shares as of the
Time of Exchange would be deemed to be accrued and unpaid dividends on
the Bank Preferred Shares.
5. Conversion. The holders of Series A Preferred Shares shall
----------
not have any rights to convert such shares into shares of any other
class or series of capital stock of the Corporation.
6. Liquidation Rights. (a) Upon the voluntary or involuntary
------------------
dissolution, liquidation or winding up of the Corporation, the holders
of the Series A Preferred Shares shall be entitled to receive and to be
paid out of the assets of the Corporation available for distribution to
its stockholders, before any payment or distribution shall be made on
the Common Stock or on any other class of stock ranking junior to the
Series A Preferred Shares upon liquidation, the amount of $50.00 per
share, plus the quarterly accrued and unpaid dividend thereon to the
date of liquidation.
5
<PAGE>
(b) After the payment to the holders of the Series A Preferred
Shares of the full preferential amounts provided for in this Section 6,
the holders of the Series A Preferred shares as such shall have no
right or claim to any of the remaining assets of the Corporation.
(c) If, upon any voluntary or involuntary dissolution,
liquidation or winding up of the Corporation, the amounts payable with
respect to the stated value of the Series A Preferred Shares and any
other shares of stock of the Corporation ranking as to any such
distribution on a parity with the Series A Preferred Shares are not
paid in full, the holders of the Series A Preferred Shares and of such
other shares will share ratably in any such distribution of assets of
the Corporation in proportion to the full respective liquidating
distributions to which they are entitled.
(d) Neither the sale of all or substantially all the property
or business of the Corporation, nor the merger or consolidation of the
Corporation into or with any other corporation or the merger or
consolidation of any other corporation into or with the Corporation
shall be deemed to be a dissolution, liquidation or winding up,
voluntary or involuntary, of the Corporation for purposes of this
Section 6.
(e) Upon the dissolution, liquidation or winding up of the
Corporation, the holders of the Series A Preferred Shares then
outstanding shall be entitled to be paid out of the assets of the
Corporation available for distribution to its stockholders all amounts
to which such holders are entitled pursuant to paragraph (a) of this
Section 6 before any payment shall be made to the holder of any class
of capital stock of the Corporation ranking junior to the Series A
Preferred Shares upon liquidation.
7. Ranking. For purposes of this resolution, any stock of any
-------
class or classes of the Corporation shall be deemed to rank:
(a) Prior to the Series A Preferred Shares, either as to
dividends or upon liquidation, if the holders of such class or classes
shall be entitled to the receipt of dividends or of amounts
distributable upon dissolution, liquidation or winding up of the
Corporation, as the case may be, in preference or priority to the
holders of the Series A Preferred Shares;
(b) On a parity with the Series A Preferred Shares, either as
to dividends or upon liquidation, whether or not the dividend rates,
dividend payment dates or redemption or liquidation prices per share or
sinking fund provisions, if any, be different from those of the Series
A Preferred Shares, if the holders of such stock shall be entitled to
the receipt of dividends or of amounts distributable upon dissolution,
liquidation or winding up of the Corporation, as the case may be,
without preference or priority, one over the other, as between the
holders of such stock and the holders of the Series A Preferred Shares;
and
(c) Junior to the Series A Preferred Shares, either as to
dividends or upon liquidation, if such class shall be Common Stock or
if the holders of the Series A Preferred Shares shall be entitled to
receipt of dividends or of amounts distributable upon dissolution,
liquidation or winding up of the Corporation, as the case may be, in
preference or priority to the holders of shares of such class or
classes.
6
<PAGE>
(8) Voting Rights. The Series A Preferred Shares shall not
-------------
have any voting powers, either general or special, except that:
(a) If at the time of any annual meeting of the Corporation's
stockholders for the election of directors there is a default in
preference dividends on the Preferred Stock, including the Series A
Preferred Shares, the number of directors then constituting the Board
of Directors of the Corporation shall be increased by two (if not
already increased by two due to a default in preference dividends), and
the holders of the Series A Preferred Shares, voting together with the
holders of all other series of Preferred Stock as a single class
without regard to series (whether or not the holders of such series of
Preferred Stock would be entitled to vote for the election of directors
if such default in preference dividends did not exist), shall have the
right at such meeting to the exclusion of the holders of Common Stock,
to elect two additional directors of the Corporation to fill such newly
created directorships. Each director elected by the holders of shares
of the Preferred Stock (a "Preferred Director") shall continue to serve
as such director until the later of (i) the full term for which he or
she shall have been elected or (ii) the payment of four quarterly
dividends on the Preferred Stock, including the Series A Preferred
Shares. Any Preferred Director may be removed by, and shall be not
removed except by, the vote of the holders of record of all the
outstanding shares of Preferred Stock, voting together as a single
class without regard to series, at a meeting of the Corporation's
stockholders, or of the holders of shares of Preferred Stock, called
for that purpose. As long as a default in any preference dividends on
the Preferred Stock shall exist (i) any vacancy in the office of a
Preferred Director may be filled (except as provided in the following
clause (ii)) by an instrument in writing signed by the remaining
Preferred Director and filed with the Corporation, and (ii) in the case
of the removal of any Preferred Director, the vacancy may be filled by
the vote of the holders of all the outstanding shares of Preferred
Stock, voting together as a single class without regard to series, at
the same meeting at which such removal shall be voted. Each director
appointed as aforesaid by the remaining Preferred Director shall be
deemed, for all purposes hereof, to be a Preferred Director. Whenever
the term of office of the Preferred Directors shall end and a default
in preference dividends shall no longer exist, the number of directors
constituting the Board of Directors shall be reduced by two. For
purposes hereof, a "default in preference dividends" on the Preferred
Stock shall be deemed to have occurred whenever the Corporation has
failed to declare and set aside for payment a quarterly dividend during
any of the four preceding quarterly dividend periods on any series of
Preferred Stock of the Corporation, including the Series A Preferred
Shares.
(b) Without the consent of the holders of shares entitled to
cast at least 67% of the votes entitled to be cast by the holders of
the total number of shares of Preferred Stock then outstanding, voting
together as a single class without regard to series, the holders of the
Series A Preferred Shares being entitled to cast one vote per share
thereon, the Corporation may not: (i) create any class or series of
stock which shall as to dividends or distribution of assets rank prior
to or on a parity with any outstanding series of Preferred Stock other
than a series which shall not have any right to object to such creation
or (ii) alter or change the provisions of the Corporation's Articles of
Amendment and Restatement, as the same may be amended or restated from
time to time, so as to adversely affect the voting powers preferences
or special rights of the holders of a series of Preferred Stock;
provided, however, that if such creation, alteration or change would
adversely affect the voting power, preferences or special rights of one
or more, but not all,
7
<PAGE>
series of Preferred Stock at the time outstanding, consent of the
holders of shares entitled to cast at least 67% of the votes entitled
to be cast by the holders of all of the shares of all such series so
affected, voting together as a single class, shall be required in lieu
of the consent of the holders of shares entitled to cast at least 67%
of the votes entitled to be cast by the holders of the total number of
shares of Preferred Stock at the time outstanding.
9. Approval of Independent Directors. (a) As long as any
---------------------------------
Series A Preferred Shares are outstanding, the Corporation may not take
the following actions without first obtaining the approval of a
majority of the Independent Directors. "Independent Director" means any
director of the Corporation who is either (i) not a current officer or
employee of the Corporation or a current director, officer or employee
of the Bank or any affiliate of the Bank, or (ii) a Preferred Director.
The actions which require the prior approval of a majority of the
Independent Directors include (i) the issuance of additional Preferred
Stock ranking on a parity with the Series A Preferred Shares, (ii) the
incurrence of debt for borrowed money in excess of 25% of the
Corporation's total stockholders' equity, (iii) the modification of the
general distribution policy of the Corporation or the declaration of
any distribution in respect of Common Stock for any year if, after
taking into account any such proposed distribution, total distributions
on the Series A Preferred Shares and the Common Stock would exceed an
amount equal to the sum of 105% of the Corporation's "REIT taxable
income" (excluding capital gains) for such year plus net capital gains
of the Corporation for that year, (iv) the acquisition of real estate
assets other than mortgage loans or mortgage securities representing
interests in or obligations backed by pools of mortgage loans, (v) the
redemption of any shares of Common Stock, (vi) the termination or
modification of, or the election not to renew, the Advisory Agreement,
dated _______ __, 1996, by and between the Corporation and the Bank or
the Servicing Agreement, dated _______ __, 1996, by and between the
Corporation and the Bank , or the subcontracting of any duties under
said Servicing Agreements to third parties unaffiliated with the Bank,
(vii) any dissolution, liquidation or termination of the Corporation
prior to ___________, 2026, (viii) any material amendment to or
modification of any agreements pursuant to which the Corporation
purchases its real estate mortgage assets, and (ix) the determination
to revoke the Corporation's status as a real estate investment trust.
(b) In assessing the benefits to the Corporation of any
proposed action requiring their consent, the Independent Directors
shall take into account the interests of holders of shares of both the
Common Stock and the Preferred Stock, including, without limitation,
the holders of the Series A Preferred Shares. In considering the
interests of the holders of the Preferred Stock, including, without
limitation, holders of the Series A Preferred Shares, the Independent
Directors shall owe the same duties that the Independent Directors owe
to holders of shares of Common Stock.
10. Maintenance of Status as Reporting Company. As long as
------------------------------------------
any Series A Preferred Shares are outstanding, the Corporation shall
maintain its status as a reporting company under the Securities
Exchange Act of 1934, as amended.
8
<PAGE>
IN WITNESS WHEREOF, CHEVY CHASE PREFERRED CAPITAL CORPORATION has
caused these Articles Supplementary to be signed and acknowledged in its name
and on its behalf by its President and Chief Executive Officer and attested to
by its Secretary on this ___ day of _______, 1996.
CHEVY CHASE PREFERRED CAPITAL CORPORATION
By:
-------------------------------
Name: B. Francis Saul II
Title: President and Chief Executive Officer
ATTEST:
- ----------------------------
Mary Lou Hayes
Secretary
THE UNDERSIGNED, President and Chief Executive Officer of CHEVY CHASE
PREFERRED CAPITAL CORPORATION, who executed on behalf of said corporation the
foregoing Articles Supplementary to its Articles of Amendment and Restatement,
of which this certificate is made a part, hereby acknowledges, in the name and
on behalf of said corporation, and further certifies that, to the best of his
knowledge, information and belief, the matters and facts set forth therein with
respect to the approval thereof are true in all material respects under the
penalties of perjury.
Dated: ___________, 1996 ------------------------------------
B. Francis Saul II, President and
Chief Executive Officer
9
<PAGE>
EXHIBIT 3(b)
BYLAWS
OF
CHEVY CHASE PREFERRED CAPITAL CORPORATION
AUGUST 20, 1996
<PAGE>
TABLE OF CONTENTS
Page
----
ARTICLE I OFFICES AND RECORDS.................................... 2
Section 1.1 Resident Agent.................................... 2
Section 1.2 Principal Office.................................. 2
Section 1.3 Additional Offices................................ 2
Section 1.4 Books and Records................................. 2
ARTICLE II STOCKHOLDERS.......................................... 2
Section 2.1 Annual Meeting.................................... 2
Section 2.2 Special Meetings.................................. 2
Section 2.3 Place of Meetings................................. 3
Section 2.4 Notice of Meetings................................ 3
Section 2.5 Meeting Without Notice; Waiver of Notice.......... 3
Section 2.6 Quorum............................................ 4
Section 2.7 Adjournments...................................... 4
Section 2.8 Proxies........................................... 4
Section 2.9 Vote of Stockholders.............................. 4
Section 2.10 Opening and Closing the Polls..................... 4
Section 2.11 Inspectors........................................ 4
Section 2.12 Informal Action by Stockholders................... 5
ARTICLE III BOARD OF DIRECTORS................................... 5
Section 3.1 General Powers.................................... 5
Section 3.2 Number, Tenure and Qualifications................. 5
Section 3.3 Composition of the Board of Directors............. 5
Section 3.4 Regular Meetings.................................. 6
Section 3.5 Special Meetings.................................. 6
Section 3.6 Notice............................................ 6
Section 3.7 Quorum............................................ 6
Section 3.8 Participation by Conference Telephone............. 7
Section 3.9 Presumption of Assent............................. 7
Section 3.10 Adjournments...................................... 7
Section 3.11 Informal Action................................... 7
Section 3.12 Vacancies......................................... 7
Section 3.13 Removal........................................... 8
Section 3.14 Committees........................................ 8
ARTICLE IV OFFICERS.............................................. 9
Section 4.1 Categories of Officers............................ 9
<PAGE>
TABLE OF CONTENTS
Page
----
Section 4.2 Election and Term of Office....................... 9
Section 4.3 Chairman of the Board............................. 9
Section 4.4 President and Chief Executive Officer............. 10
Section 4.5 Vice President.................................... 10
Section 4.6 Secretary......................................... 10
Section 4.7 Chief Executive Officer........................... 10
Section 4.8 Treasurer......................................... 11
Section 4.9 Removal........................................... 11
Section 4.10 Vacancies......................................... 11
Section 4.11 Resignations...................................... 11
ARTICLE V STOCKCERTIFICATES AND TRANSFERS....................... 11
Section 5.1 Stock Certificates................................ 11
Section 5.2 Record Date and Closing of Transfer Books......... 12
Section 5.3 Registered Stockholders........................... 12
Section 5.4 Lost Certificates................................. 12
ARTICLE VI MISCELLANEOUS PROVISIONS.............................. 13
Section 6.1 Fiscal Year....................................... 13
Section 6.2 Dividends......................................... 13
Section 6.3 Seal.............................................. 13
Section 6.4 Execution of Written Instruments.................. 13
Section 6.5 Signing of Checks and Notes....................... 13
Section 6.6 Voting of Securities Held in Other Entities....... 13
Section 6.7 Indemnification and Insurance..................... 14
A. PersonsCovered.......................................... 14
B. Enforcement.............................................. 14
C. Nonexclusively........................................... 14
D. Authorization to Purchase Insurance...................... 15
E. Nature of Right to Indemnification....................... 15
F. Authority to Further Indemnify........................... 15
Section 6.8 Reliance.......................................... 15
ARTICLE VII AMENDMENTS........................................... 16
ii
<PAGE>
BYLAWS
OF
CHEVY CHASE PREFERRED CAPITAL CORPORATION
ARTICLE I
OFFICES AND RECORDS
Section 1.1 Resident Agent. The name of the initial resident agent
--------------
for the Corporation in the State of Maryland is The Corporation Trust
Incorporated, and the address of the initial resident agent is 32 South Street,
Baltimore, Maryland 21202.
Section 1.2 Principal Office. The initial address of the principal
----------------
office of the Corporation is 8401 Connecticut Avenue, Chevy Chase, Maryland
20815.
Section 1.3 Additional Offices. The Corporation may also have
------------------
business offices at such places both within and without the State of Maryland as
the Board of Directors may from time to time determine.
Section 1.4 Books and Records. The books and records of the
-----------------
Corporation may be kept, either within or without the State of Maryland, at such
place or places as the Board of Directors from time to time may designate.
ARTICLE II
STOCKHOLDERS
Section 2.1 Annual Meeting. An annual meeting of the stockholders of
--------------
the Corporation shall be held in April of each year commencing with 1997 or as
soon thereafter as is practicable, at such time and date during that month as
may be fixed by the Board of Directors. At such meeting, the stockholders shall
elect the Board of Directors and transact any other business lawfully before
them.
Section 2.2 Special Meetings. Subject to the rights of the holders of
----------------
any series of preferred stock of the Corporation (the "Preferred Stock") to
elect additional directors under specified circumstances, special meetings of
the stockholders for any purpose or purposes, unless otherwise prescribed by
statute or by the articles of incorporation of the Corporation, as the same may
be amended or restated from time to time (the "Charter"), may be called only by
-2-
<PAGE>
the Chairman of the Board, the President and Chief Executive Officer or the
Board of Directors of the Corporation pursuant to a resolution adopted by a
majority of the total number of directors constituting the whole Board of
Directors (the "Whole Board"), or by written request to the Secretary of the
Corporation by the holders of not less than twenty-five percent (25%) of all of
the shares then outstanding and entitled to be cast at such meeting (the "Voting
Stock"); provided that (i) the Secretary shall inform the stockholders
requesting such meeting of the reasonably estimated cost of preparing and
disseminating notice thereof and shall not be required to give such notice until
the Corporation has received payment in such amount from such stockholders, and
(ii) unless requested by holders of a majority of the Voting Stock, the
Secretary shall not be required to call a special meeting to consider any matter
which is substantially the same as a matter voted on at any special meeting of
the stockholders held during the twelve (12) months preceding the request to
call such new special meeting.
Section 2.3 Place of Meetings. Meetings of the stockholders shall be
-----------------
held at the principal office of the Corporation or at such other place, within
or without the State of Maryland, as the Board of Directors from time to time by
resolution may designate.
Section 2.4 Notice of Meetings. A written or printed notice of each
------------------
stockholders' meeting, stating the place, day and hour of the meeting, and in
the case of a special meeting, the purpose or purposes of the meeting, shall be
prepared and delivered by the Corporation not less than ten (10) nor more than
ninety (90) days before the date of the meeting by personal delivery, by mail,
by facsimile or by telegram or express courier, charges prepaid, to the address
of each stockholder of record entitled to vote at such meeting and to each other
stockholder or other person, if any, entitled to notice of the meeting. If
delivered by mail, such notice shall be deemed to be delivered when deposited in
the United States mail with postage thereon prepaid, addressed to the
stockholder at (i) his or her address as it appears on the stock transfer books
of the Corporation; (ii) his or her residence; or (iii) his or her usual place
of business. If delivered personally, such notice shall be deemed given when so
delivered to the stockholder as provided above, and if by facsimile, such notice
shall be deemed given upon completion of the facsimile transmission to the
stockholder as provided above. If delivered by telegram or express courier, such
notice shall be deemed to be delivered when delivered to the telegraph or
courier company for delivery to the stockholder as provided above. Meetings may
be held without notice if all stockholders entitled to vote are present, or if
notice is waived by those not present in accordance with Section 2.5 of these
Bylaws. Any previously scheduled meeting of the stockholders may be postponed by
resolution of the Board of Directors upon public notice given prior to the date
scheduled for such meeting.
Section 2.5 Meeting Without Notice; Waiver of Notice. A stockholder,
----------------------------------------
either before or after a stockholders' meeting, may waive notice of the meeting
by signing a waiver of notice to be filed with the Corporation's records of
stockholders meetings; and his or her waiver shall be deemed the equivalent of
giving notice pursuant to Section 2.4 hereof. Attendance at a stockholders'
meeting, either in person or by proxy, by a person entitled to notice shall
constitute a waiver of notice of the meeting unless such person attends for the
express purpose of objecting
-3-
<PAGE>
to the transaction of business on the ground that the meeting was not lawfully
called or convened.
Section 2.6 Quorum. Except as otherwise provided by law or by the
------
Charter, the holders of a majority of the Voting Stock, represented in person or
by proxy, shall constitute a quorum at meetings of stockholders, except that
when specified business is to be voted on by a class or series voting as a
single class, the holders of a majority of the shares of such class or series
shall constitute a quorum for the transaction of such business.
Section 2.7 Adjournments. A meeting of stockholders convened on the
------------
date for which it was called may be adjourned prior to the completion of
business thereat to a date not more than one hundred twenty (120) days after the
record date of the original meeting. Notice of a subsequent meeting held as a
result of an adjournment, other than by announcement at the meeting at which the
adjournment was taken, shall not be necessary. If a quorum is present or
represented at such subsequent meeting, any business may be transacted thereat
which could have been transacted at the meeting which was adjourned.
Section 2.8 Proxies. At all meetings of stockholders, a stockholder
-------
entitled to vote may vote in person or by proxy executed in writing by the
stockholder or by his or her authorized agent. A proxy shall not be valid after
eleven (11) months from the date of its execution, unless a longer period is
expressly stated thereon. Each proxy must be filed with the Secretary of the
Corporation or his or her representative at or before the time of the meeting to
which it relates.
Section 2.9 Vote of Stockholders. Subject to the rights of the holders
--------------------
of any series of Preferred Stock to elect directors under specified
circumstances, and to the laws of the State of Maryland, each stockholder having
the right to vote shall be entitled at every meeting of stockholders to one (1)
vote for every share standing in his or her name on the record date fixed by the
Board of Directors pursuant to Section 5.2 of these Bylaws. Except as otherwise
provided by law, the Charter, these Bylaws, any resolution adopted by the Board
of Directors authorizing a series of Preferred Stock or any resolution adopted
by a majority of the Whole Board, all matters submitted to the stockholders at
any meeting (other than the election of directors) shall be decided by a
majority of the votes cast with respect thereto.
Section 2.10 Opening and Closing the Polls. The chairman of a meeting
-----------------------------
of stockholders shall fix, and announce at the meeting, the date and time of the
opening and the closing of the polls for each matter upon which the stockholders
are to vote at the meeting.
Section 2.11 Inspectors. At any meeting of stockholders, the chairman
----------
of such meeting may, and upon the request of any stockholder shall, appoint one
or more persons as inspectors for such meeting. Such inspector or inspectors
shall ascertain and report the number of shares represented at such meeting in
person or by proxy, based upon the determination of such inspector or inspectors
of the validity of proxies, count all votes, report the results and perform such
other acts as are proper to conduct voting with impartiality and fairness to all
stockholders.
-4-
<PAGE>
Each report of inspectors shall be in writing and signed by the
inspector or, if there is more than one, by a majority of inspectors acting at
such meeting, in which event the report of the majority shall be the report of
the inspectors. The report of the inspector or inspectors on the number of
shares represented at a meeting and the results of voting thereat shall be prima
-----
facie evidence thereof.
- -----
Section 2.12 Informal Action by Stockholders. Any action required or
-------------------------------
permitted to be taken at a meeting of stockholders may be taken without a
meeting if the following are filed with the records of stockholders meetings:
(1) a unanimous written consent which sets forth the action and is
signed by each stockholder entitled to vote on the matter; and
(2) a written waiver of any right to dissent signed by each
stockholder entitled to notice of the meeting but not entitled to vote thereat.
ARTICLE III
BOARD OF DIRECTORS
Section 3.1 General Powers. The business and affairs of the
--------------
Corporation shall be managed by, or under the direction of, its Board of
Directors. In addition to the powers and authorities expressly conferred by
these Bylaws, the Board of Directors may exercise all such powers of the
Corporation and do all such lawful acts as are not by law, by the Charter or by
these Bylaws conferred upon or reserved to the stockholders.
Section 3.2 Number, Tenure and Qualifications. Subject to the rights
---------------------------------
of the holders of any series of Preferred Stock to elect directors under
specified circumstances, the number of directors shall be fixed from time to
time pursuant to a resolution adopted by a majority of the Whole Board, but
shall consist of not more than eleven (11) nor less than three (3) directors who
need not be residents of the State of Maryland nor hold shares in the
Corporation; provided that if, at any time, the Corporation has fewer than three
(3) stockholders, the number of directors may be less than three (3) but not
less than the number of stockholders. The Board of Directors at the time of
adoption of these Bylaws shall consist of four (4) directors. Each director,
except one appointed to fill a vacancy, shall be elected to serve for a term of
one (1) year and until his or her successor shall have been duly elected and
qualified.
Section 3.3 Composition of the Board of Directors. Except during a
-------------------------------------
period of vacancy or vacancies on the Board of Directors, at least two (2) of
the directors at all times shall be "Independent Directors." For purposes of
these Bylaws, "Independent Directors" shall mean directors who are not current
officers or employees of the Corporation or current directors,
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officers or employees of Chevy Chase Bank, F.S.B. (the "Bank") or any affiliate
of the Bank, and "affiliate" shall mean, with respect to the Bank, any person or
entity who directly or indirectly controls, is controlled by or is under common
control with, the Bank.
Section 3.4 Regular Meetings. A regular meeting of the Board of
----------------
Directors to elect officers and consider other business shall be held without
notice other than this Section 3.4 immediately after, and at the same place as,
each annual meeting of stockholders. The Board of Directors may, by resolution,
designate the time and place for additional regular meetings without notice
other than such resolution.
Section 3.5 Special Meetings. Special meetings of the Board of
----------------
Directors shall be called at the request of the Chairman of the Board, the
President and Chief Executive Officer or a majority of the Board of Directors.
The person or persons authorized to call special meetings of the Board of
Directors may fix the place and time of the meeting.
Section 3.6 Notice. Notice of any special meeting shall be given to
------
each director at his or her business or residence as reflected in the books and
records of the Corporation or at such other address as such director may
designate in writing to the Secretary of the Corporation by mail, by telegram or
express courier, charges prepaid, by facsimile or by telephonic communication.
If mailed, such notice shall be deemed adequately delivered if deposited in the
United States mail so addressed, with postage thereon prepaid, at least five (5)
days before the day of such meeting. If by telegram, such notice shall be deemed
adequately delivered if the telegram is delivered to the telegraph company at
least twenty-four (24) hours before the time set for such meeting. If by express
courier, such notice shall be deemed adequately given if delivered to the
courier company at least two (2) days before the day of such meeting. If by
telephone or facsimile, such notice shall be deemed adequately delivered if
given at least six (6) hours prior to the time set for such meeting. Neither the
business to be transacted at, nor the purpose of, any regular or special meeting
of the Board of Directors need be specified in the notice of such meeting,
except for amendments to these Bylaws as provided under Article VII hereof. A
meeting may be held at any time without notice if all the directors are present
or if those not present waive notice of the meeting in writing, either before or
after such meeting. Attendance of a director at a meeting shall constitute
waiver of notice of that meeting unless he or she attends for the sole and
express purpose of objecting to the transaction of business on the ground that
the meeting was not lawfully called or convened.
Section 3.7 Quorum. A number of directors equal to at least a
------
majority of the Whole Board shall constitute a quorum for the transaction of
business. However, not less than one-third (1/3) of the Whole Board shall
constitute a quorum, unless the Whole Board consists of two (2) or three (3)
directors, in which case not less than two (2) directors shall constitute a
quorum, or unless the Whole Board consists of one (1) director, in which case
that one (1) director shall constitute a quorum. Anything else herein to the
contrary notwithstanding, if at any meeting of the Board of Directors there
shall be less than a quorum present, a majority of the directors present may
adjourn the meeting from time to time without further notice. Except as
otherwise may be provided by the Charter, these Bylaws or applicable law, the
act of the majority of the
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directors present at a meeting at which a quorum is present shall be the act of
the Board of Directors. The directors present at a duly organized meeting may
continue to transact business until adjournment, notwithstanding the withdrawal
or departure of enough directors to leave less than a quorum.
Section 3.8 Participation by Conference Telephone. Members of the
-------------------------------------
Board of Directors, or any committee thereof, may participate in a meeting of
such Board or committee by means of conference telephone or similar
communications equipment by means of which all persons participating in the
meeting can hear each other, and participation in a meeting pursuant to this
Section 3.8 shall constitute presence in person at such meeting.
Section 3.9 Presumption of Assent. A director of the Corporation who
---------------------
is present at a meeting of the Board of Directors at which action on any
corporate matter is taken shall be presumed to have assented to the action taken
unless his or her dissent shall be entered in the minutes of the meeting, unless
he or she shall file a written dissent to such action with the person acting as
the secretary of the meeting before the adjournment thereof or unless he or she
shall forward a written dissent within twenty-four (24) hours after the meeting
is adjourned, by certified mail, return receipt requested, bearing a postmark
from the United States Postal Service, to the person acting as the secretary of
the meeting or to the Secretary of the Corporation.
Section 3.10 Adjournments. Any meeting of the Board of Directors may
------------
be adjourned prior to the completion of business thereat. Notice of the
subsequent meeting held as a result of an adjournment, other than by
announcement at the meeting at which the adjournment is taken, shall not be
necessary. If a quorum is present at such subsequent meeting, any business may
be transacted thereat which could have been transacted at the meeting which was
adjourned.
Section 3.11 Informal Action. If all of the directors consent in
---------------
writing to any action required or permitted to be taken at a meeting of the
Board of Directors or a committee thereof and the writing or writings evidencing
such consent is or are filed by the Secretary of the Corporation with the
minutes of proceedings of the Board of Directors or such committee, the action
shall be as valid as though it had been taken at a meeting of the Board or
committee.
Section 3.12 Vacancies. Except as otherwise provided in this Section
---------
3.12, subject to the rights of the holder of any series of Preferred Stock to
elect additional directors under specified circumstances, unless the Board of
Directors otherwise determines, vacancies resulting from death, resignation,
retirement, disqualification or other cause relating to a then-existing Board
position shall be filled by the affirmative vote of a majority of the remaining
directors, though less than a quorum of the Board of Directors, and newly
created directorships resulting from an increase in the authorized number of
directors shall be filled by the affirmative vote of a majority of the Whole
Board and, in either event, directors so chosen shall hold office for a term
expiring at the next annual meeting of stockholders and until such director's
successor shall have been duly elected and qualified. No decrease in the number
of authorized directors constituting the Whole Board shall shorten the term of
any incumbent director. A vacancy on the Board of Directors due to the removal
of a director may be filled by the stockholders at an annual
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meeting or special meeting called for that purpose, and the director so chosen
shall hold office for the balance of the term of the removed director and until
such director's successor shall have been duly elected and qualified.
Section 3.13 Removal. Subject to the rights of the holders of any
-------
series of Preferred Stock to elect additional directors under specified
circumstances, any director, or the entire Board of Directors, may be removed
from office at any time, with or without the assignment of cause, only by the
affirmative vote of a majority of the then outstanding Voting Stock, voting
together as a single class.
Section 3.14 Committees. The Board of Directors, by resolution or
----------
resolutions adopted by a majority of the Whole Board, may designate one (1) or
more committees which, to the extent provided in such resolution or resolutions,
shall have and may exercise all of the authority of the Board of Directors in
the business and affairs of the Corporation to the extent consistent with the
Maryland General Corporation Law, as amended from time to time, or any successor
statute thereto (the "MGCL"), except the power to declare dividends or
distributions on stock, to amend these Bylaws, to issue stock other than in a
manner prescribed in these Bylaws, to recommend to the stockholders any action
that requires stockholder approval or to approve any merger, consolidation or
share exchange that does not require stockholder approval. Each such committee
shall consist of two (2) or more directors of the Corporation, including,
without limitation, the following committees:
(1) An Executive Committee, which shall have such authority as shall
be delegated by the Board of Directors, including, without
limitation, authority to acquire and dispose of real property and
to execute contracts and agreements on behalf of the Whole Board
including, without limitation, those relating to the incurrence of
debt by the Corporation or subsidiaries thereof and shall advise
the Board of Directors from time to time with respect to such
matters as the Board of Directors shall direct.
(2) An Audit Committee, which shall consist of Independent Directors.
The Audit Committee shall make recommendations concerning the
engagement of independent public accountants, review with the
independent public accountants the plans and results of each audit
engagement, approve professional services provided by the
independent public accountants, review the independence of the
independent public accountants, consider the range of audit and
non-audit fees and review the adequacy of the Corporation's
internal accounting controls.
The Board of Directors may designate one (1) or more directors as alternate
members of any committee, who may replace any absent or disqualified member at
any meeting of such committee. Unless the Board of Directors shall provide
otherwise, the presence of one-half (1/2) of the total membership of any
committee of the Board of Directors shall constitute a quorum for the
transaction of business at any meeting of such committee and the act of a
majority of those
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present shall be the act of such committee. Each committee shall keep regular
minutes of its proceedings and report the same to the Whole Board when so
requested.
ARTICLE IV
OFFICERS
Section 4.1 Categories of Officers. The elected officers of the
----------------------
Corporation shall consist of a Chairman of the Board, a President and Chief
Executive Officer, one (1) or more Executive Vice Presidents or Vice Presidents,
a Chief Financial Officer, a Secretary and a Treasurer. Such other officers,
assistant officers, agents and employees that the Board of Directors from time
to time may deem necessary may be elected by the Board or be appointed by the
Chairman of the Board. The Chairman of the Board shall be chosen from among the
directors. Two (2) or more offices may be held by the same person, except that a
person may not serve concurrently as both President and Chief Executive Officer
and an Executive Vice President or Vice President. Each officer chosen or
appointed in the manner prescribed by the Board of Directors shall have such
powers and duties as generally pertain to his or her office or offices, subject
to the specific provisions of this Article IV. Such officers also shall have
such powers and duties as from time to time may be conferred by the Board of
Directors or by any committee thereof authorized to do so.
Section 4.2 Election and Term of Office. The elected officers of the
---------------------------
Corporation shall be elected annually by the Board of Directors at the regular
meeting of the Board of Directors held after each annual meeting of the
stockholders. If the election of officers shall not be held at such meeting,
such election shall be held as soon thereafter as is convenient. Each officer
shall hold office until his or her successor shall have been duly elected and
shall have qualified, until his or her death or until he or she shall resign or
be removed from office.
Section 4.3 Chairman of the Board. The Chairman of the Board shall
---------------------
preside at all meetings of the stockholders and of the Board of Directors. The
Chairman of the Board shall be responsible for the general management of the
affairs of the Corporation and shall perform all duties incidental to his or her
office which may be required by law and all such other duties as may be properly
required by the Board of Directors. Except where by law the signature of the
President and/or Chief Executive Officer is required, the Chairman of the Board
shall possess the same power as the President and Chief Executive Officer to
sign all certificates, contracts, and other instruments of the Corporation,
which may be authorized by the Board of Directors. The Chairman of the Board
shall make reports to the Board of Directors and the stockholders as are
properly required by the Board of Directors. The Chairman of the Board shall see
that all orders and resolutions of the Board of Directors and of any committee
thereof are carried into effect.
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<PAGE>
Section 4.4 President and Chief Executive Officer. The President and
-------------------------------------
Chief Executive Officer shall be the chief operating officer of the Corporation,
shall act in a general executive capacity and shall assist the Chairman of the
Board in the administration and operation of the Corporation's business and
general supervision of its policies and affairs. The President and Chief
Executive Officer may, in the absence of or because of the inability to act of
the Chairman of the Board, perform all duties of the Chairman of the Board and
preside at all meetings of stockholders and of the Board of Directors. The
President and Chief Executive Officer may sign, alone or with the Secretary or
any assistant secretary or any other officer of the Corporation properly
authorized by the Board of Directors, certificates, contracts and other
instruments of the Corporation as authorized by the Board of Directors.
Section 4.5 Vice President. The Vice President or Vice Presidents, if
--------------
any, including any Executive Vice Presidents, in the order determined by the
Board of Directors, shall perform the duties of the President and Chief
Executive Officer in the absence or disability of the President and Chief
Executive Officer, and shall have such powers and perform such other duties as
the Board of Directors may from time to time prescribe.
Section 4.6 Secretary. The Secretary shall give, or cause to be given,
---------
notice of all meetings of stockholders and directors and all other notices
required by law, by the Charter or by these Bylaws, and in case of his or her
absence or refusal or neglect to do so, any such notice may be given by any
person thereunto directed by the Chairman of the Board, the President and Chief
Executive Officer or the Board of Directors, upon whose request the meeting is
called, as provided in these Bylaws. The Secretary shall record all the
proceedings of the meetings of the Board of Directors, any committees thereof
and the stockholders of the Corporation in a book or books to be kept for that
purpose, and shall perform such other duties as from time to time may be
prescribed by the Board of Directors, the Chairman of the Board or the President
and Chief Executive Officer. The Secretary shall have custody of the seal, if
any, of the Corporation and shall affix the same to all instruments requiring
it, when authorized by the Board of Directors, the Chairman of the Board or the
President and Chief Executive Officer, and shall attest to the same.
Section 4.7 Chief Financial Officer. The Chief Financial Officer shall
-----------------------
have custody of corporate funds and securities and shall keep full and accurate
accounts of receipts and disbursements in books belonging to the Corporation.
The Chief Financial Officer shall deposit all moneys and other valuable effects
in the name and to the credit of the Corporation in such depositories as may be
designated by the Board of Directors. The Chief Financial Officer shall
disburse the funds of the Corporation in such manner as may be ordered by the
Board of Directors, the Chairman of the Board or the President and Chief
Executive Officer, taking proper vouchers for such disbursements. The Chief
Financial Officer shall render to the Chairman of the Board, President and Chief
Executive Officer and the Board of Directors, whenever requested, an account of
all his or her transactions as the Chief Financial Officer and of the financial
condition of the Corporation. If required by the Board of Directors, the Chief
Financial Officer shall give the Corporation a bond for the faithful discharge
of his or her other duties in such amount and with such surety as the Board of
Directors shall prescribe. The Chief Financial
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<PAGE>
Officer also shall perform such duties and have such powers as the Board of
Directors shall from time to time prescribe.
Section 4.8 Treasurer. The Treasurer shall perform the duties of the
---------
Chief Financial Officer in the absence or disability of the Chief Financial
Officer and shall have such powers and perform such other duties as the Board of
Directors may from time to time prescribe.
Section 4.9 Removal. Any officer elected by the Board of Directors or
-------
appointed in the manner prescribed hereby may be removed by a majority of the
members of the Whole Board whenever, in their judgment, the best interests of
the Corporation would be served thereby.
Section 4.10 Vacancies. Any newly created office or vacancy in any
---------
office because of death, resignation or removal shall be filled by the Board of
Directors or, in the case of an office not specifically provided for in Section
4.1 hereof, by or in the manner prescribed by the Board of Directors. The
officer so selected shall hold office until his or her successor is duly
selected and shall have qualified, unless he or she sooner resigns or is removed
from office in the manner provided in these Bylaws.
Section 4.11 Resignations. Any officer, whether elected or appointed,
------------
may resign at any time by serving written notice of such resignation on the
Chairman of the Board, the President and Chief Executive Officer or Secretary,
and such resignation shall be deemed to be effective as of the close of business
on the date said notice is received by the Chairman of the Board, the President
and Chief Executive Officer or the Secretary. No action shall be required of the
Board of Directors or the stockholders to make any such resignation effective.
ARTICLE V
STOCK CERTIFICATES AND TRANSFERS
Section 5.1 Stock Certificates. Each stockholder shall be entitled to a
------------------
certificate or certificates, in a form approved by the Board of Directors and
consistent with the MGCL, which shall represent and certify the number, kind and
class of shares owned by him or her in the Corporation. Each certificate shall
be signed by the Chairman of the Board, the President and Chief Executive
Officer or a Vice President, and counter-signed by the Secretary or the
Treasurer (or an assistant secretary or assistant treasurer, if any), and
pursuant to resolutions of the Board of Directors, any such signature may be in
facsimile. In case any officer, transfer agent or registrar who has signed, or
whose facsimile signature has been placed on, a certificate has ceased to hold
such office before the certificate is issued, it nevertheless may be issued by
the Corporation with the same effect as if he or she held such office at the
date of issue.
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<PAGE>
Section 5.2 Record Date and Closing of Transfer Books. The Board of
-----------------------------------------
Directors may fix, in advance, a date as the record date for the purpose of
determining stockholders entitled to notice of, or to vote at, any meeting of
stockholders, stockholders entitled to receive payment of any dividend or
distribution or the allotment of any rights or stockholders entitled to exercise
any rights in respect of any change, conversion or exchange of stock, or in
order to make a determination of stockholders for any other proper purpose. The
record date may not be prior to the close of business on the day the record date
is fixed. Such record date shall be not more than ninety (90) days, and in case
of a meeting of stockholders, not less than ten (10) days, prior to the date on
which the particular action requiring such determination of stockholders is to
be taken. The stock transfer books of the Corporation may not be closed for a
period longer than twenty (20) days.
If no record date is fixed and the Corporation's stock transfer books
are not closed, the determination of stockholders entitled to notice of, or to
vote at, a meeting of stockholders shall be at the later of (i) the close of
business on the day on which notice of the meeting is mailed or (ii) the
thirtieth (30th) day before the meeting. If no record date is fixed, the record
date for determining stockholders for any purpose other than that specified in
the preceding sentence shall be at the close of business on the day on which the
resolution of the Board of Directors relating thereto is adopted.
When a determination of stockholders of record entitled to notice of, or
to vote at, any meeting of stockholders has been made as provided in this
Section 5.2, such determination shall apply to any future meeting in respect of
an adjournment thereof, unless the directors fix a new record date under this
Section 5.2 for such future meeting.
Section 5.3 Registered Stockholders. The Corporation shall be entitled
-----------------------
to treat the holder of record of shares as the holder in fact and, except as
otherwise provided by the laws of the State of Maryland, shall not be bound to
recognize any equitable or other claim to or interest in the shares.
Shares of the Corporation shall only be transferred on its books upon
the surrender to the Corporation of the share certificates duly endorsed or
accompanied by proper evidence of succession, assignment or authority to
transfer, and upon presentation of adequate evidence of the validity of the
transfer under this Section 5.3 and the laws of the State of Maryland. In that
event, the surrendered certificates shall be canceled, new certificates issued
to the person entitled to them and the transaction recorded on the books of the
Corporation.
Section 5.4 Lost Certificates. The Board of Directors may direct a
-----------------
new certificate to be issued in place of a certificate alleged to have been
destroyed or lost if the owner makes an affidavit that it is destroyed or lost.
The Board, in its discretion, may as a condition precedent to issuing the new
certificate, require the owner to give the Corporation a bond as indemnity
against any claim that may be made against the Corporation on the certificate
allegedly destroyed or lost.
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ARTICLE VI
MISCELLANEOUS PROVISIONS
Section 6.1 Fiscal Year. The fiscal year of the Corporation shall
-----------
begin on the first (1st) day of January and end on the thirty-first (31st) day
of December of each year.
Section 6.2 Dividends. The Board of Directors may from time to time
---------
declare, and the Corporation may pay, dividends on its outstanding shares in the
manner and upon the terms and conditions provided by law and the Charter.
Section 6.3 Seal. The corporate seal, if any, shall have inscribed
----
thereon the name of the Corporation, the year of its organization and the words
"Corporate Seal, Maryland." The seal may be used by causing it or a facsimile
thereof to be impressed, affixed or otherwise reproduced.
Section 6.4 Execution of Written Instruments. Contracts, deeds,
--------------------------------
documents, and other instruments shall be executed by the Chairman of the Board,
the President and Chief Executive Officer or a Vice President and attested by
the Secretary or an assistant secretary, unless the Board of Directors shall, in
a particular situation, designate another procedure for their execution.
Section 6.5 Signing of Checks and Notes. Checks, notes, drafts, and
---------------------------
demands for money shall be signed by such person or persons as may be designated
by the Board of Directors, the Chairman of the Board or the President and Chief
Executive Officer.
Section 6.6 Voting of Securities Held in Other Entities. In the
-------------------------------------------
absence of other arrangements by the Board of Directors, securities issued by
any other corporation, partnership or other entity and owned or controlled by
the Corporation may be voted at any securityholders' meeting of such other
entity by the Chairman of the Board of the Corporation or, if he or she is not
present at the meeting, by the President and Chief Executive Officer or any Vice
President of the Corporation, and in the event none of the Chairman of the
Board, President and Chief Executive Officer or any Vice President is to be
present at such a meeting, the securities may be voted by such person as the
Chairman of the Board and the Secretary of the Corporation shall, by duly
executed proxy, designate to represent the Corporation at the meeting.
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Section 6.7 Indemnification and Insurance.
-----------------------------
A. Persons CoveredA..Persons Covered . Each "director" (as that term is
----------------------------------
defined in Section 2-418 of the MGCL) or officer of the Corporation who is made
a "party" (as that term is defined in Section 2-418 of the MGCL) to a
"proceeding" (as that term is defined in Section 2-418 of the MGCL), whether the
basis of such proceeding is alleged action in an "official capacity" (as that
term is defined in Section 2-418 of the MGCL) as a director or officer or in any
other capacity (including, without limitation, service at the request of the
Corporation for any other foreign or domestic corporation or any partnership,
joint venture, trust, other enterprise or employee benefit plan), shall be
indemnified and held harmless to the fullest extent authorized by the MGCL (but,
in the case of any amendment of the MGCL, only to the extent that such amendment
permits the Corporation to provide broader indemnification rights than said law
permitted the Corporation to provide prior to such amendment), against all
judgments, penalties, fines, settlements and expenses (including, without
limitation, attorneys' fees and expenses and excise taxes or penalties under the
Employee Retirement Income Security Act of 1974, as amended) reasonably incurred
by such person in connection therewith and indemnification shall continue as to
a person who has ceased to be a director or officer and shall inure to the
benefit of his or her heirs, executors and administrators; provided, however,
that except as provided in Paragraph B of this Section 6.7 with respect to
proceedings seeking to enforce rights to indemnification, the Corporation shall
indemnify any such person seeking indemnification in connection with a
proceeding (or part thereof) initiated by such person only if such proceeding
(or part thereof) was authorized by the Board of Directors of the Corporation.
B. Enforcement. If a claim under Paragraph A of this Section 6.7 is
-----------
not paid in full by the Corporation within thirty (30) calendar days after a
written claim has been received by the Corporation, the claimant may at any time
thereafter (but prior to payment of the claim) bring suit against the
Corporation to recover the unpaid amount of the claim and, if successful, in
whole or in part, the claimant shall be entitled to be paid also the expense of
prosecuting such claim. It shall be a defense to any such action (other than an
action brought to enforce a claim for expenses incurred in defending any
proceeding in advance of its final disposition where the required undertaking,
if any, has been tendered to the Corporation) that the claimant has not met the
standards of conduct which make it permissible under the MGCL for the
Corporation to indemnify the claimant for the amount claimed, but the burden of
proving such defense shall be on the Corporation. Neither the failure of the
Corporation (including its Board of Directors, independent legal counsel or
stockholders) to have made a determination prior to the commencement of such
action that indemnification of the claimant is proper in the circumstances
because he or she has met the applicable standard by the Corporation (including
its Board of Directors, independent legal counsel or stockholders) that the
claimant has not met such applicable standard of conduct, shall be a defense to
the action or create a presumption that the claimant has not met the applicable
standard of conduct.
C. Nonexclusively. The right to indemnification and the payment of
--------------
expenses incurred in defending a proceeding in advance of its final disposition
conferred in this Section 6.7 shall not be exclusive of any other right which
any person may have or hereafter
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acquire under any statute, provision of the Charter or these Bylaws, agreement,
vote of stockholders or disinterested directors or otherwise.
D. Authorization to Purchase Insurance. The Corporation may purchase
-----------------------------------
and maintain insurance, at its expense, on its own behalf and on behalf of any
person who is or was a director, officer, employee or agent of the Corporation
or who while a director, officer, employee or agent of the Corporation is or was
serving at the request of the Corporation as a director, officer, partner,
trustee, employee or agent of another foreign or domestic corporation,
partnership, joint venture, trust or other enterprise, or employee benefit plan,
against any liability asserted against and incurred by such person in any such
capacity or arising out of such person's position, whether or not the
Corporation would have the power to indemnify such person against such expense
or liability under the MGCL.
E. Nature of Right to Indemnification. The right to indemnification
----------------------------------
conferred in this Section 6.7 shall be a contract right and shall include the
right to be paid by the Corporation the expenses incurred in defending any such
proceeding in advance of its final disposition; provided, however, that if the
-------- -------
MGCL requires, the payment of such expenses incurred by a director or officer in
his or her capacity as a director or officer (and not in any other capacity in
which service was or is rendered by such person while a director or officer,
including, without limitation, service to an employee benefit plan) in advance
of the final disposition of a proceeding, shall be made only upon delivery to
the Corporation of (a) a written affirmation of the director or officer of his
or her good faith belief that the standard of conduct necessary of
indemnification by the Corporation has been met and (b) a written undertaking by
or on behalf of such director or officer to repay all amounts so advanced if it
shall ultimately be determined that the standard of conduct has not been met.
F. Authority to Further Indemnify. The Corporation may, to the extent
------------------------------
authorized from time to time by the Board of Directors, grant rights of
indemnification and rights to be paid by the Corporation the expenses incurred
in defending any proceeding in advance of its final disposition to any employee
or agent of the Corporation to the fullest extent of the provisions of this
Section 6.7 with respect to the indemnification and advancement of expenses of
directors and officers of the Corporation.
Section 6.8 Reliance. Each director, officer, employee and agent of the
--------
Corporation, in the performance of his or her duties with respect to the
Corporation, shall be fully justified and protected with regard to any act or
failure to act in reliance in good faith upon the books of account or other
records of the Corporation, upon an opinion of counsel or upon reports made to
the Corporation by any other of its officers, employees, agents, or by the
advisers, accountants, appraisers or other experts or consultants selected by
the Board of Directors or officers of the Corporation, regardless of whether
such counsel, expert or consultant also is a director.
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ARTICLE VII
AMENDMENTS
These Bylaws may be amended, added to, rescinded or repealed at any
meeting of the Board of Directors or of the stockholders, provided that notice
of the proposed change was given (i) in the case of a meeting of the
stockholders, in the notice of the meeting given pursuant to Section 2.4 of
these Bylaws, and (ii) in the case of a meeting of the Board of Directors, in a
notice given pursuant to Section 3.4 or 3.6 hereof, as the case may be;
provided, however, that, in the case of amendments by stockholders,
- -------- -------
notwithstanding any other provisions of these Bylaws or the Charter or any
provision of law which might otherwise permit a lesser vote or no vote, but in
addition to any affirmative vote of the holders of any particular class or
series of the Voting Stock required by law, the Charter or these Bylaws with
respect to any series of Preferred Stock, the affirmative vote of the holders of
that proportion of the Voting Stock necessary to approve an amendment to the
Corporation's Charter pursuant to such Charter and the MGCL, voting together as
a single class, shall be required to alter, amend or repeal any provision of
these Bylaws.
-16-
<PAGE>
EXHIBIT 5
November __, 1996
Chevy Chase Preferred Capital Corporation
8401 Connecticut Avenue
Chevy Chase, Maryland 20815
Ladies and Gentlemen:
We have acted as counsel to Chevy Chase Preferred Capital Corporation,
a Maryland corporation (the "Company"), in connection with the registration of
up to 3,200,000 shares (including the underwriters' over-allotment option, if
exercised) of the Company's __% Noncumulative Exchangeable Preferred Stock,
Series A, par value $5.00 per share (the "Shares"), pursuant to a registration
statement on Form S-11 (Registration No. 333-10495), including prospectuses and
all amendments, exhibits and documents related thereto (collectively, the
"Registration Statement"), under the Securities Act of 1933, as amended, and
with the proposed sale of the Shares to the public through certain underwriters.
Based upon our examination of the originals or copies of such
documents, corporate records, certificates of officers of the Company and other
instruments as we have deemed necessary, and upon the laws as presently in
effect, we are of the opinion that the Shares to be offered by the Company
pursuant to the Registration Statement have been duly authorized for issuance by
the Company, and that upon issuance and delivery in accordance with the terms of
the purchase agreements referred to in the Registration Statement, will be
validly issued, fully paid and nonassessable.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the reference to our firm under the caption
"Certain Legal Matters" in the prospectuses.
Very truly yours,
SHAW, PITTMAN, POTTS & TROWBRIDGE
<PAGE>
Exhibit 8
FORM OF TAX OPINION
November [__], 1996
Chevy Chase Preferred Capital Corporation
8401 Connecticut Avenue
Chevy Chase, Maryland 20815
Ladies and Gentlemen:
Chevy Chase Preferred Capital Corporation (the "Company") has filed a
Registration Statement on Form S-11, file number 33-10495, with the Securities
and Exchange Commission. Such registration statement (the "Registration
Statement") contains a prospectus (the "Prospectus"). The Prospectus and
Registration Statement contemplate an offering of a series of the Company's
preferred shares (the "Preferred Shares") to the public (the "Offering"), with
the Company's common stock being retained by Chevy Chase Bank, F.S.B. (the
"Bank"). All capitalized terms used but not otherwise defined herein shall have
the respective meanings given to them in the Prospectus, unless otherwise noted.
We have acted as tax counsel in connection with the preparation of the
Registration Statement. In connection with the filing of the Registration
Statement, you have asked us to render an opinion regarding the application of
the U.S. federal income tax laws to the Company. Specifically, you have
requested that we render an opinion addressing whether the Company will be
organized in conformity with the requirements for qualification as a real estate
investment trust (a "REIT") under sections 856 through 860 of the Internal
Revenue Code of 1986, as amended (the "Code") commencing with its taxable year
ending December 31, 1996, and whether the Company's proposed method of
operation, as set forth in the Registration Statement and Prospectus, will
enable it to meet the requirements for qualification as a REIT in the future.
The opinion set forth herein is based upon the existing provisions of the
Code, Treasury Regulations, and the reported interpretations thereof by the
Internal Revenue Service ("IRS") and by the courts in effect as of the date
hereof, all of which are subject to change, both retroactively or prospectively,
and to possibly different interpretations. We assume no obligation to update
the opinions set forth in this letter. We believe that the
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 2
conclusions expressed herein, if challenged by the IRS, would be sustained in
court. However, because our opinion is not binding upon the IRS or the courts,
there can be no assurance that contrary positions may not be successfully
asserted by the IRS.
I. Documents and Representations
-----------------------------
For the purpose of rendering this opinion, we have examined and relied on
originals, or copies certified or otherwise identified to our satisfaction, of
the following: (1) the First Amended and Restated Articles of Incorporation of
Chevy Chase Preferred Capital Corporation (the "Articles"); (2) the Articles
Supplementary establishing the Series A Preferred Shares (the "Articles
Supplementary"); (3) the Registration Statement, as amended through the date
hereof; (4) the Prospectus; and (5) such other documents or information as we
have deemed necessary for the opinions set forth below. In our examination, we
have assumed the genuineness of all signatures, the legal capacity of natural
persons, the authenticity of all documents submitted to us as originals, the
conformity to original documents of all documents submitted to us as certified
or photostatic copies, and the authenticity of the originals of such copies.
In addition, this opinion is conditioned upon certain representations made
by the Company as to factual and other matters as set forth in the attached
letter and in the discussion of "Federal Income Tax Considerations" in the
Prospectus. This opinion is also based on the assumptions that (i) the Company
will be operated in accordance with the terms and provisions of the Articles,
and (ii) the various elections, procedural steps, and other actions by the
Company described in the discussion of "Federal Income Tax Considerations" in
the Prospectus Supplement will be completed in a timely fashion or otherwise
carried out as so described.
Unless facts material to the opinion expressed herein are specifically
stated to have been independently established or verified by us, we have relied
as to such facts solely upon the representations made by the Company. We are
not, however, aware of any facts or circumstances contrary to or inconsistent
with the representations. To the extent the representations are with respect to
matters set forth in the Code or Treasury Regulations, we have reviewed with the
individuals making such representations the relevant provisions of the Code, the
Treasury Regulations and published administrative interpretations.
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 3
II. Opinion
-------
A. Organizational Requirements for REIT Qualification
--------------------------------------------------
1. In General
----------
The Code defines a REIT as a corporation, trust, or association (i) that is
managed by one or more trustees or directors; (ii) the beneficial ownership of
which is evidenced by transferable shares, or by transferable certificates of
beneficial interest; (iii) that would be taxable as a domestic corporation, but
for the REIT Requirements; (iv) that is neither a financial institution nor an
insurance company subject to certain provisions of the Code; (v) the beneficial
ownership of which is held by 100 or more persons; (vi) not more than 50 percent
in value of the outstanding stock of which is owned, directly or indirectly, by
five or fewer individuals (as defined in the Code to include certain entities)
at any time during the last half of each taxable year; and (vii) meets certain
other tests, described below, regarding the nature of its income and assets./1/
The Code provides that conditions (i) through (iv), inclusive, must be met
during the entire taxable year and that condition (v) must be met during at
least 335 days of a taxable year of 12 months, or during a proportionate part of
a taxable year of less than 12 months./2/ Conditions (v) and (vi) do not apply
until after the first taxable year for which an election is made to be taxed as
a REIT./3/
The Company has represented that (i) it will be organized and operated as
described in the Prospectus, and (ii) based upon certain opinions of Shaw,
Pittman, Potts and Trowbridge set forth below, it will satisfy the six
conditions for REIT qualification set forth above.
2. Calendar Year Taxpayer
----------------------
In addition to the abovementioned organizational conditions, a corporation
may not elect to become a REIT unless its taxable year is the calendar year.
The Company has represented that it will elect a calendar taxable year.
- ------------------------------------------------
/1/Sections 856(a), 856(h), and 542(a)(2).
/2/Section 856(b).
/3/Section 856(h)(2).
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 4
3. Prohibition on Financial Institutions Electing REIT Status
----------------------------------------------------------
As noted above, the Company cannot qualify as a REIT if it is a financial
institution. The Code defines a financial institution as including any bank,
mutual savings bank, cooperative bank, domestic building and loan association,
small business investment company or business development corporation./4/ The
Company will not be organized or operated as any type of entity that would be
treated as a financial institution under the Code. See United States v. Seattle
First International Corp., 79-2 U.S.T.C. (P) 9495 (W.D. Wash. 1979) (wholly
owned subsidiary of bank did not qualify as bank under section 581). In
contrast, we have assumed that the Bank has been and will be treated as a
domestic building and loan association for federal income tax purposes.
However, the Bank will own only approximately 50 percent of the value of the
Company's stock after the proposed stock offering, and both the Bank and the
Company will be operated as separate entities with their own employees, books
and records. As a consequence, in our opinion, the Bank's status as a financial
institution will not be attributed to the Company and will not prevent the
Company from qualifying as a REIT.
4. 100 or More Beneficial Owner Test
---------------------------------
As noted above, the beneficial ownership of a REIT must be held by 100 or
more persons. Preferred stock is taken into account for purposes of determining
whether a REIT satisfies this beneficial ownership test./5/ The Company has
represented that after the Offering there will be more than 100 persons with
beneficial ownership of the Preferred Shares. Moreover, the Articles provide in
section 5.4(B)(3) that any transfer or other change in beneficial ownership of
the Preferred Shares that would result in the Preferred Shares being actually
owned by fewer than 100 persons will be void ab initio. As a consequence, in
-- ------
our opinion, at all times after the Offering, the Company will satisfy the
requirement that its beneficial ownership be held by 100 or more persons.
5. Closely Held Test
-----------------
As noted above, a REIT may not be "closely held" (i.e., five or fewer
---
individuals may not own more than 50 percent (by value) of the stock of a REIT
at any time during the second half of each taxable year after its first year of
electing REIT status). In applying this "closely
- ------------------------------------------------
/4/Sections 856(a)(4), 582(c)(2) (formerly Section 582(c)(5)), and 591.
/5/See, e.g., P.L.R. 8342016 (July 13, 1983) (REIT treated as having 100 or
--- ---
more beneficial owners with a single entity owning all of its common stock and
125 individuals owning its preferred stock).
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 5
held" prohibition, all classes of stock, however denominated, are taken into
account./6/ Ownership of such stock is determined by applying several
attribution rules. Under these rules: (a) stock owned, directly or indirectly,
by or for a corporation, partnership, estate or trust is treated as owned
proportionately by its shareholders, partners, or beneficiaries; (b) an
individual is treated as owning stock owned by or for his siblings, spouse,
ancestors and lineal descendants; (c) an individual or entity that has an option
to acquire stock is treated as owning such stock; and (d) stock owned, directly
or indirectly, by certain pension plans is treated as held directly by the
beneficiaries of such plans in proportion to their actuarial interests in such
plans./7/ For purposes of this opinion, we have assumed, based on data furnished
by the Bank, that (i) after the application of these attribution rules, not more
than approximately 97 percent of the common stock of the Bank will be treated as
owned by two individuals; (ii) the Bank's preferred stock will remain
outstanding and currently represents approximately 10 percent of the value of
the Bank, although that percentage is expected to decline as the Bank has
earnings; and (iii) at all times, the value of the Common Stock will not exceed
approximately 52 percent of the value of the Company (this assumption is based,
in part on the provision in the Articles providing for so-called "Balancing
Distributions," as described below).
Furthermore, section 5.4 of the Articles includes various limitations on
the ownership of the Preferred Shares. No individual holder of the Preferred
Shares is permitted to own (including shares deemed to be owned under the
attribution rules described above) more than 1 percent (the "Ownership Limit")
of any issued and outstanding series of Preferred Shares. In addition, any
transfer or other change in ownership of the Preferred Shares that would result
in any individual holder owning (actually or by attribution) Preferred Shares in
excess of the Ownership Limit will be void ab initio, and any transfer or other
-- ------
change in ownership of the Preferred Shares that would result in the Company
being treated as closely held or otherwise would cause the Company to fail to
qualify as a REIT also will be void ab initio. Moreover, shares of any series
-- ------
of Preferred Shares deemed to be owned by, or transferred to a stockholder in
excess of the Ownership Limit or in violation of the other ownership
restrictions described above, or which would otherwise cause the Company to fail
to qualify as a REIT (the "Excess Shares"), will be automatically transferred,
by operation of law, to a trustee of a trust for the exclusive benefit of a
charity to be named by the Company as of the day prior to the day the prohibited
transaction took place. Any distribution paid prior to the discovery of the
prohibited transfer are to be repaid by the original transferee to the Company
and by the Company to the trustee; any vote of the shares while the shares were
held by the original transferee prior to the Company's discovery thereof shall
be void ab initio and the original transferee shall be deemed to have given its
-- ------
proxy to the trustee. Any unpaid
- -----------------------------------------
/6/Treas. Reg. (S) 1.544-1(c).
/7/Section 544.
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 6
distributions with respect to the original transferee will be rescinded as void
ab initio. In liquidation the original transferee stockholder's ratable share of
- -- ------
the Company's assets would be limited to the price paid by the original
transferee for the Excess Shares or, if no value was given, the price per share
equal to the closing market price on the date of the purported transfer. The
trustee of the trust shall promptly sell the shares to any person whose
ownership of such shares is not prohibited, whereupon the interest of the trust
will terminate. Proceeds of the sale shall be paid to the original transferee up
to its purchase price (or, if the original transferee did not purchase the
shares, the value of such shares on their date of acquisition) and any remaining
proceeds shall be paid to a charity to be named by the Company.
In addition to the limitations on ownership of the Preferred Shares
described above, the Articles also provide for so-called "Balancing
Distributions" from the Company to the holder of the Common Stock in order to
ensure that the value of the Common Stock not exceed approximately 52 percent of
the total value of the Company due to any future appreciation of the Company's
assets. Such distributions should prevent any appreciation of the Company's
assets or reduction in the value of the Preferred Shares from resulting in a
significant increase in the value of the Common Stock relative to that of the
Preferred Shares, and together with the ownership limitations described above,
should prevent the Company from becoming closely held. It should be noted,
however, that Balancing Distributions may not be made during periods with
respect to which the payment of dividends to the holders of the Common Stock is
prohibited by the Articles Supplementary.
Based upon the assumptions described above and our review of portions of
the Articles providing for the limitations on ownership of the Preferred Shares
and the Balancing Distributions described above, it is our opinion that
immediately after the Offering, the Company will satisfy the requirement that
its stock not be closely held, and the Company is organized so as to satisfy the
requirement in the future.
6. Treatment of Automatic Exchange Feature
---------------------------------------
In determining whether the Company is closely held, the Code sets forth
certain attribution rules which must be applied. It is necessary to address the
characterization of the Automatic Exchange requirement under these attribution
rules, and in particular under section 544(a)(3), which deals with attribution
resulting from the ownership of an option. In the present case, more than 50
percent of the Bank itself is owned by five or fewer individuals. If the
Automatic Exchange were treated as giving the Bank an option to acquire all the
outstanding Company Preferred Shares, the Bank would be treated as owning 100
percent of the stock of the Company--the common stock it actually owns, and the
Preferred Shares by
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 7
attribution. The Bank's ownership, direct and by attribution, would then be
attributed to the Bank's owners, and so the Company would be considered to be
closely held.
It has, however, long been settled under a similar attribution provision,
section 318(a)(4), that an option on stock results in attribution only where its
holder may acquire the stock at his or her election and there exist no
contingencies with respect to this election. Rev. Rul. 89-64, 1989-1 C.B. 91;
Rev. Rul. 68-601, 1968-2 C.B. 124. This attribution rule is worded identically
to section 544(a)(3), and the two provisions have been interpreted by the
Internal Revenue Service as being coextensive. P.L.R. 9205030 (Nov. 5, 1991).
In the present case, the Automatic Exchange is subject to two
contingencies: (i) the Bank's capital must drop below a certain threshold, the
Bank must be placed in conservatorship or receivership, or the applicable
regulatory authorities must anticipate in their sole discretion that the Bank
will become undercapitalized in the near term; and (ii) the applicable
regulatory authorities must direct that the Automatic Exchange take place. The
Bank does not itself have the right to initiate the Automatic Exchange.
As a consequence, it is our opinion that the existence of the Automatic
Exchange feature will not cause the Bank to be treated as owning the Company's
Preferred Shares or otherwise cause the Company to be treated as closely held at
any time prior to the triggering of the Automatic Exchange by the applicable
regulatory authorities.
B. Income Tests
------------
In order to maintain qualification as a REIT, the Company must annually
satisfy three gross income requirements. First, at least 75 percent of the
Company's gross income (excluding gross income from prohibited transactions) for
each taxable year must be derived directly or indirectly from investments
relating to real property or mortgages on real property (as interest on
obligations secured by mortgages on real property, certain "rents from real
property" or as gain on the sale or exchange of such property and certain fees
with respect to agreements to make or acquire mortgage loans), from certain
types of temporary investments or certain other types of gross income./8/
Second, at least 95 percent of the Company's gross income (excluding gross
income from prohibited transactions) for each taxable year must be derived from
such real property investments as aforesaid and from dividends, interest, and
gain from the sale or other disposition of stock or securities and certain other
types of gross income (or from any combination of the foregoing)./9/ Third,
short-term gain from the sale or
- ------------------------------------------
/8/Section 856(c)(3).
/9/Section 856(c)(2).
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 8
other disposition of stock or securities, gain from prohibited transactions, and
gain on the sale or other disposition of real property held for less than four
years (apart from involuntary conversions and sales of foreclosure property)
from the date of acquisition must represent less than 30 percent of the
Company's gross income (including gross income from prohibited transactions) for
each taxable year./10/
For interest to qualify as "interest on obligations secured by mortgages on
real property or on interests in real property," the obligation must be secured
by real property having a fair market value at the time of acquisition at least
equal to the principal amount of the loan./11/ The term "interest" includes
only an amount that constitutes compensation for the use or forbearance of
money. For example, a fee received or declared by a lender which is in fact a
charge for services performed for a borrower rather than a charge for the use of
borrowed money is not includable as interest; amounts earned as consideration
for entering into agreements to make loans secured by real property, although
not interest, are otherwise treated as within the 75 percent and 95 percent
classes of gross income so long as the determination of those amounts does not
depend on the income or profits of any person. By statute, the term interest
does not include any amount based on income or profits except that the Code
provides that (i) interest "based on a fixed percentage or percentages of
receipts or sales" is not excluded and (ii) when the REIT makes a loan that
provides for interest based on the borrower's receipts or sales and a portion of
such receipts or sales under one or more leases is based on income or profits,
only a proportionate amount of the contingent interest paid by the borrower will
be disqualified as interest./12/
The Company has represented that it expects that over 95 percent of its
income to be derived from sources that will satisfy both the 75 percent and 95
percent gross income requirements (including interest derived from the Mortgage
Assets) and that it does not anticipate engaging in any transactions that would
cause it to recognize gross income of a type or in an amount that would cause it
to violate the 30 percent gross income requirement. As a consequence, in our
opinion, the Company's proposed method of operation, as set forth in the
Registration Statement and Prospectus will allow it to satisfy all three gross
income requirements for REIT qualification.
C. Asset Tests
-----------
- ----------------------------------------
/10/Section 856(c)(4).
/11/Treas. Reg. (S) 1.856-5(c)(1).
/12/Section 856(f)(1).
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 9
At the close of each quarter of its taxable year, the Company must satisfy
three tests relating to the nature of its assets. First, at least 75 percent of
the value of the Company's total assets must be represented by real estate
assets (including stock or debt instruments held for not more than one year that
were purchased with the proceeds of a stock offering or long-term (at least five
years) debt offering of the Company), cash, cash items, and government
securities./13/ Second, not more than 25 percent of the Company's total assets
may be represented by securities other than those in the 75 percent asset
class./14/ Third, of the investments included in the 25 percent asset class,
the value of any one issuer's securities owned by the Company may not exceed 5
percent of the value of the Company's total assets and the Company may not own
more than 10 percent of any one issuer's outstanding voting securities./15/ The
Company has represented that substantially all of its assets, including the
Mortgage Assets, will be real estate assets, and that the value of any one
issuer's securities owned by the Company will not exceed 5 percent of the value
of the Company's total assets and the Company will not own more than 10 percent
of any one issuer's outstanding voting securities. Moreover, the Company has
represented that in the future it will maintain adequate records of the value of
its assets to ensure compliance with the asset tests, and to take such action
within 30 days after the close of any quarter as may be required to cure any
noncompliance with the asset tests. As a consequence, in our opinion, the
Company's proposed method of operation, as set forth in the Registration
Statement and Prospectus will allow it to satisfy all three asset tests for REIT
qualification.
D. Annual Distribution Requirements
--------------------------------
In order to be treated as a REIT, the Company is required to distribute
dividends (other than capital gain dividends) to its stockholders in an amount
at least equal to (A) the sum of (i) 95 percent of the Company's "REIT taxable
income" (computed without regard to the dividends paid deduction and the
Company's net capital gain) plus (ii) 95 percent of the net income, if any, from
foreclosure property in excess of the special tax on income from foreclosure
property, minus (B) the sum of certain items of noncash income./16/ Such
distributions must be paid in the taxable year to which they relate or in the
following taxable year if declared before the Company timely files its tax
return for such year and if paid on or before the first regular dividend payment
after such declaration./17/ The Company has
- ---------------------------------------
/13/Sections 856(c)(5)(A); 856(c)(6)(C) and 856(c)(6)(D)(ii).
/14/Section 856(c)(5)(B).
/15/Section 856(c)(5)(B).
/16/Section 857(a)(1)(A).
/17/Section 858(a).
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 10
represented that it intends to make timely distributions sufficient to satisfy
the annual distribution requirement described above and for purposes of
this opinion we have assumed that such timely distributions will be made.
E. Conclusion
----------
Based on the foregoing, it is our opinion that the Company is organized in
conformity with the requirements for qualification as a REIT commencing with its
taxable year ending December 31, 1996, and its proposed manner of operation will
enable it to meet the requirements for qualification as a REIT in the future.
III. Additional Limitations
----------------------
The foregoing opinion is limited to the specific matters covered thereby
and should not be interpreted to imply that the undersigned has offered its
opinion on any other matter. Moreover, the Company's ability to achieve and
maintain qualification and taxation as a REIT depends upon the Company's ability
to meet certain diversity of stock ownership requirements and, through actual
annual operating results, certain requirements under the Code regarding its
income, assets and distribution levels. No assurance can be given that the
actual ownership of the Company's stock and its actual operating results and
distributions for any taxable year will satisfy the tests necessary to achieve
and maintain its status as a REIT.
Very truly yours,
SHAW, PITTMAN, POTTS & TROWBRIDGE
<PAGE>
Exhibit 10(a)
MORTGAGE LOAN PURCHASE AGREEMENT
This MORTGAGE LOAN PURCHASE AGREEMENT ("Agreement"), dated as of _____________,
1996, by and between Chevy Chase Preferred Capital Corporation, a Maryland
corporation having its principal office at 8401 Connecticut Avenue, Chevy Chase,
Maryland 20815 ("Purchaser") and Chevy Chase Bank, F.S.B., a federal savings
bank having its principal office at 7926 Jones Branch Drive, McLean, Virginia
22101 ("Seller").
W I T N E S S E T H.:
WHEREAS, Seller desires to sell to Purchaser, and Purchaser desires to purchase
from Seller, certain conventional residential first mortgage loans ("Mortgage
Loans") on a servicing retained basis as described herein, and which shall be
delivered as whole loans on the Closing Date, as defined below;
WHEREAS, each Mortgage Loan is secured by a mortgage, deed of trust or other
security instrument creating a first lien on a residential dwelling located in
the jurisdiction indicated on the Mortgage Loan Schedule; and
WHEREAS, Purchaser and Seller wish to prescribe the manner of the conveyance,
servicing and control of the Mortgage Loans.
NOW, THEREFORE, in consideration of the promises and mutual agreements set forth
herein, and for other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, Purchaser and Seller agree as
follows:
SECTION 1. DEFINITIONS. For purposes of this Agreement the following
capitalized terms shall have the respective meanings set forth below. Other
capitalized terms used in this Agreement and not defined herein shall have the
respective meanings set forth in the Servicing Agreement attached hereto as
Exhibit B.
"Accepted Servicing Practices" means, with respect to any Mortgage Loan, those
mortgage servicing practices of prudent mortgage lending institutions which
service mortgage loans of the same type as such Mortgage Loan in the
jurisdiction where the related Mortgaged Property is located.
"Act" means The National Housing Act, as amended from time to time.
"Adjustable Rate Mortgage Loan" or "ARM" means any individual Mortgage Loan
purchased pursuant to this Agreement the interest rate of which adjusts
periodically.
"Affiliate" means, with respect to any specified Person, any other Person
controlling or controlled by or under common control with such specified Person.
For the purposes of this definition,
"Control" when used with respect to any specified Person means the power to
direct the management and policies of such Person, directly or indirectly,
whether through the ownership of voting securities, by contract or otherwise and
the terms "controlling" and "controlled" have meanings correlative to the
foregoing.
"Agreement" means this Mortgage Loan Purchase Agreement and all amendments and
supplements hereto.
"ALTA" means The American Land Title Association or any successor thereto.
"Ancillary Income" means all late charges, assumption fees, escrow account
benefits, reinstatement fees, and similar types of fees arising from or in
connection with any Mortgage, to the extent not otherwise payable to the
Mortgagor under applicable law or pursuant to the terms of the related Mortgage
Note.
"Appraised Value" means the value set forth in an appraisal made in connection
with the origination of the related Mortgage Loan as the value of the Mortgaged
Property.
"Assignment and Assumption Agreement" has the meaning set forth in Section 19
hereof.
<PAGE>
"Assignment of Mortgage" means an assignment of the Mortgage delivered in blank,
or equivalent instrument in recordable form, sufficient under the laws of the
jurisdiction wherein the related Mortgaged Property is located to reflect the
sale of the Mortgage to Purchaser.
"Business Day" means any day other than (i) a Saturday or Sunday, or (ii) a day
on which banking and savings and loan institutions in the State of Maryland are
authorized or obligated by law or executive order to be closed.
"Closing Date" means ____________, 1996, or such other date as is mutually
agreed upon by the parties.
"Code" means the Internal Revenue Code of 1986, as amended.
"Condemnation Proceeds" means all awards or settlements in respect of a
Mortgaged Property, whether permanent or temporary, partial or entire, by
exercise of the power of eminent domain or condemnation, to the extent not
required to be released to a Mortgagor in accordance with the terms of the
related Mortgage Loan Documents.
"Conventional Loan" means a conventional residential first lien mortgage loan
which is a Mortgage Loan.
"Convertible Mortgage Loan" means any individual Mortgage Loan purchased
pursuant to this Agreement which contains a provision whereby the Mortgagor is
permitted to convert the Mortgage Loan to a fixed rate Mortgage Loan in
accordance with the terms of the related Mortgage Note.
"Custodial Account" means the separate trust account created and maintained
pursuant to Section 2.04 of the Servicing Agreement.
"Cut-off Date" means ______________, 1996.
"Deleted Mortgage Loan" means a Mortgage Loan that is repurchased or replaced
with a Qualified Substitute Mortgage Loan by Seller in accordance with the terms
of this Agreement.
"Determination Date" means the earlier of two (2) Business Days prior to the
related Remittance Date or the 15th day of the month in which the related
Remittance Date occurs.
"Due Date" means the day of the month on which the Monthly Payment is due on a
Mortgage Loan, exclusive of any days of grace.
"Escrow Account" means the separate account created and maintained pursuant to
Section 2.06 of the Servicing Agreement with respect to each Mortgage Loan, as
specified in the Servicing Agreement.
"Escrow Payments" means, with respect to any Mortgage Loan, the amounts
constituting ground rents, taxes, assessments, water rates, sewer rents,
municipal charges, mortgage insurance premiums, fire and hazard insurance
premiums, condominium charges, and any other payments required to be escrowed by
the Mortgagor with the mortgagee pursuant to the Mortgage or any other document.
"FHA" means the Federal Housing Administration, an agency within the United
States Department of Housing and Urban Development, or any successor thereto and
including the Federal Housing Commissioner and the Secretary of Housing and
Urban Development where appropriate under the FHA Regulations.
"FHLMC" means the Federal Home Loan Mortgage Corporation, or any successor
thereto.
"FNMA" means the Federal National Mortgage Association, or any successor
thereto.
"HUD" means the Department of Housing and Urban Development, or any federal
agency or official thereof which may from time to time succeed to the functions
thereof with regard to FHA mortgage insurance. The term "HUD," for purposes
of this Agreement, is also deemed to include subdivisions thereof such as the
FHA and Government National Mortgage Association.
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"Index", with respect to each ARM Loan, shall have the respective meaning
ascribed to it in each related Mortgage Note.
"Insurance Proceeds" means, with respect to each Mortgage Loan, proceeds of
insurance policies insuring the Mortgage Loan or the related Mortgaged Property.
"Interest Rate Adjustment Date" means, with respect to each ARM Loan, the date,
specified in the related Mortgage Note and the Mortgage Loan Schedule, on which
the Mortgage Interest Rate is adjusted.
"Lifetime Rate Caps" means the provision of each Mortgage Note related to an ARM
Loan which provides for an absolute maximum Mortgage Interest Rate thereunder.
The Mortgage Interest Rate during the terms of each ARM Loan shall not at any
time exceed the amount per annum set forth on Exhibit J hereto.
"Liquidation Proceeds" means cash received in connection with the liquidation of
a defaulted Mortgage Loan, whether through the sale or assignment of such
Mortgage Loan, trustee's sale, foreclosure sale or otherwise, or the sale of the
related Mortgaged Property if the Mortgaged Property is acquired in satisfaction
of the Mortgage Loan.
"Loan-to-Value Ratio" or "LTV" means, with respect to any Mortgage Loan, the
ratio (expressed as a percentage) of the original principal amount of the
Mortgage Loan to the lesser of (a) the Appraised Value of the Mortgaged Property
at origination and (b) if the Mortgage Loan was made to finance the acquisition
of the related Mortgaged Property, the purchase price of the Mortgaged Property.
"Margin" means, with respect to each ARM Loan, the fixed percentage amount set
forth in the related Mortgage Note which amount is added to the Index in
accordance with the terms of the related Mortgage Note to determine on each
Interest Rate Adjustment Date the Mortgage Interest Rate for such Mortgage Loan.
"Monthly Payment" means the scheduled monthly payment of principal and interest
on a Mortgage Loan.
"Mortgage" means the mortgage, deed of trust or other instrument securing a
Mortgage Note, which creates a first lien on an unsubordinated estate in fee
simple in real property securing the Mortgage Note; except that with respect to
real property located in jurisdictions in which the use of leasehold estates for
residential properties is a widely accepted practice, the mortgage, deed of
trust or other instrument securing the Mortgage Note may secure and create a
first lien upon a leasehold estate of the Mortgagor.
"Mortgage File" means the items pertaining to a particular Mortgage Loan
referred to in Exhibit A annexed hereto, and any additional documents required
to be added to the Mortgage File pursuant to this Agreement.
"Mortgage Interest Rate" means the annual rate of interest set forth in a
Mortgage Note, which, in the case of an ARM Loan, shall be adjusted from time to
time, with respect to each Mortgage Loan.
"Mortgage Interest Rate Cap" means, with respect to each ARM Loan, the limit on
each Mortgage Interest Rate adjustment as set forth in the related Mortgage
Note.
"Mortgage Loan" means an individual Mortgage Loan which is the subject of this
Agreement, each Mortgage Loan originally sold and subject to this Agreement
being identified on the applicable Mortgage Loan Schedule, which Mortgage Loan
includes without limitation the Mortgage File, the Monthly Payments, Principal
Prepayments, Liquidation Proceeds, Condemnation Proceeds, Insurance Proceeds,
and all other rights, benefits, proceeds and obligations arising from or in
connection with such Mortgage Loan, excluding replaced or repurchased mortgage
loans.
"Mortgage Loan Documents" means, with respect to each Mortgage Loan, the
following documents pertaining to such Mortgage Loan:
a. The original Mortgage Note (or, with respect to the Mortgage Loan listed on
Schedule I to Exhibit A hereto, a lost note affidavit, executed by an
officer of Seller, with a copy of the original note attached thereto)
bearing all intervening endorsements, endorsed "Pay to the order of _____
without recourse" and signed in the name of Seller by
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an authorized officer. To the extent that there is no room on the face of
the Mortgage Notes for endorsements, the endorsement may be contained on an
allonge, if applicable state law so allows. If the Mortgage Loan was
acquired by Seller in a merger, the endorsement must be by "[Seller],
successor by merger to [name of predecessor]". If the Mortgage Loan was
acquired or originated by Seller while doing business under another name,
the endorsement must be by "[Seller], formerly known as [previous name]";
and
b. The original Assignment of Mortgage for each Mortgage Loan in form and
substance acceptable for recording endorsed "Pay to the order of ______" and
signed in the name of Seller. If the Mortgage Loan was acquired by Seller in
a merger, the Assignment of Mortgage must be made by "[Seller], successor by
merger to [name of predecessor]". If the Mortgage Loan was acquired or
originated by Seller while doing business under another name, the Assignment
of Mortgage must be by "[Seller], formerly known as [previous name]".
c. The original of any guarantee executed in connection with the Mortgage Note.
d. The original Mortgage, with evidence of recording thereon. If in connection
with any Mortgage Loan, Seller cannot deliver or cause to be delivered the
original Mortgage with evidence of recording thereon on, or prior to the
Closing Date because of a delay caused by the public recording office where
much Mortgage has been delivered for recordation, a photocopy of such
Mortgage certified by Seller to be true and correct will be delivered; if
such Mortgage has been lost or if such public recording office retains the
original recorded Mortgage, Seller shall deliver or cause to be delivered to
Purchaser, a photocopy of such Mortgage, certified by such public recording
office to be a true and complete copy of the original recorded Mortgage.
e. The originals of all assumption, modification, consolidation or extension
agreements, if any, with evidence of recording thereon or certified copies
of such documents if the originals thereof are unavailable.
f. Originals of all intervening assignments of the Mortgage with evidence of
recording thereon, if such intervening assignment has been recorded.
g. The original mortgagee policy of title insurance or, in the event such
original title policy is unavailable, a certified true copy of the related
policy binder or commitment for title certified to be true and complete by
the title insurance company.
h. Any security agreement, chattel mortgage or equivalent executed in
connection with the Mortgage.
i. For Mortgage Loans with original LTV's greater than 85%, evidence of a PMI
Policy.
"Mortgage Loan Schedule" means the schedule of Mortgage Loans attached hereto as
Exhibit J setting forth at least the following information with respect to each
Mortgage Loan: (1) Seller's Mortgage Loan identifying number; (2) the
Mortgagor's name; (3) the street address of the Mortgaged Property including the
city, state and zip code; (4) a code indicating whether the Mortgaged Property
is owner-occupied, second home or investor owned; (s) the type of residential
units constituting the Mortgaged Property; (6) the original number of months to
maturity; (7) the remaining months to maturity from the Cut-off Date, based on
the original amortization schedule, and, if different, the maturity expressed in
the same manner but based on the actual amortization schedule; (8) the Loan-to-
Value Ratio at origination; (9) the Mortgage Interest Rate as of the Cut-off
Date; (10) the stated maturity date; (11) the amount of the Monthly Payment as
of the Cut-off Date; (12) the original principal amount of the Mortgage Loan;
(13) the principal balance of the Mortgage Loan as of the close of business on
the Cut-off Date, after deduction of payments of principal due on or before the
Cut-off Date whether or not collected; (14) a code indicating the purpose of the
loan (i.e., purchase, rate and term refinance, equity take-out refinance); (15)
a code indicating the documentation style (i.e. full, alternative or reduced);
(16) a code indicating whether the Mortgage Loan is a Convertible Mortgage Loan;
(17) the number of times during the 12 month period preceding the Closing Date
that any Monthly Payment has been received thirty or more days after its Due
Date; (18) the type of Mortgage Loan product, if any; (19) the first payment Due
Date; (19) the initial Mortgage Interest Rate; (20) the amount of the first
Monthly Payment; (21) the name of any Qualified Insurer with respect to a PMI
Policy; and (22) the Servicing Fee Rate; and, with respect to any ARM Loan: (1)
the Interest Rate Adjustment Dates; (2) the Margin; (3) the Lifetime Rate Cap;
(4) any Periodic Rate Caps; (5) any minimum interest rate, if other than the
Margin; (6) the first Rate Adjustment Date after
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the Cut-off Date; and (8) the applicable Index, in each case, under the terms of
the Mortgage Note. With respect to the Mortgage Loans in the aggregate, the
Mortgage Loan Schedule shall set forth the following information, as of the Cut-
off Date: (1) the number of Mortgage Loans; (2) the current aggregate
outstanding principal balance of the Mortgage Loans; (3) the weighted average
Mortgage Interest Rate of the Mortgage Loans; and (4) the weighted average
maturity of the Mortgage Loans.
"Mortgage Note" means the note or other evidence of the indebtedness of a
Mortgagor secured by a Mortgage.
"Mortgaged Property" means the real property (or leasehold estate, if
applicable) securing repayment of the debt evidenced by a Mortgage Note.
"Mortgagor" means the obliger on a Mortgage Note.
"Officer's Certificate" means a certificate signed by the Chairman of the Board
or the Vice Chairman of the Board or a President or a Vice President and by the
Treasurer or the Secretary or one of the Assistant Treasurers or Assistant
Secretaries of Seller, and delivered to Purchaser as required by this Agreement.
"Opinion of Counsel" means a written opinion of counsel, who may be counsel for
Seller, reasonably acceptable to Purchaser.
"Periodic Rate Cap" means the provision of each Mortgage Note related to each
ARM Loan which provides for an absolute maximum amount by which the Mortgage
Interest Rate therein may increase or decrease on an Interest Rate Adjustment
Date above or below the Mortgage Interest Rate previously in effect. The
Periodic Rate Cap for each ARM Loan is the rate set forth on Exhibit K hereto.
"Person" means any individual, corporation, partnership, joint venture,
association, joint-stock company, trust, limited liability company,
unincorporated organization, government or any agency or political subdivision
thereof.
"PMI Policy" means a policy of primary mortgage guaranty insurance issued by a
Qualified Insurer.
"Principal Prepayment" means any payment or other recovery of principal on a
Mortgage Loan which is received in advance of its scheduled Due Date, including
any prepayment penalty or premium thereon and which is not accompanied by an
amount of interest representing scheduled interest due on any date or dates in
any month or months subsequent to the month of prepayment.
"Purchase Price" means the price paid on the Closing Date by Purchaser to Seller
in exchange for the Mortgage Loans purchased on the Closing Date as set forth in
Section 4 of this Agreement.
"Purchaser" means Chevy Chase Preferred Capital Corporation, its designees,
successors or assigns.
"Qualified Appraiser" means an appraiser who had no interest, direct or indirect
in the Mortgaged Property or in any loan made on the security thereof, and whose
compensation is not affected by the approval or disapproval of the Mortgage
Loan, and such appraiser and the appraisal made by such appraiser both satisfy
the requirements of Title XI of the Federal Institutions Reform, Recovery, and
Enforcement Act of 1989 and the regulations promulgated thereunder, all as in
effect on the date the Mortgage Loan was originated.
"Qualified Insurer" means an insurance company which is: duly qualified as such
under the laws of the state in which the related Mortgaged Property is located;
duly authorized and licensed in such states to transact the applicable insurance
business and to write the insurance provided; approved as an insurer by FNMA and
FHLMC with respect to primary mortgage insurance; and, with respect to hazard
and flood insurance, rated by Best's in one of its two highest categories.
"Qualified Substitute Mortgage Loan" means a mortgage loan eligible to be
substituted by Seller for a Deleted Mortgage Loan which must, on the date of
such substitution, (i) have an outstanding principal balance, after deduction of
all scheduled payments due in the month of substitution (or in the case of a
substitution of more than one mortgage loan for a Deleted
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Mortgage Loan, an aggregate principal balance), not in excess of the outstanding
principal balance of the Deleted Mortgage Loan (the amount of any shortfall will
be deposited in the Custodial Account by Seller in the month of substitution);
(ii) have a Mortgage Interest Rate equal to, or not more than 1.00% greater
than, the Mortgage Interest Rate of the Deleted Mortgage Loan; (iii) have a
remaining term to maturity equal to, or not more than one year less than that of
the Deleted Mortgage Loan (iv) be of the same type as the Deleted Mortgage Loan
(i.e., Mortgage Loan with the same Mortgage Interest Rate Caps or fixed rate);
and (v) comply with each representation and warranty (respecting individual
Mortgage Loans) set forth in Section 8.02 hereof.
"Remittance Date" is defined in the Servicing Agreement.
"Repurchase Price" means, with respect to any Mortgage Loan, a price equal to
(i) the unpaid principal balance of such Mortgage Loan plus (ii) interest on
such unpaid principal balance of such Mortgage Loan at the Mortgage Interest
Rate from the last date through which interest has been paid and distributed to
Purchaser to the date of repurchase, less amounts received or advanced, if any,
by Seller in respect of such repurchased Mortgage Loan.
"RESPA" means the Real Estate Settlement Procedures Act, as amended.
"Seller" means Chevy Chase Bank, F.S.B., its successors and assigns.
"Servicing Agreement" means the agreement, attached hereto as Exhibit B, to be
entered into by Seller, as servicer, and Purchaser.
"Servicing Fee" means the fee to be paid to Seller by Purchaser for servicing
each Mortgage Loan as more specifically defined in the Servicing Agreement.
"Servicing Fee Rate" means, with respect to each Mortgage Loan, the rate
specified in the Mortgage Loan Schedule with respect to such Mortgage Loan.
"Servicing File" means with respect to each Mortgage Loan, the file retained by
Seller during the period in which Seller is acting as servicer pursuant to the
Servicing Agreement consisting of originals of all documents in the Mortgage
File which are not delivered to Purchaser and copies of the Mortgage Loan
Documents.
"Stated Principal Balance" means as to each Mortgage Loan, (i) the principal
balance of the Mortgage Loan at the Cut-off Date after giving effect to payments
of principal due on or before such date, whether or not received, minus (ii) all
amounts previously received by Purchaser with respect to the related Mortgage
Loan representing payments or recoveries of principal or advances in lieu
thereof.
[SECTION 2. RESERVED.]
[SECTION 3. RESERVED.]
SECTION 4. AGREEMENT TO PURCHASE. Seller agrees to sell and Purchaser agrees to
purchase at par Mortgage Loans having an aggregate principal balance on the Cut-
off Date of $________, or such other amount as agreed by Purchaser and Seller as
evidenced by the actual aggregate principal balance of the Mortgage Loans
accepted by Purchaser on the Closing Date. The initial principal amount of the
Mortgage Loans shall be the aggregate principal balance of the Mortgage Loans,
so computed as of the Cut-off Date, after application of scheduled payments of
principal due on or before the Cut-off Date whether or not collected.
In addition to the Purchase Price as described above, Purchaser shall pay to
Seller, at closing, accrued interest on the initial principal amount of the
related Mortgage Loans at the weighted average Mortgage Interest Rate of those
Mortgage Loans, minus any amounts attributable to Servicing Fees as provided in
the Servicing Agreement from the Cut-off Date through the day prior to the
Closing Date, inclusive.
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The Purchase Price plus accrued interest as set forth in the preceding paragraph
shall be paid on the Closing Date by wire transfer of immediately available
funds.
Purchaser shall be entitled to (1) all scheduled principal due after the Cut-off
Date, (2) all other recoveries of principal collected on or after the Cut-off
Date (provided, however, that all scheduled payments of principal due on or
before the Cut-off Date and collected after the Cut-off Date shall belong, and
be paid , to Seller), and (3) all payments of interest on the Mortgage Loans net
of applicable Servicing Fees collected on or after the Cut-off Date (minus that
portion of any such payment which is allocable to the period prior to the Cut-
off Date). The outstanding principal balance of each Mortgage Loan as of the
Cut-off Date is determined after application of payments of principal due on or
before the Cut-off Date whether or not collected, together with any unscheduled
principal prepayments collected prior to the Cut-off Date; provided, however,
that payments of scheduled principal and interest prepaid for a Due Date beyond
the Cut-off Date shall not be applied to the principal balance as of the Cut-off
Date. Such prepaid amounts shall be the property of Purchaser. Any such prepaid
amounts shall be deposited into the Custodial Account, which account is
established for the benefit of Purchaser for subsequent remittance to Purchaser.
SECTION 5. EXAMINATION OF MORTGAGE FILES. Prior to the date hereof, Seller has
(a) delivered to Purchaser in escrow, for examination with respect to each
Mortgage Loan to be purchased, the related Mortgage File, including a copy of
the Assignment of Mortgage, pertaining to each Mortgage Loan, or (b) made the
related Mortgage File available to Purchaser for examination at Seller's offices
or such other location as shall otherwise be agreed upon by Purchaser and
Seller. The fact that Purchaser has conducted or has failed to conduct any
partial or complete examination of the Mortgage Files shall not affect
Purchaser's (or its successor's) rights to demand repurchase, substitution or
other relief as provided herein.
SECTION 6. CONVEYANCE FROM SELLER TO PURCHASER.
6.01. Conveyance of Mortgage Loans; Possession of Files. Seller hereby agrees
to sell, transfer, assign and convey to Purchaser on the Closing Date, without
recourse, but subject to the terms of this Agreement, all right, title and
interest of Seller in and to the Mortgage Loans and the Mortgage Files and all
rights and obligations arising under the documents contained therein. The
Servicing File shall be retained by Seller in accordance with the terms of the
Servicing Agreement and, as provided therein, shall be appropriately identified
in Seller's books and records to clearly reflect the sale of the related
Mortgage Loan to Purchaser.
On and after the Closing Date, each Mortgage and related Mortgage Note shall be
possessed solely by Purchaser. All rights arising out of the Mortgage Loans
including, but not limited to, all funds received by Seller after the Cut-off
Date in connection with a Mortgage Loan shall be vested in Purchaser provided,
however, that all funds received on or in connection with a Mortgage Loan shall
be received and held by Seller in trust for the benefit of Purchaser as the
owner of the Mortgage Loans pursuant to the terms of this Agreement.
The sale of each Mortgage Loan shall be reflected on Seller's balance sheet and
other financial statements as a sale of assets by Seller.
6.02. Delivery of Mortgage Loan Documents. On the Closing Date, Seller shall
deliver to Purchaser the Mortgage Loan Documents with respect to each Mortgage
Loan set forth on the Mortgage Loan Schedule. Seller shall forward to Purchaser
original documents evidencing an assumption, modification, consolidation,
conversion or extension of any Mortgage Loan entered into in accordance with
this Agreement within two (2) weeks of their execution, provided, however, that
Seller shall provide Purchaser with a certified true copy of any such document
submitted for recordation within two (2) weeks of its execution, and shall
promptly provide the original of any document submitted for recordation or a
copy of such document certified by the appropriate public recording office to be
a true and complete copy of the original within ninety (90) days of its
submission for recordation.
In the event that such original or copy of any document submitted for
recordation to the appropriate public recording office is not so delivered to
Purchaser within 90 days following the Closing Date (other than with respect to
the Assignments of Mortgage which shall be delivered to Purchaser in blank and
recorded subsequently by Purchaser), and in the event that Seller does not cure
such failure within 30 days of discovery or receipt of written notification of
such failure from Purchaser, the related Mortgage Loan shall, upon the request
of Purchaser, be repurchased by Seller at the price and in the manner specified
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in Subsection 8.03. The foregoing repurchase obligation shall not apply in the
event that Seller cannot deliver, or cause to be delivered, such original or
copy of any document submitted for recordation to the appropriate public
recording office within the specified period due to a delay caused by the
recording office in the applicable jurisdiction; provided that Seller shall
instead deliver, or cause to be delivered, a recording receipt of such recording
office or, if such recording receipt is not available, an officer's certificate
of a servicing officer of Seller confirming that such documents have been
accepted for recording; provided that, upon request of Purchaser and delivery by
Purchaser to Seller of a schedule of the related Mortgage Loans, Seller shall
reissue and deliver to Purchaser said officer's certificate relating to the
related Mortgage Loans.
Seller shall pay all initial recording fees, if any, for the Assignments of
Mortgage and any other fees or costs in transferring all original documents to
Purchaser. Purchaser shall be responsible for recording the Assignments of
Mortgage and shall be reimbursed by Seller for the reasonable costs associated
therewith pursuant to the preceding sentence.
SECTION 7. SERVICING OF THE MORTGAGE LOANS. The Mortgage Loans have been sold
by Seller to Purchaser on a servicing retained basis. Purchaser shall retain
Seller as independent contract servicer of the Mortgage Loans pursuant to and in
accordance with the terms and conditions contained in the Servicing Agreement.
Purchaser and Seller shall execute the Servicing Agreement on the Closing Date
in the form attached hereto as Exhibit B. Pursuant to the Servicing Agreement,
Seller shall begin servicing the Mortgage Loans on behalf of Purchaser and shall
be entitled to the Servicing Fee and any Ancillary Income with respect to such
Mortgage Loans from the Closing Date until the termination of the Servicing
Agreement with respect to any of the Mortgage Loans as set forth in the
Servicing Agreement.
SECTION 8. REPRESENTATIONS, WARRANTIES AND COVENANTS OF Seller; REMEDIES FOR
BREACH.
8.01. Representations and Warranties Regarding Seller. Seller represents,
warrants and covenants to Purchaser that as of the date hereof and as of the
Closing Date:
a. DUE ORGANIZATION AND AUTHORITY; ENFORCEABILITY. Seller is a federal savings
bank duly organized, validly existing and in good standing under the laws of
the United States and has all licenses necessary to carry on its business as
now being conducted in each state wherein it owns or leases any material
properties or where a Mortgaged Property is located. Seller is in compliance
with the laws of any such state to the extent necessary to ensure the
enforceability of the related Mortgage Loan in accordance with the terms of
this Agreement; Seller has the full corporate power, authority and legal
right to hold, transfer and convey the Mortgage Loans and to execute and
deliver this Agreement and to perform its obligations hereunder; the
execution, delivery and performance of this Agreement (including all
instruments of transfer to be delivered pursuant to this Agreement) by
Seller and the consummation of the transactions contemplated hereby have
been duly and validly authorized; this Agreement and all agreements
contemplated hereby have been duly executed and delivered and constitute the
valid, legal, binding and enforceable obligations of Seller subject to
bankruptcy laws and other similar laws of general application affecting
rights of creditors and subject to the application of the rules of equity,
including those respecting the availability of specific performance, none of
which will materially interfere with the realization of the benefits
provided thereunder, regardless of whether such enforcement is sought in a
proceeding in equity or at law; and all requisite corporate action has been
taken by Seller to make this Agreement and all agreements contemplated
hereby valid and binding upon Seller in accordance with their terms;
b. ORDINARY COURSE OF BUSINESS. The consummation of the transactions
contemplated by this Agreement are in the ordinary course of business of
Seller, and the transfer, assignment and conveyance of the Mortgage Notes
and the Mortgages by Seller pursuant to this Agreement are not subject to
the bulk transfer or any similar statutory provisions in effect in any
applicable jurisdiction;
c. NO CONFLICTS. Neither the execution and delivery of this Agreement, the sale
of the Mortgage Loans to Purchaser, the consummation of the transactions
contemplated hereby, nor the fulfillment of or compliance with the terms and
conditions of this Agreement, will conflict with or result in a breach of
any of the terms, conditions or provisions of Seller's charter or by-laws or
any legal restriction or any agreement or instrument to which Seller is now
a party or by which it is bound, or constitute a default or result in an
acceleration under any of the foregoing, or result in the violation of any
law, rule, regulation, order, judgment or decree to which Seller or its
property is subject, or result in the creation or imposition of any lien,
charge or encumbrance that would have an adverse effect upon any of its
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properties pursuant to the terms of any mortgage, contract, deed of trust or
other instrument, or impair the ability of Purchaser to realize on the
Mortgage Loans, impair the value of the Mortgage Loans, or impair the
ability of Purchaser to realize the full amount of any mortgage insurance
benefits accruing pursuant to this Agreement;
d. ABILITY TO PERFORM; SOLVENCY. Seller does not believe, nor does it have any
reason or cause to believe, that it cannot perform each and every covenant
contained in this Agreement. Seller is solvent and the sale of the Mortgage
Loans will not cause Seller to become insolvent. The sale of the Mortgage
Loans is not undertaken with the intent to hinder, delay or defraud any of
Seller's creditors;
e. NO LITIGATION PENDING. There is no action, suit, proceeding or investigation
pending or threatened against Seller, before any court, administrative
agency or other tribunal asserting the invalidity of this Agreement, seeking
to prevent the consummation of any of the transactions contemplated by this
Agreement or which, either in any one instance or in the aggregate, could
result in any material adverse change in the business, operations, financial
condition, properties or assets of Seller, or in any material impairment of
the right or ability of Seller to carry on its business substantially as now
conducted, or in any material liability on the part of Seller, or which
would draw into question the validity of this Agreement or the Mortgage
Loans or of any action taken or to be taken in connection with the
obligations of Seller contemplated herein, or which would be likely to
impair materially the ability of Seller to perform under the terms of this
Agreement;
f. NO CONSENT REQUIRED. No consent, approval, authorization or order of, or
registration or filing with, or notice to any court or governmental agency
or body including HUD is required for the execution, delivery and
performance by Seller of or compliance by Seller with this Agreement or the
Mortgage Loans, the delivery of a portion of the Mortgage Files to Purchaser
or the sale of the Mortgage Loans or the consummation of the transactions
contemplated by this Agreement, or if required, such approval has been
obtained prior to the Closing Date;
g. SELECTION PROCESS. The Mortgage Loans were selected from among the
outstanding one- to four-family mortgage loans in Seller's portfolio at the
Closing Date as to which the representations and warranties set forth in
Subsection 8.02 could be made and such selection was not made in a manner so
as to affect adversely the interests of Purchaser;
h. INITIAL PORTFOLIO. The aggregate characteristics of the Mortgage Loans are
as set forth under the heading " Business and Strategy--Description of
Initial Portfolio" in the Prospectus of Purchaser dated ______, 1996;
i. NO UNTRUE INFORMATION. Neither this Agreement nor any information,
statement, tape, diskette, report, form, or other document furnished or to
be furnished pursuant to this Agreement or in connection with the
transactions contemplated hereby contains or will contain any untrue
statement of a material fact or omits or will omit to state a material fact
necessary to make the statements contained herein or therein not misleading;
and
j. NO BROKERS. Seller has not dealt with any broker, investment banker, agent
or other person that may be entitled to any commission or compensation in
connection with the sale of the Mortgage Loans.
8.02. Representations and Warranties Regarding Individual Mortgage Loans.
Seller hereby represents and warrants to Purchaser that, as to each Mortgage
Loan, as of the Closing Date for such Mortgage Loan:
a. MORTGAGE LOANS AS DESCRIBED. The information set forth in the Mortgage
Loan Schedule is complete, true and correct in all material respects;
b. PAYMENTS CURRENT; STATUS. All payments required to be made up to, but not
including, the Cut-off Date for the Mortgage Loan under the terms of the
Mortgage Note have been made and credited. No payment required under the
Mortgage Loan is delinquent nor has any payment under the Mortgage Loan
been 30 days or more delinquent more than once within the twelve (12)
months prior to the Cut-off Date. The Mortgage Loan is not, and has not
been at any time in the preceding twelve months, (i) classified, (ii) in
nonaccrual status or (iii) renegotiated due to the deterioration of the
financial condition of the Mortgagor;
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c. NO OUTSTANDING CHARGES. There are no defaults in complying with the terms
of the Mortgage, and all taxes, governmental assessments, insurance
premiums, water, sewer and municipal charges, leasehold payments or ground
rents which previously became due and owing have been paid, or an escrow
of funds has been established in an amount sufficient to pay for every
such item which remains unpaid and which has been assessed but is not yet
due and payable. Seller has not advanced funds, or induced, solicited or
knowingly received any advance of funds by a party other than the
Mortgagor, directly or indirectly, for the payment of any amount required
under the Mortgage Loan, except for interest accruing from the date of the
Mortgage Note or date of disbursement of the Mortgage Loan proceeds,
whichever is earlier, to the day which precedes by one month the Due Date
of the first installment of principal and interest;
d. ORIGINAL TERMS UNMODIFIED. The terms of the Mortgage Note and Mortgage
have not been impaired, waived, altered or modified in any respect except
by a written instrument which has been recorded (if necessary to protect
the interests of Purchaser) and which has been delivered to Purchaser and
the terms of which are reflected in the Mortgage Loan Schedule, if
applicable. The substance of any such waiver, alteration or modification
has been approved by the title insurer, if any, to the extent required by
the policy, and its terms are reflected on the Mortgage Loan Schedule, if
applicable. No Mortgagor has been released, in whole or in part, except in
connection with an assumption agreement, which assumption agreement is
part of the Mortgage Loan File delivered to Purchaser and the terms of
which are reflected in the Mortgage Loan Schedule;
e. NO DEFENSES. The Mortgage Loan is not subject to any right of rescission,
set-off, counterclaim or defense, including without limitation the defense
of usury, nor will the operation of any of the terms of the Mortgage Note
or the Mortgage, or the exercise of any right thereunder, render either
the Mortgage Note or the Mortgage unenforceable, in whole or in part and
no such right of rescission, set-off, counterclaim or defense has been
asserted with respect thereto, and no Mortgagor is now or was, at the time
of origination of the related Mortgage Loan, a debtor in any state or
Federal bankruptcy or insolvency proceeding;
f. HAZARD INSURANCE. Pursuant to the terms of the Mortgage, all buildings or
other improvements upon the Mortgaged Property are insured by a generally
acceptable insurer against loss by fire, hazards of extended coverage and
such other hazards as are set forth in Section 2.10 of the Servicing
Agreement. If required by the Flood Disaster Protection Act of 1973, as
amended, the Mortgage Loan is covered by a flood insurance policy which
meets all current federal guidelines and conforms to FNMA and FHLMC
guidelines , as well as all additional requirements set forth in Section
2.10 of the Servicing Agreement. All individual insurance policies contain
a standard mortgagee clause naming Seller and its successors and assigns
as mortgagee, and all premiums thereon have been paid. The Mortgage for
each Mortgage Loan obligates the Mortgagor thereunder to maintain the
hazard insurance policy at the Mortgagor's cost and expense, and on the
Mortgagor's failure to do so, authorizes the holder of the Mortgage to
obtain and maintain such insurance at such Mortgagor's cost and expense,
and to seek reimbursement therefor from the Mortgagor. Where required by
state law or regulation, the Mortgagor has been given an opportunity to
choose the carrier of the required hazard insurance, provided the policy
is not a "master" or "blanket" hazard insurance policy covering a
condominium, or any hazard insurance policy covering the common facilities
of a planned unit development. The hazard insurance policy is the valid
and binding obligation of the insurer, is in full force and effect, and
will be in full force and effect and inure to the benefit of Purchaser
upon the consummation of the transactions contemplated by this Agreement.
Seller has not engaged in, and has no knowledge that the Mortgagors have
engaged in, any act or omission which would impair the coverage of any
such policy, the benefits of the endorsement provided for herein, or the
validity and binding effect of either including, without limitation, no
unlawful fee, commission, kickback or other unlawful compensation or value
of any kind has been or will be received, retained or realized by any
attorney, firm or other person or entity, and no such unlawful items have
been received, retained or realized by Seller;
g. COMPLIANCE WITH APPLICABLE LAWS. All applicable federal, state and local
laws and regulations including, without limitation, usury, truth-in-
lending, real estate settlement procedures, consumer credit protection,
fair housing, equal credit opportunity and disclosure laws applicable to
the Mortgage Loan have been complied with, the consummation of the
transactions contemplated hereby will not involve the violation of any
such laws or regulations, and Seller shall maintain in its possession,
available for Purchaser's inspection, and shall deliver to Purchaser upon
demand, evidence of such compliance. ****
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h. NO SATISFACTION OF MORTGAGE. The Mortgage has not been satisfied,
canceled, subordinated or rescinded, in whole or in part, and the
Mortgaged Property has not been released from the lien of the Mortgage, in
whole or in part, nor has any instrument been executed that would effect
any such release, cancellation, subordination or rescission. Seller has
not waived the performance by the Mortgagor of any action, if the
Mortgagor's failure to perform such action would cause the Mortgage Loan
to be in default, nor has Seller waived any default resulting from any
action or inaction by the Mortgagor;
i. LOCATION AND TYPE OF MORTGAGED PROPERTY. The Mortgaged Property is located
in the state identified in the Mortgage Loan Schedule and consists of a
single parcel of real property with a detached single family residence
erected thereon, or a townhouse, or a two- to four-family dwelling, or an
individual condominium unit in a condominium project, or an individual
unit in a planned unit development, provided, however, that any
condominium unit or planned unit development shall conform with
requirements acceptable to FNMA or FHLMC regarding such dwellings and that
no residence or dwelling is a single parcel of real property with a
cooperative housing corporation erected thereon, a mobile home or a
manufactured dwelling. As of the date of origination, no portion of the
Mortgaged Property is used for commercial purposes, and since the date of
origination no portion of the Mortgaged Property is used for commercial
purposes;
j. VALID FIRST LIEN. The Mortgage is a valid, subsisting, enforceable and
perfected first lien on the Mortgaged Property, including all buildings
and improvements on the Mortgaged Property and all installations and
mechanical, electrical, plumbing, heating and air conditioning systems
located in or annexed to such buildings, and all additions alterations and
replacements made at any time with respect to the foregoing. The lien of
the Mortgage is subject only to:
1. the lien of current real property taxes and assessments not yet due
and payable;
2. covenants, conditions and restrictions, rights of way, easements and
other matters of the public record as of the date of recording
acceptable to prudent mortgage lending institutions generally and
specifically referred to in the lender's title insurance policy
delivered to the originator of the Mortgage Loan and (a) specifically
referred to or otherwise considered in the appraisal made for the
originator of the Mortgage Loan or (b) which do not adversely affect
the Appraised Value of the Mortgaged Property set forth in such
appraisal; and
3. other matters to which like properties are commonly subject which do
not materially interfere with the benefits of the security intended to
be provided by the Mortgage or the use, enjoyment, value or
marketability of the related Mortgaged Property.
Any security agreement, chattel mortgage or equivalent document related to
and delivered in connection with the Mortgage Loan establishes and creates
a valid, subsisting, enforceable and perfected first lien and first
priority security interest on the property described therein and Seller
has full right to sell and assign the same to Purchaser. The Mortgaged
Property was not, as of the date of origination of the Mortgage Loan,
subject to a mortgage, deed of trust, deed to secure debt or other
security instrument creating a lien subordinate to the lien of the
Mortgage (except any such subordinate loan which was created in connection
with the origination of the related Mortgage Loan details of which are
contained in the related Mortgage File);
k. VALIDITY OF MORTGAGE DOCUMENTS. The Mortgage Note and the Mortgage and any
other agreement executed and delivered by a Mortgagor in connection with a
Mortgage Loan are genuine, and each is the legal, valid and binding
obligation of the maker thereof enforceable in accordance with its terms.
All parties to the Mortgage Note, the Mortgage and any other such related
agreement had legal capacity to enter into the Mortgage Loan and to
execute and deliver the Mortgage Note, the Mortgage and any such
agreement, and the Mortgage Note, the Mortgage and any other such related
agreement have been duly and properly executed by such parties. No fraud,
error, omission, misrepresentation, negligence or similar occurrence with
respect to a Mortgage Loan has taken place on the part of any Person,
including without limitation, the Mortgagor, any appraiser, any builder or
developer, or any other party involved in the origination of the Mortgage
Loan. Seller has reviewed all of the documents constituting the Servicing
File and has made such inquiries as it deems necessary to make and confirm
the accuracy of the representations set forth herein;
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l. FULL DISBURSEMENT OF PROCEEDS. The Mortgage Loan has been closed and the
proceeds of the Mortgage Loan have been fully disbursed and there is no
requirement for future advances thereunder, and any and all requirements
as to completion of any on-site or off-site improvement and as to
disbursements of any escrow funds therefor have been complied with. All
costs, fees and expenses incurred in making or closing the Mortgage Loan
and the recording of the Mortgage were paid, and the Mortgagor is not
entitled to any refund of any amounts paid or due under the Mortgage Note
or Mortgage;
m. OWNERSHIP. Seller is the sole owner of record and holder of the Mortgage
Loan and the indebtedness evidenced by each Mortgage Note, except for the
assignments of mortgage which have been sent for recording and upon
recordation, Seller will be the owner of record of each Mortgage and the
indebtedness evidenced by each Mortgage Note, and upon the sale of the
Mortgage Loans to Purchaser, Seller will retain the Mortgage Files or any
part thereof with respect thereto not delivered to Purchaser in trust only
for the purpose of servicing and supervising the servicing of each
Mortgage Loan. The Mortgage Loan is not assigned or pledged, and Seller
has good, indefeasible and marketable title thereto, and has full right to
transfer and sell the Mortgage Loan to Purchaser free and clear of any
encumbrance, equity, participation interest, lien, pledge, charge, claim
or security interest, and has full right and authority subject to no
interest or participation of, or agreement with, any other party, to sell
and assign each Mortgage Loan pursuant to this Agreement and following the
sale of each Mortgage Loan, Purchaser will own such Mortgage Loan free and
clear of any encumbrance, equity, participation interest, lien, pledge,
charge, claim or security interest. Seller intends to relinquish all
rights to possess, control and monitor the Mortgage Loan, except
indirectly for purposes of servicing the Mortgage Loan as set forth in the
Servicing Agreement. After the Closing Date, Seller will have no right to
modify or alter the terms of the sale of the Mortgage Loan and Seller will
have no obligation or right to repurchase the Mortgage Loan or substitute
another Mortgage Loan, except as provided in this Agreement;
n. DOING BUSINESS. All parties which have had any interest in the Mortgage
Loan, whether as mortgagee, assignee, pledges or otherwise, are (or,
during the period in which they held and disposed of such interest, were)
(1) in compliance with any and all applicable licensing requirements of
the laws of the state wherein the Mortgaged Property is located, and (2)
either (i) organized under the laws of such state, or (ii) qualified to do
business in such state, or (iii) a federal savings and loan association, a
savings bank or a national bank having a principal office in such state,
or (3) not doing business in such state;
o. LTV, PMI POLICY. No Conventional Loan has an LTV greater than 95%. The
original LTV of each Conventional Loan either was not more than 85% or the
excess over 75% is and will be insured as to payment defaults by a PMI
Policy until the LTV of such Conventional Loan is reduced to 85%. All
provisions of such PMI Policy have been and are being complied with, such
policy is valid and remains in full force and effect, and all premiums due
thereunder have been paid. No action, inaction, or event has occurred and
no state of facts exists that has, or will result in the exclusion from,
denial of, or defense to coverage by the PMI Policy. Any Conventional Loan
subject to a PMI Policy obligates the Mortgagor thereunder to maintain the
PMI Policy and to pay all premiums and charges in connection therewith.
The Mortgage Interest Rate for each Conventional Loan as set forth on the
Mortgage Loan Schedule is net of any such insurance premium;
p. TITLE INSURANCE. The Mortgage Loan is covered by an ALTA lender's title
insurance policy or other generally acceptable form of policy or insurance
acceptable to FNMA or FHLMC and each such title insurance policy is issued
by a title insurer acceptable to FNMA or FHLMC and qualified to do
business in the jurisdiction where the Mortgaged Property is located,
insuring Seller, its successors and assigns, as to the first priority lien
of the Mortgage in the original principal amount of the Mortgage Loan,
subject only to the exceptions contained in clauses (1), (2) and (3) of
paragraph (j) of this Subsection 8.02, and against any loss by reason of
the invalidity or unenforceability of the lien resulting from the
provisions of the Mortgage providing for adjustment to the Mortgage
Interest Rate and Monthly Payment. Where required by state law or
regulation, the Mortgagor has been given the opportunity to choose the
carrier of the required mortgage title insurance. Additionally, such
lender's title insurance policy affirmatively insures ingress and egress,
and against encroachments by or upon the Mortgaged Property or any
interest therein. Seller, its successor and assigns, are the sole insureds
under such lender's title insurance policy, and such lender's title
insurance policy is valid and remains in full force and effect and will be
in force and effect upon the consummation of the transactions contemplated
by this Agreement. No claims have been made under such lender's title
insurance policy,
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and no prior holder of the related Mortgage, including Seller, has done,
by act or omission, anything which would impair the coverage of such
lender's title insurance policy, including without limitation, no unlawful
fee, commission, kickback or other unlawful compensation or value of any
kind has been or will be received, retained or realized by any attorney,
firm or other person or entity, and no such unlawful items have been
received, retained or realized by Seller;
q. NO DEFAULTS. No default, breach, violation or event which would permit
acceleration exists under the Mortgage or the Mortgage Note and no event
which, with the passage of time or with notice and the expiration of any
grace or cure period, would constitute a default, breach, violation or
event which would permit acceleration, and neither Seller nor its
predecessors have waived any default, breach, violation or event which
would permit acceleration;
r. NO MECHANICS' LIENS. There are no mechanics' or similar liens or claims
which have been filed for work, labor or material (and no rights are
outstanding that under law could give rise to such liens) affecting the
related Mortgaged Property which are or may be liens prior to, or equal
with, the lien of the related Mortgage;
s. LOCATION OF IMPROVEMENTS; NO ENCROACHMENTS. All improvements which were
considered in determining the Appraised Value of the Mortgaged Property
lay wholly within the boundaries and building restriction lines of the
Mortgaged Property, and no improvements on adjoining properties encroach
upon the Mortgaged Property. No improvement located on or being part of
the Mortgaged Property is in violation of any applicable zoning law or
regulation;
t. ORIGINATION; PAYMENT TERMS. The Mortgage Loan was originated by a
mortgagee approved by the Secretary of Housing and Urban Development
pursuant to Sections 203 and 211 of the Act, a savings and loan
association, a savings bank, a commercial bank, credit union, insurance
company or similar institution which is supervised and examined by a
federal or state authority. The documents, instruments and agreements
submitted for loan underwriting were not falsified and contain no untrue
statement of material fact or omit to state a material fact required to be
stated therein or necessary to make the information and statements therein
not misleading. Principal payments on the Mortgage Loan commenced no more
than sixty (60) days after funds were disbursed in connection with the
Mortgage Loan. The Mortgage Interest Rate, as well as the Lifetime Rate
Cap and the Periodic Rate Cap if the Mortgage Loan is an ARM Loan, are as
set forth on Exhibit J and/or Exhibit K hereto. The Mortgage Note is
payable on the first day of each month in equal monthly installments of
principal and interest, which installments of interest are subject to
change if the Mortgage Loan is an ARM Loan due to the adjustments to the
Mortgage Interest Rate on each Interest Rate Adjustment Date, with
interest calculated and payable in arrears, sufficient to amortize the
Mortgage Loan fully by the stated maturity date, over an original term of
not more than thirty years from commencement of amortization. There is no
negative amortization with respect to any Mortgage Loan. Each Convertible
Mortgage Loan contains a provision allowing the Mortgagor to convert the
Mortgage Note from an adjustable interest rate Mortgage Note to a fixed
interest rate Mortgage Note in accordance with the terms of the Mortgage
Note or a rider to the related Mortgage Note;
u. CUSTOMARY PROVISIONS. The Mortgage contains customary and enforceable
provisions such as to render the rights and remedies of the holder thereof
adequate for the realization against the Mortgaged Property of the
benefits of the security provided thereby, including, (i) in the case of a
Mortgage designated as a deed of trust, by trustee's sale, and (ii)
otherwise by judicial foreclosure. Upon default by a Mortgagor on a
Mortgage Loan and foreclosure on, or trustee's sale of, the Mortgaged
Property pursuant to the proper procedures, the holder of the Mortgage
Loan will be able to deliver good and merchantable title to the Mortgaged
Property. There is no homestead or other exemption available to a
Mortgagor which would interfere with the right to sell the Mortgaged
Property at a trustee's sale or the right to foreclose the Mortgage,
subject to applicable federal and state laws and judicial precedent with
respect to bankruptcy and right of redemption or similar law. The Mortgage
contains due-on-sale provisions providing for the acceleration of the
payment of the unpaid principal balance of such Mortgage Loan in the event
that all or any part of the Mortgaged Property is sold or transferred
without the prior written consent of the Mortgagee;
v. CONFORMANCE WITH AGENCY AND UNDERWRITING STANDARDS. The Mortgage Loan was
underwritten in accordance with the underwriting standards of Seller (a
copy of which is attached hereto as Exhibit L), or FNMA's underwriting
standards (except that the principal balance of certain Mortgage Loans may
have exceeded the limits of FNMA), in
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each case in effect at the time the Mortgage Loan was originated. The
Mortgage Note and Mortgage are on forms acceptable to FHLMC or FNMA,
except with respect to Mortgage Loans underwritten in accordance with the
underwriting guidelines of Seller, which are on forms acceptable to
Purchaser, in Purchaser's sole discretion, as evidenced by Purchaser's
purchase of the related Mortgage Loans, and, in either case, Seller has
not made any representations to a Mortgagor that are inconsistent with the
mortgage instruments used. All Mortgage Loans have full asset
verification;
w. OCCUPANCY OF THE MORTGAGED PROPERTY. As of the Closing Date, the Mortgaged
Property is lawfully occupied under applicable law. All inspections,
licenses and certificates required to be made or issued with respect to
all occupied portions of the Mortgaged Property and, with respect to the
use and occupancy of the same, including but not limited to certificates
of occupancy and fire underwriting certificates, have been made or
obtained from the appropriate authorities. Unless otherwise specified on
the description of characteristics for the Mortgage Loans delivered
pursuant to Section 10 on the Closing Date in the form attached as Exhibit
K hereto and the Mortgage Loan Schedule attached as Exhibit J hereto, the
Mortgagor represented at the time of origination of the Mortgage Loan that
the Mortgagor would occupy the Mortgaged Property as the Mortgagor's
primary residence;
x. NO ADDITIONAL COLLATERAL. The Mortgage Note is not and has not been
secured by any collateral except the lien of the corresponding Mortgage
and the security interest of any applicable security agreement or chattel
mortgage referred to in clause (j) above;
y. DEEDS OF TRUST. In the event the Mortgage constitutes a deed of trust, a
trustee, authorized and duly qualified under applicable law to serve as
such, has been properly designated and currently so serves and is named in
the Mortgage, and no fees or expenses are or will become payable by
Purchaser to the trustee under the deed of trust, except in connection
with a trustee's sale after default by the Mortgagor;
z. ACCEPTABLE INVESTMENT. There are no circumstances or conditions with
respect to the Mortgage, the Mortgaged Property, the Mortgagor, the
Mortgage File or the Mortgagor's credit standing that can reasonably be
expected to cause the Mortgage Loan to become delinquent, or adversely
affect the value or marketability of the Mortgage Loan;
aa. DELIVERY OF MORTGAGE DOCUMENTS. The Mortgage Note, the Mortgage, the
Assignment of Mortgage and any other Mortgage Loan Documents for each
Mortgage Loan have been delivered to Purchaser. Seller is in possession of
a complete, true and accurate Mortgage File in compliance with Exhibit A
hereto, except for such documents the originals of which have been
delivered to Purchaser;
bb. CONDOMINIUMS/PLANNED UNIT DEVELOPMENTS. If the Mortgaged Property is a
condominium unit or a planned unit development, it is acceptable to FNMA
or FHLMC or is located in a condominium or planned unit development
project which has received project approval from FNMA or FHLMC;
cc. TRANSFER OF MORTGAGE LOANS. The Assignment of Mortgage with respect to
each Mortgage Loan is in recordable form and is acceptable for recording
under the laws of the jurisdiction in which the Mortgaged Property is
located;
dd. ASSUMABILITY. The Mortgage Loan Documents provide that a related Mortgage
Loan may only be assumed if the party assuming such Mortgage Loan meets
certain credit requirements stated in the Mortgage Loan Documents, except
that with respect to Mortgage Loans underwritten in accordance with the
underwriting guidelines of Seller, the Mortgage Loan Documents relating to
such Mortgage Loans do not preclude assumability;
ee. NO BUYDOWN PROVISIONS; NO GRADUATED PAYMENTS OR CONTINGENT INTERESTS. The
Mortgage Loan does not contain provisions pursuant to which Monthly
Payments are paid or partially paid with funds deposited in any separate
account established by Seller, the Mortgagor, or anyone on behalf of the
Mortgagor, or paid by any source other than the Mortgagor nor does it
contain any other similar provisions which may constitute a "buydown"
provision. The Mortgage Loan is not a graduated payment mortgage loan and
the Mortgage Loan does not have a shared appreciation or other contingent
interest feature;
ff. RESERVED
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gg. MORTGAGED PROPERTY UNDAMAGED; NO CONDEMNATION PROCEEDINGS. There is no
proceeding pending or threatened for the total or partial condemnation of
the Mortgaged Property. The Mortgaged Property is undamaged by waste,
fire, earthquake or earth movement, windstorm, flood, tornado or other
casualty so as to affect adversely the value of the Mortgaged Property as
security for the Mortgage Loan or the use for which the premises were
intended and each Mortgaged Property is in good repair. There have not
been any condemnation proceedings with respect to the Mortgaged Property
and Seller has no knowledge of any such proceedings in the future;
hh. COLLECTION PRACTICES; ESCROW DEPOSITS; INTEREST RATE ADJUSTMENTS. The
origination and collection practices used by Seller with respect to the
Mortgage Loan have in all respects been in compliance with Accepted
Servicing Practices, applicable laws and regulations, and have in all
respects been legal and proper. With respect to escrow deposits and Escrow
Payments, all such payments are in the possession of, or under the control
of, Seller, and there exist no deficiencies in connection therewith for
which customary arrangements for repayment thereof have not been made. All
Escrow Payments have been collected in full compliance with state and
federal law and the provisions of the related Mortgage Note and Mortgage.
An escrow of funds is not prohibited by applicable law and has been
established in an amount sufficient to pay for every item that remains
unpaid and has been assessed but is not yet due and payable. No escrow
deposits or Escrow Payments or other charges or payments due Seller have
been capitalized under the Mortgage or the Mortgage Note. All Mortgage
Interest Rate adjustments to the Monthly Payment, if the Mortgage Loan is
an ARM Loan, have been made in strict compliance with state and federal
law and the terms of the related Mortgage and Mortgage Note on the related
Interest Rate Adjustment Date. With respect to each ARM Loan, the Mortgage
Interest Rate adjusts as set forth herein. If, pursuant to the terms of
the Mortgage Note, another index was selected for determining the Mortgage
Interest Rate, the same index was used with respect to each Mortgage Note
which required a new index to be selected, and such selection did not
conflict with the terms of the related Mortgage Note. Seller executed and
delivered any and all notices required under applicable law and the terms
of the related Mortgage Note and Mortgage regarding the Mortgage Interest
Rate and the Monthly Payment adjustments. Any interest required to be paid
pursuant to state, federal and local law has been properly paid and
credited;
ii. OTHER INSURANCE POLICIES. No action, inaction or event has occurred and no
state of facts exists or has existed that has resulted or could result in
the exclusion from, denial of, or defense to coverage under any hazard
insurance policy or PMI Policy. In connection with the placement of any
such insurance, no commission, fee, or other compensation has been or will
be received by Seller or by any officer, director, or employee of Seller
or any designee of Seller or any corporation in which Seller or any
officer, director, or employee had a financial interest at the time of
placement of such insurance;
jj. NO VIOLATION OF ENVIRONMENTAL LAWS. There is no pending action or
proceeding directly involving the Mortgaged Property in which compliance
with any environmental law, rule or regulation is an issue; there is no
violation of any environmental law, rule or regulation with respect to the
Mortgaged Property; and nothing further remains to be done to satisfy in
full all requirements of each such law, rule or regulation constituting a
prerequisite to use and enjoyment of said property;
kk. SOLDIERS' AND SAILORS' CIVIL RELIEF ACT. The Mortgagor has not notified
Seller and Seller has no knowledge of any relief requested or allowed to
the Mortgagor under the Soldiers' and Sailors' Civil Relief Act of 1940;
ll. APPRAISAL. The Mortgage File contains an appraisal of the related
Mortgaged Property signed prior to the approval of the Mortgage Loan
application by a Qualified Appraiser who had no interest, direct or
indirect in the Mortgaged Property or in any loan made on the security
thereof, and whose compensation is not affected by the approval or
disapproval of the Mortgage Loan, and the appraisal and appraiser both
satisfy the requirements of PUMA or FHLMC and Title XI of the Federal
Institutions Reform, Recovery, and Enforcement Act of 1989 and the
regulations promulgated thereunder, all as in effect on the date the
Mortgage Loan was originated;
mm. DISCLOSURE MATERIALS. The Mortgagor has received all disclosure materials
required by and Seller complied with all applicable law with respect to
the making of the Mortgage Loans;
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nn. CONSTRUCTION OR REHABILITATION OF MORTGAGED PROPERTY. No Mortgage Loan was
made in connection with the construction or rehabilitation of a Mortgaged
Property or facilitating the trade-in or exchange of a Mortgaged Property;
oo. VALUE OF MORTGAGED PROPERTY. Seller has no knowledge of any circumstances
existing that could reasonably be expected to adversely affect the value
or the marketability of any Mortgaged Property or Mortgage Loan;
pp. NO DEFENSE TO INSURANCE COVERAGE. No action has been taken or failed to be
taken, no event has occurred and no state of facts exists or has existed
on or prior to the Closing Date (whether or not known to Seller on or
prior to such date) which has resulted or will result in an exclusion
from, denial of, or defense to coverage under any primary mortgage
insurance (including, without limitation, any exclusions, denials or
defenses which would limit or reduce the availability of the timely
payment of the full amount of the loss otherwise due thereunder to the
insured) whether arising out of actions, representations, errors,
omissions, negligence, or fraud of Seller, the related Mortgagor or any
party involved in the application for such coverage, including the
appraisal, plans and specifications and other exhibits or documents
submitted therewith to the insurer under such insurance policy, or for any
other reason under such coverage, but not including the failure of such
insurer to pay by reason of such insurer's breach of such insurance policy
or such insurer's financial inability to pay;
qq. ESCROW ANALYSIS. With respect to each Mortgage, Seller has within the last
twelve months (unless such Mortgage was originated within such twelve
month period) analyzed the required Escrow Payments for each Mortgage and
adjusted the amount of such payments so that, assuming all required
payments are timely made, any deficiency will be eliminated on or before
the first anniversary of such analysis, or any overage will be refunded to
the Mortgagor, in accordance with RESPA and any other applicable law; and
rr. PRIOR SERVICING. Each Mortgage Loan has been serviced in all material
respects in compliance with Accepted Servicing Practices; provided that,
in the event any Mortgage Loan was not so serviced, Seller shall not be
required to repurchase such Mortgage Loan unless such breach had, and
continues to have, a material and adverse effect on the value of the
related Mortgage Loan or the interest of Purchaser therein.
8.03. Remedies for Breach of Representations and Warranties. It is understood
and agreed that the representations and warranties set forth in Subsections 8.01
and 8.02 shall survive the sale of the Mortgage Loans to Purchaser and shall
inure to the benefit of Purchaser, notwithstanding any restrictive or qualified
endorsement on any Mortgage Note or Assignment of Mortgage or the examination or
failure to examine any Mortgage File. Upon discovery by either Seller or
Purchaser of a breach of any of the foregoing representations and warranties
which materially and adversely affects the value of the Mortgage Loans or the
interest of Purchaser (or which materially and adversely affects the interests
of Purchaser in the related Mortgage Loan in the case of a representation and
warranty relating to a particular Mortgage Loan), the party discovering such
breach shall give prompt written notice to the other.
Promptly after discovery of a breach of any representation or warranty, Seller
shall notify Purchaser of such breach and the details thereof. Within sixty (60)
days of the earlier of (i) notice by Seller pursuant to the immediately
preceding sentence or (ii) notice by Purchaser to Seller of any breach of a
representation or warranty with respect to a Mortgage Loan, Seller shall use its
best efforts promptly to cure such breach in all material respects and, if such
breach cannot be cured, Seller shall, at Purchaser's option and subject to
Subsection 8.04, repurchase such Mortgage Loan at the Repurchase Price, unless
Seller elects to substitute a Qualified Substitute Mortgage Loan for such
Mortgage Loan pursuant to this Subsection. In the event that a breach shall
involve any representation or warranty set forth in Subsection 8.01, and such
breach cannot be cured within sixty (60) days of the earlier of either discovery
by or notice to Seller of such breach, all of the Mortgage Loans shall, at
Purchaser's option and subject to Subsection 8.04, be repurchased by Seller at
the Repurchase Price. However, if the breach shall involve a representation or
warranty set forth in Subsection 8.02 and Seller discovers or receives notice of
any such breach within two (2) years of the Closing Date, Seller may, at
Seller's option and provided that Seller has a Qualified Substitute Mortgage
Loan, rather than repurchase the Mortgage Loan as provided above, remove such
Mortgage Loan (a "Deleted Mortgage Loan") and substitute in its place a
Qualified Substitute Mortgage Loan or Loans, provided that any such substitution
shall be effected not later than two (2) years after the Closing Date. If Seller
has no Qualified Substitute Mortgage Loan, it shall repurchase the deficient
Mortgage Loan. Any repurchase of a Mortgage Loan or Loans pursuant to the
foregoing provisions of this Subsection 8.03 shall be accomplished by either (a)
if the Servicing Agreement is in effect, by
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deposit in the Custodial Account of the amount of the Repurchase Price for
payment to Purchaser on the next scheduled Remittance Date, after deducting
therefrom any amount received in respect of such repurchased Mortgage Loan or
Loans and being held in the Custodial Account for future distribution or (b) if
the Servicing Agreement is no longer in effect, by direct remittance of the
Repurchase Price to Purchaser in accordance with Purchaser's instructions.
At the time of repurchase or substitution, Purchaser and Seller shall arrange
for the reassignment of the Deleted Mortgage Loan to Seller and the delivery to
Seller of any documents held by Purchaser relating to the Deleted Mortgage Loan.
In addition, upon any such repurchase, all funds maintained in the Escrow
Account with respect to such Deleted Mortgage Loan shall be transferred to
Seller. In the event of a repurchase or substitution, Seller shall,
simultaneously with such reassignment, give written notice to Purchaser that
such repurchase or substitution has taken place, amend the Mortgage Loan
Schedule to reflect the withdrawal of the Deleted Mortgage Loan from this
Agreement, and, in the case of substitution, identify a Qualified Substitute
Mortgage Loan and amend the Mortgage Loan Schedule to reflect the addition of
such Qualified Substitute Mortgage Loan to this Agreement. In connection with
any such substitution, Seller shall be deemed to have made as to such Qualified
Substitute Mortgage Loan the representations and warranties set forth in this
Agreement except that all such representations and warranties set forth in this
Agreement shall be deemed made as of the date of such substitution. Seller shall
effect such substitution by delivering to Purchaser for such Qualified
Substitute Mortgage Loan the documents required by Subsection 6.03, with the
Mortgage Note endorsed as required by Subsection 6.03. No substitution will be
made in any calendar month after the Determination Date for such month. Seller
shall deposit in the Custodial Account the Monthly Payment, or in the event that
the Servicing Agreement is no longer in effect remit directly to Purchaser in
accordance with Purchaser's instructions the Monthly Payment less the Servicing
Fee due, if any, on such Qualified Substitute Mortgage Loan or Loans in the
month following the date of such substitution. Monthly Payments due with respect
to Qualified Substitute Mortgage Loans in the month of substitution shall be
retained by Seller. For the month of substitution, payments to Purchaser shall
include the Monthly Payment due on any Deleted Mortgage Loan in the month of
substitution, and Seller shall thereafter be entitled to retain all amounts
subsequently received by Seller in respect of such Deleted Mortgage Loan.
For any month in which Seller substitutes a Qualified Substitute Mortgage Loan
for a Deleted Mortgage Loan, Seller shall determine the amount (if any) by which
the aggregate principal balance of all Qualified Substitute Mortgage Loans as of
the date of substitution is less than the aggregate Stated Principal Balance of
all Deleted Mortgage Loans (after application of scheduled principal payments
due in the month of substitution). The amount of such shortfall shall be
distributed by Seller directly to Purchaser in accordance with Purchaser's
instructions within two (2) Business Days of such substitution.
In addition to such repurchase or substitution obligation, Seller shall
indemnify Purchaser and hold it harmless against any losses, damages, penalties,
fines, forfeitures, reasonable and necessary legal fees and related costs,
judgments, and other costs and expenses resulting from any claim, demand,
defense or assertion based on or grounded upon, or resulting from, a breach of
Seller representations and warranties contained in this Agreement. It is
understood and agreed that the obligations of Seller set forth in this
Subsection 8.03 to cure, substitute for or repurchase a defective Mortgage Loan
and to indemnify Purchaser as provided in this Subsection 8.03 constitute the
sole remedies of Purchaser respecting a breach of the foregoing representations
and warranties.
Any cause of action against Seller relating to or arising out of the breach of
any representations and warranties made in Subsections 8.01 and 8.02 shall
accrue as to any Mortgage Loan upon (i) discovery of such breach by Purchaser or
notice thereof by Seller to Purchaser, (ii) failure by Seller to cure such
breach or repurchase such Mortgage Loan as specified above, and (iii) demand
upon Seller by Purchaser for compliance with this Agreement.
SECTION 9. CLOSING. The closing for the purchase and sale of the Mortgage Loans
shall take place on the Closing Date. At Purchaser's option, the closing shall
be either: by telephone, confirmed by letter or wire as the parties shall agree,
or conducted in person, at such place as the parties shall agree.
Such closing shall be subject to the following conditions:
a. all of the representations and warranties of Seller under this Agreement
and under the Servicing Agreement (with respect to each Mortgage Loan, as
specified therein) shall be true and correct as of the Closing Date and no
event shall have occurred which, with notice or the passage of time, would
constitute a default under this Agreement or an Event of Default under the
Servicing Agreement;
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b. Purchaser shall have received, or Purchaser's attorneys shall have
received in escrow, all closing documents as specified in Section 10 of
this Agreement, in such forms as are agreed upon and acceptable to
Purchaser, duly executed by all signatories other than Purchaser as
required pursuant to the terms hereof;
c. Seller shall have delivered and released to Purchaser all Mortgage Loan
Documents with respect to each Mortgage Loan; and
d. all other terms and conditions of this Agreement shall have been complied
with.
Subject to the foregoing conditions, Purchaser shall pay to Seller on the
Closing Date the Purchase Price, plus accrued interest pursuant to Section 4 of
this Agreement, by wire transfer of immediately available funds to the account
designated by Seller.
SECTION 10. CLOSING DOCUMENTS. The closing documents for the Mortgage Loans to
be purchased on the Closing Date shall consist of fully executed originals of
the following documents:
a. this Agreement;
b. the Servicing Agreement, dated as of the Cut-off Date, in the form of
Exhibit B hereto;
c. a Custodial Account Letter Agreement or a Custodial Account Certification,
as applicable, as required under the Servicing Agreement;
d. an Escrow Account Letter Agreement or an Escrow Account Certification, as
applicable, as required under the Servicing Agreement;
e. an Officer's Certificate, in the form of Exhibit C hereto, including all
attachments thereto;
f. an Opinion of Counsel of Seller (who may be an employee of Seller), in the
form of Exhibit D hereto;
g. a Security Release Certification, in the form of Exhibit G or Exhibit H.
if applicable, hereto executed by any person, as requested by Purchaser,
if any of the Mortgage Loans have at any time been subject to any security
interest, pledge or hypothecation for the benefit of such person;
h. a certificate or other evidence of merger or change of name, signed or
stamped by the applicable regulatory authority, if any of the Mortgage
Loans were acquired by Seller by merger or acquired or originated by
Seller while conducting business under a name other than its present name,
if applicable;
i. the underwriting guidelines of Seller to be attached hereto as Exhibit L;
and
j. Exhibit K to this Agreement.
Seller shall bear the risk of loss of the closing documents until such time as
they are received by Purchaser or its attorneys.
SECTION 11. COSTS. Purchaser shall pay all legal fees and expenses of its
attorneys. All other costs and expenses incurred in connection with the transfer
and delivery of the Mortgage Loans including recording fees, fees for recording
Assignments of Mortgage, fees for title policy endorsements and continuations,
if applicable, Seller's attorney's fees, shall be paid by Seller.
SECTION 12. MERGER OR CONSOLIDATION OF SELLER. Seller will keep in full effect
its existence, rights and franchises as a federal savings bank, and will obtain
and preserve its qualification to do business in each jurisdiction in which such
qualification is or shall be necessary to protect the validity and
enforceability of this Agreement, or any of the Mortgage Loans and to perform
its duties under this Agreement.
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Any Person into which Seller may be merged or consolidated, or any corporation
resulting from any merger, conversion or consolidation to which Seller shall be
a party, or any Person succeeding to the business of Seller, shall be the
successor of Seller hereunder, without the execution or filing of any paper or
any further act on the part of any of the parties hereto, anything herein to the
contrary notwithstanding; provided, however, that the successor or surviving
Person shall have a tangible net worth of at least $30,000,000.
SECTION 13. MANDATORY DELIVERY; GRANT OF SECURITY INTEREST. The sale and
delivery on the Closing Date of the Mortgage Loans described on the Mortgage
Loan Schedule is mandatory from and after the date of the execution of this
Agreement, it being specifically understood and agreed that each Mortgage Loan
is unique and identifiable on the date hereof and that an award of money damages
would be insufficient to compensate Purchaser for the losses and damages
incurred by Purchaser (including damages to prospective purchasers of the
Mortgage Loans) in the event of Seller's failure to deliver (i) each of the
Mortgage Loans or (ii) one or more Qualified Substitute Mortgage Loans or (iii)
one or more Mortgage Loans otherwise acceptable to Purchaser on or before the
Closing Date. Seller hereby grants to Purchaser a lien on, and a continuing
security interest in, each Mortgage Loan and each document and instrument
evidencing each such Mortgage Loan to secure the performance by Seller of its
obligations under this Agreement, and Seller agrees that it shall hold such
Mortgage Loans in custody for Purchaser subject to Purchaser's (i) right to
reject any Mortgage Loan (or Qualified Substitute Mortgage Loan) under the terms
of this Agreement and to require another Mortgage Loan (or Qualified Substitute
Mortgage Loan) to be substituted therefor, and (ii) obligation to pay the
Purchase Price plus accrued interest as set forth in Section 4 hereof for the
Mortgage Loans. All rights and remedies of Purchaser under this Agreement are
distinct from, and cumulative with, any other rights or remedies under this
Agreement or afforded by law or equity and all such rights and remedies may be
exercised concurrently, independently or successively.
SECTION 14. NOTICES. All demands, notices and communications hereunder shall be
in writing and shall be deemed to have been duly given if mailed, by registered
or certified mail, return receipt requested, or, if by other means, when
received by the other party at the address as follows:
If to Seller:
Chevy Chase Bank, F.S.B.
7926 Jones Branch Drive
McLean, Virginia 22101
Attention:
If to Purchaser:
Chevy Chase Preferred Capital Corporation
8401 Connecticut Avenue
Chevy Chase, Maryland 20815
Attention:
or such other address as may hereafter be furnished to the other party by like
notice. Any such demand, notice or communication hereunder shall be deemed to
have been received on the date delivered to or received at the premises of the
addressee (as evidenced, in the case of registered or certified mail, by the
date noted on the return receipt).
SECTION 15. SEVERABILITY CLAUSE. Any part, provision, representation or
warranty of this Agreement which is prohibited or unenforceable or is held to be
void or unenforceable in any jurisdiction shall be ineffective, as to such
jurisdiction, to the extent of such prohibition or unenforceability without
invalidating the remaining provisions hereof, and any such prohibition or
unenforceability in any jurisdiction as to any Mortgage Loan shall not
invalidate or render unenforceable such provision in any other jurisdiction. To
the extent permitted by applicable law, the parties hereto waive any provision
of law which prohibits or renders void or unenforceable any provision hereof. If
the invalidity of any part, provision, representation or warranty of this
Agreement shall deprive any party of the economic benefit intended to be
conferred by this Agreement, the parties shall negotiate, in good faith, to
develop a structure the economic effect of which is nearly as possible the same
as the economic effect of this Agreement without regard to such invalidity.
SECTION 16. COUNTERPARTS. This Agreement may be executed simultaneously in any
number of counterparts. Each counterpart shall be deemed to be an original, and
all such counterparts shall constitute one and the same instrument.
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SECTION 17. GOVERNING LAW. This Agreement shall be deemed in effect when a
fully executed counterpart thereof is received by Purchaser in the State of
Maryland and shall be deemed to have been made in the State of Maryland. The
Agreement shall be construed in accordance with the laws of the State of
Maryland and the obligations, rights and remedies of the parties hereunder shall
be determined-in accordance with the substantive laws of the State of Maryland
(without regard to conflicts of laws principles), except to the extent preempted
by Federal law.
SECTION 18. INTENTION OF THE PARTIES. It is the intention of the parties that
Purchaser is purchasing, and Seller is selling the Mortgage Loans and not a debt
instrument of Seller or another security. Accordingly, the parties hereto each
intend to treat the transaction for Federal income tax purposes as a sale by
Seller, and a purchase by Purchaser, of the Mortgage Loans.
SECTION 19. SUCCESSORS AND ASSIGNS; ASSIGNMENT OF PURCHASE AGREEMENT. This
Agreement shall bind and inure to the benefit of and be enforceable by Seller
and Purchaser and the respective permitted successors and assigns of Seller and
the successors and assigns of Purchaser. This Agreement shall not be assigned,
pledged or hypothecated by Seller to a third party without the consent of
Purchaser. This Agreement may be assigned, pledged or hypothecated by Purchaser
without the prior consent of Seller. If Purchaser assigns all or any of its
rights as Purchaser hereunder, the assignee of Purchaser will become the
"Purchaser" hereunder to the extent of such assignment, provided that at no time
shall there be more than fifteen (15) persons having the status of '"Purchaser"
hereunder. Any assignment by Purchaser shall be accompanied by the delivery and
execution of an Assignment and Assumption Agreement (the "Assignment and
Assumption Agreement") substantially in the form attached hereto as Exhibit I.
The Servicer shall be required to remit all amounts required to be remitted to
Purchaser hereunder to said assignee commencing with the first Remittance Date
falling after receipt of said copy of the related Assignment and Assumption
Agreement provided that Seller receives said copy no later than three (3)
Business Days immediately prior to the first day of the month of the related
Remittance Date.
SECTION 20. WAIVERS. No term or provision of this Agreement may be waived or
modified unless such waiver or modification is in writing and signed by the
party against whom such waiver or modification is sought to be enforced.
SECTION 21. EXHIBITS. The exhibits to this Agreement are hereby incorporated
and made a part hereof and are an integral part of this Agreement.
SECTION 22. GENERAL INTERPRETIVE PRINCIPLES. For purposes of this Agreement,
except as otherwise expressly provided or unless the context otherwise requires:
a. the terms defined in this Agreement have the meanings assigned to them in
this Agreement and include the plural as well as the singular, and the use
of any gender herein shall be deemed to include the other gender;
b. accounting terms not otherwise defined herein have the meanings assigned
to them in accordance with generally accepted accounting principles;
c. references herein to "Articles", "Sections," "Subsections," "Paragraphs,"
and other subdivisions without reference to a document are to designated
Articles, Sections, Subsections, Paragraphs and other subdivisions of this
Agreement;
d. reference to a Subsection without further reference to a Section is a
reference to such Subsection as contained in the same Section in which the
reference appears, and this rule shall also apply to Paragraphs and other
subdivisions;
e. the words "herein", "hereof", "hereunder" and other words of similar
import refer to this Agreement as a whole and not to any particular
provision; and
f. the term "include" or "including" shall mean without limitation by reason
of enumeration.
SECTION 23. REPRODUCTION OF DOCUMENTS. This Agreement and all documents
relating thereto, including, without limitation, (a) consents, waivers and
modifications which may hereafter be executed, (b) documents received by any
party at the closing, and (c) financial statements, certificates and other
information previously or hereafter furnished, may be reproduced by any
photographic, photostatic, microfilm, micro-card, miniature photographic or
other similar process.
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The parties agree that any such reproduction shall be admissible in evidence as
the original itself in any judicial or administrative proceeding, whether or not
the original is in existence and whether or not such reproduction was made by a
party in the regular course of business, and that any enlargement, facsimile or
further reproduction of such reproduction shall likewise be admissible in
evidence.
SECTION 24. FURTHER AGREEMENTS. Seller and Purchaser each agree to execute and
deliver to the other such reasonable and appropriate additional documents,
instruments or agreements as may be necessary or appropriate to effectuate the
purposes of this Agreement.
SECTION 25. RECORDATION OF ASSIGNMENTS OF MORTGAGE. To the extent permitted by
applicable law, each of the Assignments of Mortgage is subject to recordation in
all appropriate public offices for real property records in all the counties or
their comparable jurisdictions in which any or all of the Mortgaged Properties
are situated, and in any other appropriate public recording office or elsewhere,
such recordation to be effected at Seller's expense for a single recordation
with respect to each Assignment of Mortgage in the event recordation is either
necessary under applicable law or requested by Purchaser at its sole option.
IN WITNESS WHEREOF, the parties have executed this Agreement under seal as of
the date and year first above written.
ATTEST: CHASE PREFERRED CAPITAL CORPORATION (Purchaser)
By:
- ---------------------------- -----------------------------------
Name:
-----------------------------------
Title:
-----------------------------------
ATTEST: CHEVY CHASE BANK, F.S.B. (Seller)
By:
- ---------------------------- ------------------------------------
Name:
-----------------------------------
Title:
-----------------------------------
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EXHIBIT A
CONTENTS OF EACH MORTGAGE FILE
With respect to each Mortgage Loan, the Mortgage File shall include each of the
following items which shall be available for inspection by Purchaser and which
shall be delivered to Purchaser pursuant to Section 6.03 of the Mortgage Loan
Purchase Agreement (the "Agreement"):
1. The original Mortgage Note (or, with respect to the Mortgage Loan listed
on Schedule I hereto, a lost note affidavit, executed by an officer of
Seller, with a copy of the original note attached thereto) bearing all
intervening endorsements, endorsed "Pay to the order of ____ without
recourse" and signed in the name of Seller by an authorized officer. To
the extent that there is no room on the face of the Mortgage Notes for
endorsements, the endorsement may be contained on an allonge, if
applicable state law so allows. If the Mortgage Loan was acquired by
Seller in a merger, the endorsement must be by "[Seller], successor by
merger to [name of predecessor]". If the Mortgage Loan was acquired or
originated by Seller while doing business under another name, the
endorsement must be by "[Seller], formerly known as [previous name]".
2. The original of any guarantee executed in connection with the Mortgage
Note.
3. The original Mortgage, with evidence of recording thereon. If in
connection with any Mortgage Loan, Seller cannot deliver or cause to be
delivered the original Mortgage with evidence of recording thereon on or
prior to the Closing Date because of a delay caused by the public
recording office where such Mortgage has been delivered for recordation, a
photocopy of such Mortgage certified by Seller to be true and correct will
be delivered; if such Mortgage has been lost or if such public recording
office retains the original recorded Mortgage, Seller shall deliver or
cause to be delivered to Purchaser, a photocopy of such Mortgage,
certified by such public recording office to be a true and complete copy
of the original recorded Mortgage.
4. The originals of all assumption, modification, consolidation or extension
agreements, if any, with evidence of recording thereon or certified copies
of such documents if the originals thereof are unavailable.
5. The original Assignment of Mortgage for each Mortgage Loan endorsed "Pay
to the order of ___ " and signed in the name of Seller by an authorized
officer. If the Mortgage Loan was acquired by Seller in a merger, the
Assignment of Mortgage must be made by "[Seller], successor by merger to
[name of predecessor]". If the Mortgage Loan was acquired or originated by
Seller while doing business under another name, the Assignment of Mortgage
must be by "[Seller], formerly known as [previous name]".
6. Originals of all intervening assignments of the Mortgage with evidence of
recording thereon if such intervening assignment has been recorded.
7. The original mortgagee policy of title insurance or, in the event such
original title policy is unavailable, a certified true copy of the related
policy binder or commitment for title certified to be true and complete by
the title insurance company.
8. Any original security agreement, chattel mortgage or equivalent executed
in connection with the Mortgage.
9. The original hazard insurance policy and, if required by law, flood
insurance policy, in accordance with Section 8.02(f) of the Agreement.
10. Residential loan application.
11. Mortgage Loan closing statement.
12. Verification of employment and income.
13. Verification of acceptable evidence of source and amount of down payment.
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14. Credit report on the Mortgagor(s).
15. Residential appraisal report.
16. Photograph of the Mortgaged Property.
17. Survey of the Mortgaged Property, if any.
18. Copy of each instrument necessary to complete identification of any
exception set forth in the exception schedule in the title policy, i.e.,
map or plat, restrictions, easements, sewer agreements, home association
declarations, etc.
19. All required disclosure statements.
20. If available, termite report, structural engineer's report, water
portability and septic certification.
21. Sales contract.
22. Tax receipts, insurance premium receipts, ledger sheets, insurance claim
files, correspondence, current and historical computerized data files, and
all other processing, underwriting and closing papers and records which
are customarily contained in a mortgage loan file and which are required
to document the Mortgage Loan or to service the Mortgage Loan.
23. For Mortgage Loans with original LTV's greater than 85%, evidence of a PMI
Policy.
In the event that such original or copy of any document submitted for
recordation to the appropriate public recording office is not so delivered to
Purchaser within 90 days following the Closing Date (other than with respect to
the Assignments of Mortgage which shall be delivered to Purchaser in blank and
recorded subsequently by Purchaser), and in the event that Seller does not cure
such failure within 30 days of discovery or receipt of written notification of
such failure from Purchaser, the related Mortgage Loan shall, upon the request
of Purchaser, be repurchased by Seller at the price and in the manner specified
in Subsection 8.03 of the Agreement. The foregoing repurchase obligation shall
not apply in the event that Seller cannot deliver such original or copy of any
document submitted for recordation to the appropriate public recording office
within the specified period due to a delay caused by the recording office in the
applicable jurisdiction; provided that Seller shall instead deliver a recording
receipt of such recording office or, if such recording receipt is not available,
an officer's certificate of a servicing officer of Seller, confirming that all
such documents have been accepted for recording; provided that, upon request of
Purchaser and delivery by Purchaser to Seller of a schedule of the related
Mortgage Loans, Seller shall reissue and deliver to Purchaser said officer's
certificate relating to the related Mortgage Loans.
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EXHIBIT B
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EXHIBIT C
FORM OF SELLER'S OFFICER'S CERTIFICATE
I,_________ , hereby certify that I am the duly elected [Vice] President of
Chevy Chase Bank, F.S.B., a federal savings bank organized under the laws of the
United States ("Seller") and further certify as follows:
1. Attached hereto as Exhibit 1 is a true, correct and complete copy of
Seller's Charter which is in full force and effect on the date hereof and
which has been in effect without amendment, waiver, rescission or
modification since
2. Attached hereto as Exhibit 2 is a true, correct and complete copy of the
bylaws of Seller which are in effect on the date hereof and which have
been in effect without amendment, waiver, rescission or modification since
3. Attached hereto as Exhibit 3 is a certificate of corporate existence of
Seller issued by the Office of Thrift Supervisions within 90 days of the
date hereof, and no event has occurred since the date thereof which would
render such certificate inaccurate.
4. Attached hereto as Exhibit 4 is a true, correct and complete copy of the
corporate resolutions of the Board of Directors of Seller authorizing
Seller to execute and deliver the Mortgage Loan Purchase Agreement, dated
as of ___________, 1996, by and between Chevy Chase Preferred Capital
Corporation ("Purchaser") and Seller (the "Purchase Agreement"), and to
endorse the mortgage notes and execute the assignments of mortgages by
original or facsimile signature, and such resolutions are in effect on the
date hereof and have been in effect without amendment, waiver, rescission
or modification since
5. Either (i) no consent, approval, authorization or order of any court or
governmental agency or body is required for the execution, delivery and
performance by Seller of or compliance by Seller with the Purchase
Agreement, the sale of the mortgage loans or the consummation of the
transactions contemplated by the Purchase Agreement; or (ii) any required
consent, approval, authorization or order has been obtained by Seller.
6. Neither the consummation of the transactions contemplated by, nor the
fulfillment of the terms of, the Purchase Agreement conflicts or will
conflict with or results or will result in a breach of or constitutes or
will constitute a default under the charter or by-laws of Seller, the
terms of any indenture or other agreement or instrument to which Seller is
a party or by which it is bound or to which it is subject, or any statute
or order, rule, regulations, writ, injunction or decree of any court,
governmental authority or regulatory body to which Seller is subject or by
which it is bound.
7. To the best of my knowledge, there is no action, suit, proceeding or
investigation pending or threatened against Seller which, in my judgment,
either in any one instance or in the aggregate, may result in any material
adverse change in the business, operations, financial condition,
properties or assets of Seller or in any material impairment of the right
or ability of Seller to carry on its business substantially as now
conducted or in any material liability on the part of Seller or which
would draw into question the validity of the Purchase Agreement or the
Mortgage Loans or of any action taken or to be taken in connection with
the transactions contemplated hereby, or which would be likely to impair
materially the ability of Seller to perform under the terms of the
Purchase Agreement.
8. Each person listed on Exhibit 5 attached hereto who, as an officer or
representative of Seller, signed the Purchase Agreement and any other
document delivered prior to or on the date hereof in connection with any
purchase described in the Purchase Agreement was, at the respective times
of such signing and delivery, and is now, a duly elected or appointed,
qualified and acting officer or representative of Seller, who holds the
office set forth opposite his or her name on Exhibit 5, and the signatures
of such persons appearing on such documents are their genuine signatures.
9. Seller is duly authorized to engage in the transactions described and
contemplated in the Purchase Agreement.
IN WITNESS WHEREOF, I have hereunto signed my name and affixed the seal of Chevy
Chase Bank, F.S.B.
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Dated: , 1996 By:
------------------------ -----------------------------
Name:
----------------------------
Title: Vice President
----------------------------
I, __________________________, a Vice President of Chevy Chase Bank, F.S.B.,
hereby certify that ________ is the duly elected, qualified and acting Vice
President of Seller and that the signature appearing above is [her] [his]
genuine signature.
IN WITNESS WHEREOF, I have hereunto signed my name.
Dated: , 1996 By:
------------------------ ----------------------------
Name:
----------------------------
Title: Vice President
----------------------------
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EXHIBIT D
FORM OF OPINION OF COUNSEL TO SELLER
November ___, 1996
- ---------------------------------
- ---------------------------------
- ---------------------------------
Dear Sirs:
You have requested [my] opinion, as General Counsel of Chevy Chase Bank, F.S.B.
("Seller"), with respect to certain matters in connection with the sale by
Seller of the Mortgage Loans pursuant to that certain Mortgage Loan Purchase and
Warranties Agreement by and between Seller and Chevy Chase Preferred Capital
Corporation ("Purchaser"), dated as of __________________, 1996 (the "Purchase
Agreement") which sale is in the form of whole loans, delivered pursuant to a
Purchase Agreement and serviced pursuant to an Servicing Agreement, dated as of
_____________, 1996, by and between Seller and Purchaser (the "Servicing
Agreement"). Capitalized terms not otherwise defined herein have the meanings
set forth in the Purchase Agreement and the Servicing Agreement.
I have examined the following documents:
1. the Purchase Agreement;
2. the Servicing Agreement;
3. the form of Assignment of Mortgage;
4. the form of endorsement of the Mortgage Notes; and
5. such other documents, records and papers as we have deemed necessary and
relevant as a basis for this opinion.
To the extent I have deemed necessary and proper, I have relied upon the
representations and warranties of Seller contained in the Purchase Agreement. I
have assumed the authenticity of all documents submitted to me as originals, the
genuineness of all signatures, the legal capacity of natural persons and the
conformity to the originals of all documents.
Based upon the foregoing, it is my opinion that:
1. Seller is a federal savings bank duly organized, validly existing and in
good standing under the laws of the United States and is qualified to
transact business in, and is in good standing under all applicable laws;
2. Seller has the power to engage in the transactions contemplated by the
Purchase Agreement and all requisite power, authority and legal right to
execute and deliver the Purchase Agreement and to perform and observe the
terms and conditions of such agreements.
3. The Purchase Agreement has been duly authorized, executed and delivered by
Seller and is a legal, valid and binding agreement enforceable in
accordance with its respective terms against Seller, subject to bankruptcy
laws and other similar laws of general application affecting rights of
creditors and subject to the application of the rules of equity, including
those respecting the availability of specific performance, none of which
will materially interfere with the realization of the benefits provided
thereunder or with Purchaser's ownership of the Mortgage Loans.
4. Seller has been duly authorized to allow certain specified officers to
execute any and all documents by original signature in order to complete
the transactions contemplated by the Purchase Agreement and, by original
or facsimile signature, in order to execute the endorsements to the
Mortgage Notes and the Assignments of Mortgages, and the
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original or facsimile signature of the officer at Seller executing the
endorsements to the Mortgage Notes and the Assignments of Mortgages
represents the legal and valid signature of said officer of Seller.
5. Either (i) no consent, approval, authorization or order of any court or
governmental agency or body is required for the execution, delivery and
performance by Seller of or compliance by Seller with the Purchase
Agreement and the sale of the Mortgage Loans or the consummation of the
transactions contemplated by the Purchase Agreement or (ii) any required
consent, approval, authorization or order has been obtained by Seller.
6. Neither the consummation of the transactions contemplated by, nor the
fulfillment of the terms of, the Purchase Agreement conflicts or will
conflict with or results or will result in a breach of or constitutes or
will constitute a default under the charter or by-laws of Seller, the
terms of any indenture or other agreement or instrument to which Seller is
a party or by which it is bound or to which it is subject, or violates any
statute or order, rule, regulations, writ, injunction or decree of any
court, governmental authority or regulatory body to which Seller is
subject or by which it is bound.
7. There is no action, suit, proceeding or investigation pending or, to the
best of my knowledge, threatened against Seller which, in my judgment,
either in any one instance or in the aggregate, may result in any material
adverse change in the business, operations, financial condition,
properties or assets of Seller or in any material impairment of the right
or ability of Seller to carry on its business substantially as now
conducted or in any material liability on the part of Seller or which
would draw into question the validity of the Purchase Agreement or the
Mortgage Loans or of any action taken or to be taken in connection with
the transactions contemplated thereby, or which would be likely to impair
materially the ability of Seller to perform under the terms of the
Purchase Agreement.
8. The sale of each Mortgage Note and Mortgage as and in the manner
contemplated by the Purchase Agreement is sufficient to fully transfer to
Purchaser all right, title and interest of Seller thereto as noteholder
and mortgagee.
9. The Mortgages have been duly assigned and the Mortgage Notes have been
duly endorsed as provided in the Purchase Agreement. The Assignments of
Mortgage are in recordable form, except for the insertion of the name of
the assignee, and upon the name of the assignee being inserted, and to the
best of my knowledge, are acceptable for recording under the laws of the
states in which such recording would occur. The endorsement of the
Mortgage Notes, the delivery to Purchaser of the Assignments of Mortgage,
and the delivery of the original endorsed Mortgage Notes to Purchaser, are
sufficient to permit Purchaser to avail itself of all protection available
under applicable law against the claims of any present or future creditors
of Seller, and are sufficient to prevent any other sale, transfer,
assignment, pledge or hypothecation of the Mortgages and the Mortgage
Notes by Seller from being enforceable.
This opinion is given to you for your sole benefit, and no other person or
entity is entitled to rely hereon except that Purchaser or purchasers to which
you initially and directly resell the Mortgage Loans may rely on this opinion as
if it were addressed to them as of its date.
Very truly yours,
Leslie A. Nicholson, Jr.
General Counsel
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EXHIBIT G
November ___1996
Federal Home Loan Bank of Atlanta (the "Association")
Attention:
Re: Notice of Sale and Release of Collateral
Dear Sirs:
This letter serves as notice that Chevy Chase Bank, F.S.B. ("Bank") has
committed to sell to Chevy Chase Preferred Capital Corporation ("Purchaser")
under a Mortgage Loan Purchase Agreement, dated as of ________, 1996, certain
mortgage loans originated by the Association. The Bank warrants that the
mortgage loans to be sold to Purchaser are in addition to and beyond any
collateral required to secure advances made by the Association to the Bank.
The Bank acknowledges that the mortgage loans to be sold to Purchaser shall not
be used as additional or substitute collateral for advances made by the
Association. Purchaser understands that the balance of the Bank's mortgage loan
portfolio may be used as collateral or additional collateral for advances made
by the Association, and confirms that it has no interest therein.
Execution of this letter by the Association shall constitute a full and complete
release of any security interest, claim, or lien which the Association may have
against the mortgage loans to be sold to Purchaser.
Very truly yours,
Chevy Chase Bank, F.S.B.
By:
-----------------------------
Name:
-----------------------------
Title:
-----------------------------
Date:
-----------------------------
Acknowledged and approved:
Federal Home Loan Bank of Atlanta
By:
-----------------------------
Name:
-----------------------------
Title:
-----------------------------
Date:
-----------------------------
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EXHIBIT H
FORM OF SECURITY RELEASE CERTIFICATION
I. Release of Security Interest
The financial institution named below hereby relinquishes any and all right,
title and interest it may have in all Mortgage Loans to be purchased by Chevy
Chase Preferred Capital Corporation from Chevy Chase Bank, F.S.B. pursuant to
that certain Mortgage Loan Purchase Agreement, dated as of _____, 1996, and
certifies that all notes, mortgages, assignments and other documents in its
possession relating to such Mortgage Loans have been delivered and released to
Chevy Chase Bank, F.S.B. or its designees, as of the date and time of the sale
of such Mortgage Loans to Chevy Chase Preferred Capital Corporation.
Name and Address of Financial Institution
(name)
(Address)
By:
II. Certification of Release
Chevy Chase Bank, F.S.B. hereby certifies to Chevy Chase Preferred Capital
Corporation that, as of the date and time of the sale of the above-mentioned
Mortgage Loans to Chevy Chase Preferred Capital Corporation, the security
interests in the Mortgage Loans released by the above-named financial
institution comprise all security interests relating to or affecting any and all
such Mortgage Loans. The Company warrants that, as of such time, there are and
will be no other security interests affecting any or all of such Mortgage Loans.
By: Title: Date:
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EXHIBIT I
FORM OF ASSIGNMENT AND ASSUMPTION AGREEMENT
ASSIGNMENT AND ASSUMPTION AGREEMENT, dated ___, between ____, a
corporation ("Assignor") and ____, a corporation ("Assignee"):
For good and valuable consideration the receipt and sufficiency of which hereby
are acknowledged, and of the mutual covenants herein contained, the parties
hereto hereby agree as follows:
1. The Assignor hereby grants, transfers and assigns to Assignee, as
Purchaser, all of the right, title and interest of Assignor with respect to the
mortgage loans listed on Exhibit A attached hereto ("Mortgage Loans"), and with
respect to such Mortgage Loans, in, to and under (a) that certain Mortgage Loan
Purchase and Warranties Agreement dated _____, 1996 by and between Chevy Chase
Bank, F.S.B. ("Seller") and Chevy Chase Preferred Capital Corporation ("Purchase
Agreement"), and (b) that certain Servicing Agreement dated as of _________
1996, by and between Purchaser and Chevy Chase Bank, F.S.B. ("Servicer")
("Servicing Agreement"; the Servicing Agreement and the Purchase Agreement are
collectively referred to as the "Agreements").
2. The Assignor warrants and represents to, and covenants with, the Assignee
that:
a. The Assignor is the lawful owner of the Mortgage Loans with the full
right to transfer the Mortgage Loans free from any and all claims and
encumbrances whatsoever;
b. The Assignor has not received notice of, and has no knowledge of, any
offsets, counterclaims or other defenses available to Seller with
respect to the Agreements or the Mortgage Loans;
c. The Assignor has not waived or agreed to any waiver under, or agreed
to any amendment or other modification of, the Agreements. The
Assignor has no knowledge of, and has not received notice of, any
waivers under or amendments or other modifications of, or assignments
of rights or obligations under, the Agreements; and
d. Neither the Assignor nor anyone acting on its behalf has offered,
transferred, pledged, sold or otherwise disposed of the Mortgage Loans
or any interest in the Mortgage Loans, or solicited any offer to buy
or accept a transfer, pledge or other disposition of the Mortgage
Loans, or any interest in the Mortgage Loans or otherwise approached
or negotiated with respect to the Mortgage Loans, or any interest in
the Mortgage with any person in any manner, or made any general
solicitation by means of general advertising or in any other manner,
or taken any other action which would constitute a distribution of the
Mortgage Loans under the Securities Act of 1933, as amended (the "1933
Act") or which would render the disposition of the Mortgage Loans a
violation of Section 5 of the 1933 Act or require registration
pursuant thereto.
3. The Assignee warrants and represents to, and covenants with, Assignor and
Seller pursuant to the Agreements that:
a. The Assignee is a corporation duly organized, validly existing and in
good standing under the laws of the jurisdiction of its incorporation,
and has all requisite corporate power and authority to acquire, own
and purchase the Mortgage Loans;
b. The Assignee has full corporate power and authority to execute,
deliver and perform under this Assignment and Assumption Agreement,
and to consummate the transactions set forth herein. The execution,
delivery and performance of the Assignee of this Assignment and
Assumption Agreement, and the consummation by it of the transactions
contemplated hereby, have been duly authorized by all necessary
corporate action of the Assignee. This Assignment and Assumption
Agreement has been duly executed and delivered by the Assignee and
constitutes the valid and legally binding obligation of the Assignee
enforceable against the Assignee in accordance with its respective
terms;
c. To the best of Assignee's knowledge, no material consent, approval,
order or authorization of, or declaration, filing or registration
with, any governmental entity is required to be obtained or made by
the Assignee in
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connection with the execution, delivery or performance by the Assignee
of this Assignment and Assumption Agreement, or the consummation by it
of the transactions contemplated hereby;
d. The Assignee agrees to be bound, as Purchaser, by all of the terms,
covenants and conditions of the Agreements, the Mortgage Loans, and
from and after the date hereof, the Assignee assumes for the benefit
of each of Seller and the Assignor all of the Assignor' s obligations
as Purchaser thereunder, including, without limitation, the limitation
on assignment set forth in Section _ of the Purchase Agreement;
e. The Assignee understands that the Mortgage Loans have not been
registered under the 1933 Act or the securities laws of any state;
f. The purchase price being paid by the Assignee for the Mortgage Loans
is in excess of $250,000 and will be paid by cash remittance of the
full purchase price within sixty (60) days of the sale;
g. The Assignee is acquiring the Mortgage Loans for investment for its
own account only and not for any other person;
h. The Assignee considers itself a sophisticated institutional investor
having such knowledge and experience in financial and business matters
that it is capable of evaluating the merits and risks of investment in
the Mortgage Loans;
i. The Assignee has been furnished with all information regarding the
Mortgage Loans that it has requested from the Assignor or Seller;
j. Neither the Assignee nor anyone acting on its behalf has offered,
transferred, pledged, sold or otherwise disposed of the Mortgage Loans
or any interest in the Mortgage Loans, or solicited any offer to buy
or accept a transfer, pledge or other disposition of the Mortgage
Loans or any interest in the Mortgage Loans, or otherwise approached
or negotiated with respect to the Mortgage Loans or any interest in
the Mortgage Loans with any person in any manner which would
constitute a distribution of the Mortgage Loans under the 1933 Act or
which would render the disposition of the Mortgage Loans a violation
of Section 5 of the 1933 Act or require registration pursuant thereto,
nor will it act, nor has it authorized or will it authorize any person
to act, in such manner with respect to the Mortgage Loans; and
k. Either: (1) the Assignee is not an employee benefit plan ("Plan")
within the meaning of section 3(3) of the Employee Retirement Income
Security Act of 1974, as amended ("ERISA") or a plan (also "Plan")
within the meaning of section 4975(e)(1) of the Internal Revenue Code
of 1986 ("Code"), and the Assignee is not directly or indirectly
purchasing the Mortgage Loans on behalf of, investment manager of, as
named fiduciary of, as Trustee of, or with assets of, a Plan; or (2)
the Assignee's purchase of the Mortgage Loans will not result in a
prohibited transaction under section 406 of ERISA or section 4975 of
the Code.
4. a. The Assignee's address for purposes of all notices and correspondence
related to the Mortgage Loans and the Agreements is:
b. The Assignee's wire instructions for purposes of all remittances and
payments related to the Mortgage Loans are:
c. The Assignor's address for purposes for all notices and correspondence
related to the Mortgage Loans and this Agreement is:
5. This Agreement shall be construed in accordance with the substantive laws
of the State of Maryland (without regard to conflicts of laws principles) and
the obligations, rights and remedies of the parties hereunder shall be
determined in accordance with such laws, except to the extent preempted by
federal law.
6. This Agreement shall inure to the benefit of the successors and assigns of
the parties hereto. This Agreement may not be assigned by the Assignee without
the express written consent of the Assignor. Any entity into which the Assignor
or
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<PAGE>
Assignee may be merged or consolidated shall, without the requirement for any
further writing, be deemed the Assignor or Assignee, respectively, hereunder.
7. No term or provision of this Agreement may be waived or modified unless
such waiver or modification is in writing and signed by the party against whom
such waiver or modification is sought to be enforced.
8. This Agreement shall survive the conveyance of the Mortgage Loans and the
assignment of the Agreements by the Assignor.
9. Notwithstanding the assignment of the Agreements by either the Assignor or
Assignee, this Agreement shall not be deemed assigned by the Assignor or the
Assignee unless assigned by separate written instrument.
10. For the purpose for facilitating the execution of this Agreement as herein
provided and for other purposes, this Agreement may be executed simultaneously
in any number of counterparts, each of which counterparts shall be deemed to be
an original, and such counterparts shall constitute and be one and the same
instrument.
IN WITNESS WHEREOF, the parties have caused this Assignment and Assumption
Agreement to be executed by their duly authorized officers as of the date first
above written.
Assignor Assignee
By: By:
Its: Its:
Taxpayer Identification No. Taxpayer Identification No.
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<PAGE>
Exhibit 10(b)
SERVICING AGREEMENT
This Servicing Agreement (the "Servicing Agreement" or the "Agreement") is
entered into as of ****, 1996, by and between Chevy Chase Bank, F.S.B. (the
"Servicer"), a federal savings bank, and Chevy Chase Preferred Capital
Corporation, a Maryland corporation (the "Purchaser").
WHEREAS, the Purchaser and Chevy Chase Bank, F.S.B. (as "Seller") entered into a
Mortgage Loan Purchase Agreement dated as of **** 1996 (the "Purchase
Agreement") pursuant to which the Purchaser agreed to purchase from the Seller
certain conventional, residential, adjustable rate first mortgage loans (the
"Mortgage Loans") to be delivered as whole loans, with the Servicer retaining
servicing rights in connection with the purchase of such Mortgage Loans; and
WHEREAS, the Purchaser desires to have the Servicer service the Mortgage Loans,
the Servicer desires to service and administer the Mortgage Loans on behalf of
the Purchaser, and the parties desire to provide the terms and conditions of
such servicing by the Servicer.
NOW, THEREFORE, in consideration of the mutual promises and agreements set forth
herein and for other good and valuable consideration, the receipt and the
sufficiency of which are hereby acknowledged, the parties hereto hereby agree as
follows:
ARTICLE I
DEFINITIONS
SECTION 1. DEFINITIONS. All capitalized terms not otherwise defined herein have
the respective meanings set forth in the Purchase Agreement. The following terms
are defined as follows:
"Accepted Servicing Practices" means, with respect to any Mortgage Loan, those
mortgage servicing practices of prudent mortgage lending institutions which
service mortgage loans of the same type as such Mortgage Loan in the
jurisdiction where the related Mortgaged Property is located.
"Ancillary Income" means all late charges, assumption fees, escrow account
benefits, reinstatement fees, and similar types of fees arising from or in
connection with any Mortgage Loan to the extent not otherwise payable to the
Mortgagor under applicable law or pursuant to the terms of the related Mortgage
Note.
"Bests" means Best's Key Rating Guide.
"BIF" means The Bank Insurance Fund, or any successor thereto.
"Chevy Chase" means Chevy Chase Bank, F.S.B.
"Closing Date" means ****, 1996, or such other date as is mutually agreed upon
by the parties hereto.
"Custodial Account" means the separate account or accounts created and
maintained pursuant to Section 2.04.
"Cut-off Date" means ****, 1996.
"Condemnation Proceeds" means all awards or settlements in respect of a
Mortgaged Property, whether permanent or temporary, partial or entire, by
exercise of the power of eminent domain or condemnation, to the extent not
required to be released to a Mortgagor in accordance with the terms of the
related Mortgage Loan Documents.
"Due Period" means with respect to each Remittance Date, the period commencing
on the second day of the month preceding the month of the Remittance Date and
ending on the first day of the month of the Remittance Date.
<PAGE>
"Errors and Omissions Insurance Policy" means an errors and omissions insurance
policy to be maintained by the Servicer pursuant to Section 2.12.
"Escrow Account" means the separate account or accounts created and maintained
pursuant to Section 2.06.
"Escrow Payment" means, with respect to any Mortgage Loan, the amounts
constituting ground rents, taxes, assessments, water rates, sewer rents,
municipal charges, mortgage insurance premiums, fire and hazard insurance
premiums, condominium charges, and any other payments required to be escrowed by
the Mortgagor with the mortgagee pursuant to the Mortgage or any other document.
"Event of Default" means any one of the conditions or circumstances enumerated
in Section 11.01.
"FDIC" means The Federal Deposit Insurance Corporation, or any successor
thereto.
"FHLMC Guide" means the FHLMC Sellers' and Servicers' Guide and all amendments
or additions thereto.
"Fidelity Bond" means a fidelity bond to be maintained by the Servicer pursuant
to Section 2.12.
"FNMA Guides" means the FNMA Sellers' Guide and the FNMA Servicers' Guide and
all amendments or additions thereto.
"Insurance Proceeds" means, with respect to each Mortgage Loan, proceeds of
insurance policies insuring the Mortgage Loan or the related Mortgaged Property.
"Liquidation Proceeds" means cash received in connection with the liquidation of
a defaulted Mortgage Loan, whether through the sale or assignment of such
Mortgage Loan, trustee Is sale, foreclosure sale or otherwise, or the sale of
the related Mortgaged Property if the Mortgaged Property is acquired in
satisfaction of the Mortgage Loan.
"Monthly Remittance Advice" means the monthly remittance advice, in the form of
Exhibit A annexed hereto, to be provided to the Purchaser pursuant to Section
3.02.
"Mortgage Impairment Insurance Policy" means a mortgage impairment or blanket
hazard insurance policy as described in Section 2.11.
"Nonrecoverable Advance" means any advance of principal and interest previously
made or proposed to be made in respect of a Mortgage Loan which, in the good
faith judgment of the Servicer, will not or, in the case of a proposed advance
of principal and interest, would not, be ultimately recoverable from related
Insurance Proceeds, Liquidation Proceeds or otherwise. The determination by the
Servicer that it has made a Nonrecoverable Advance or that any proposed advance
of principal and interest, if made, would constitute a Nonrecoverable Advance,
shall be evidenced by an Officers' Certificate delivered to the Purchaser.
"OCC" means Office of the Comptroller of the Currency, or any successor thereto.
"Officer's Certificate" means a certificate signed by the Chairman of the Board
or the Vice Chairman of the Board or a President or a Vice President and by the
Treasurer or the Secretary or one of the Assistant Treasurers or Assistant
Secretaries of the Servicer, and delivered to the Purchaser as required by this
Agreement.
"PMI Policy" means a policy of primary mortgage guaranty insurance issued by a
Qualified Insurer, as required by this Agreement with respect to certain
Mortgage Loans.
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"Prime Rate" means the prime rate announced to be in effect from time to time,
as published as the average rate in The Wall Street Journal (Northeast edition).
"Principal Prepayment" means any payment or other recovery of principal on a
Mortgage Loan which is received in advance of its scheduled Due Date, including
any prepayment penalty or premium thereon and which is not accompanied by an
amount of interest representing scheduled interest due on any date or dates in
any month or months subsequent to the month of prepayment.
"Purchase Agreement" means the Mortgage Loan Purchase and Warranties Agreement
between the Purchaser and the Seller related to the purchase of the Mortgage
Loans dated as of ****, 1996.
"Qualified Depository" means a depository the accounts of which are insured by
the FDIC through the BIF or the SAIF.
"Qualified Insurer" means an insurance company duly qualified as such under the
laws of the states in which the Mortgaged Properties are located, duly
authorized and licensed in such states to transact the applicable insurance
business and to write the insurance provided, approved as an insurer by FLEA and
FHLMC with respect to primary mortgage insurance and, in addition, in the two
highest rating categories by Best's with respect to hazard and flood insurance.
"Remittance Date" means the 18th day (or if such 18th day is not a Business Day,
the first Business Day immediately following) of any month, beginning with the
first Remittance Date on **** 18, 1996.
"REO Property" means a Mortgaged Property acquired by the Servicer on behalf of
the Purchaser through foreclosure or by deed in lieu of foreclosure, as
described in Section 2.17.
"SAIF" means The Savings Association Insurance Fund, or any successor thereto.
"Servicer Employees" has the meaning set forth in Section 2.12.
"Servicing Advances" means all customary, reasonable and necessary "out of
pocket" costs and expenses (including reasonable attorneys' fees and
disbursements) incurred in the performance by the Servicer of its servicing
obligations, including, but not limited to, the cost of (a) the preservation,
restoration and protection of the Mortgaged Property, (b) any enforcement or
judicial proceedings, including foreclosures, (c) the management and liquidation
of the Mortgaged Property if the Mortgaged Property is acquired in satisfaction
of the Mortgage and (d) compliance with the obligations under Section 2.08
(except with respect to any expenses incurred in connection with procuring or
transferring Tax Service Contracts, as provided therein).
"Servicing Agreement" means this agreement between the Purchaser and the
Servicer for the servicing and administration of the Mortgage Loans.
"Servicing Fee" means, with respect to each Mortgage Loan, the amount of the
annual fee the Purchaser shall pay to the servicer, which shall, for a period of
one (1) full month, be equal to one-twelfth of the product of the Servicing Fee
Rate and (2) the Stated Principal Balance of such Mortgage Loan. Such fee shall
be payable monthly, computed on the basis of the same principal amount and
period in respect of which any related interest payment on a Mortgage Loan is
computed and shall be pro rated for any portion of a month during which the
Mortgage Loan is serviced by the Servicer under this Agreement. The obligation
of the Purchaser to pay the Servicing Fee is limited to, and the Servicing Fee
is payable solely from, the interest portion (including recoveries with respect
to interest from Liquidation Proceeds, to the extent permitted by Section 4.03)
of such Monthly Payment collected by the Servicer, or as otherwise provided
under Section 4.03.
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"Servicing Fee Rate" means, with respect to each Mortgage Loan, the rate
specified in the Mortgage Loan Schedule with respect to such Mortgage Loan.
"Servicing File" means, with respect to each Mortgage Loan, the file retained by
the Servicer consisting of originals of all documents in the Mortgage File which
are not delivered to the Purchaser or its designee and copies of the Mortgage
Loan Documents listed on Exhibit A to the Purchase Agreement.
"Tax Service Contract" means a paid-in-full, life-of-loan tax service contract
with TransAmerica Real Estate Tax Service, Inc., as described in Section 2.08
hereof.
"Termination Fee" means the amount paid by the Purchaser to the Servicer in the
event of the Servicer's termination, without cause, as servicer. Such fee shall
equal the percentage amount set forth in Section 6.04 hereof of the then current
aggregate unpaid principal balance of the related Mortgage Loans.
ARTICLE II
SERVICING
SECTION 2.01. CMSI TO ACT AS SERVICER. From and after the Closing Date, the
Servicer, as an independent contractor, shall service and administer the
Mortgage Loans and shall have full power and authority, acting alone, to do any
and all things in connection with such servicing and administration which the
Servicer may deem necessary or desirable, consistent with the terms of this
Agreement and with Accepted Servicing Practices. Except as set forth in this
Agreement, the Servicer shall service the Mortgage Loans in strict compliance
with the servicing provisions related to the FNMA MBS Program (Special Servicing
Option) of the FNMA Guides. In the event of any conflict, inconsistency or
discrepancy between any of the servicing provisions of this Agreement and any of
the servicing provisions of the FNMA Guides, the provisions of this Agreement
shall control and be binding upon the Purchaser and the Servicer.
Consistent with the terms of this Agreement, the Servicer may waive, modify or
vary any term of any Mortgage Loan or consent to the postponement of strict
compliance with any such term or in any manner grant Indulgence to any Mortgagor
if in the Servicer's reasonable and prudent determination such waiver
modification, postponement or indulgence is not materially adverse to the
Purchaser, provided. however, that unless the Servicer has obtained the prior
written consent of the Purchaser, the Servicer shall not permit any modification
with respect to any Mortgage Loan that would change the Mortgage Interest Rate,
defer or forgive the payment of principal or interest, reduce or increase the
outstanding principal balance (except for actual payments of principal) or
change the final maturity date on such Mortgage Loan. In the event of any such
modification which permits the deferral of interest or principal payments on any
Mortgage Loan, the Servicer shall, on the Business Day immediately preceding the
Remittance Date in any month in which any such principal or interest payment has
been deferred, deposit in the Custodial Account from its own funds, in
accordance with Section 2.04, the difference between (a) such month's principal
and one (1) month's interest at the Mortgage Interest Rate on the unpaid
principal balance of such Mortgage Loan and (b) the amount paid by the
Mortgagor. The Servicer shall be entitled to reimbursement for such advances to
the same extent as for all other advances made pursuant to Section 2.05. Without
limiting the generality of the foregoing, the Servicer shall continue, and is
hereby authorized and empowered, to execute and deliver on behalf of itself and
the Purchaser, all instruments of satisfaction or cancellation, or of partial or
full release, discharge and all other comparable instruments, with respect to
the Mortgage Loans and with respect to the Mortgaged Properties. If reasonably
required by the Servicer, the Purchaser shall furnish the Servicer with any
powers of attorney and other documents necessary or appropriate to enable the
Servicer to carry out its servicing and administrative duties under this
Agreement.
In servicing and administering the Mortgage Loans, the Servicer shall employ
procedures (including collection procedures) and exercise the same care that it
customarily employs and exercises in servicing and administering mortgage loans
for its own account, giving due consideration to Accepted Servicing Practices
where such practices
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do not conflict with the requirements of this Agreement, the FNMA Guides and the
Purchaser's reliance on the Servicer.
The Servicer shall keep at its servicing office books and records in which,
subject to such reasonable regulations as it may prescribe, the Servicer shall
note transfers of Mortgage Loans. No transfer of a Mortgage Loan may be made
unless such transfer is in compliance with the terms hereof. For the purposes of
this Agreement, the Servicer shall be under no obligation to deal with any
Person with respect to this Agreement or the Mortgage Loans unless the Servicer
has been notified of such transfers as provided in this Section 2.01. The
Purchaser may sell and transfer, in whole or in part, the Mortgage Loans,
provided that no such sale and transfer shall be binding upon the Servicer
unless such transferee shall agree in writing in the form of the Assignment and
Assumption Agreement attached to the Purchase Agreement as Exhibit G. to be
bound by the terms of this Agreement and the Purchase Agreement, and an executed
copy of the same shall have been delivered to the Servicer. Upon receipt
thereof, the Servicer shall mark its books and records to reflect the ownership
of the Mortgage Loans by such assignee, and the previous Purchaser shall be
released from its obligations hereunder. The Servicer shall be required to remit
all amounts required to be remitted to the Purchaser hereunder to said
transferee commencing with the first Remittance Date falling after receipt of
said copy of the related Assignment and Assumption Agreement provided that the
Servicer receives said copy no later than three (3) Business Days immediately
pr__r to the first day of the month of the related Remittance Date. This
Agreement shall be binding upon and inure to the benefit of the Purchaser and
the Servicer and their permitted successors, assignees and designees.
The Servicing File retained by the Servicer pursuant to this Agreement shall be
appropriately marked and identified in the Servicer's computer system to clearly
reflect the sale of the related Mortgage Loan to the Purchaser. The Servicer
shall release from its custody the contents of any Servicing File retained by it
only in accordance with this Agreement, except when such release is required in
connection with a repurchase of any such Mortgage Loan pursuant to Section 8.03
of the Purchase Agreement.
The Servicer must have an internal quality control program that verifies, on a
regular basis, the existence and accuracy of the legal documents, credit
documents, property appraisals, and underwriting decisions. The program must be
capable of evaluating and monitoring the overall quality of its loan production
and servicing activities. The program is to ensure that the Mortgage Loans are
serviced in accordance with prudent mortgage banking practices and accounting
principles; guard against dishonest, fraudulent, or negligent acts; and guard
against errors and omissions by officers, employees, or other authorized
persons.
SECTION 2.02. LIQUIDATION OF MORTGAGE LOANS. In the event that any payment due
under any Mortgage Loan and not postponed pursuant to Section 2.01 is not paid
when the same becomes due and payable, or in the event the Mortgagor fails to
perform any other covenant or obligation under the Mortgage Loan and such
failure continues beyond any applicable grace period, the Servicer shall take
such action as (1) the Servicer would take under similar circumstances with
respect to a similar mortgage loan held for its own account for investment, (2)
shall be consistent with Accepted Servicing Practices, (3) the Servicer shall
determine prudently to be in the best interest of Purchaser, and (4) is
consistent with any related PMI Policy. In the event that any payment due under
any Mortgage Loan is not postponed pursuant to Section 2.01 and remains
delinquent for a period of ninety (90) days or any other default continues for a
period of ninety (90) days beyond the expiration of any grace or cure period (or
such other period as is required by law in the jurisdiction where the related
Mortgaged Property is located), the Servicer shall commence foreclosure
proceedings in accordance with the FNMA Guides, provided that, prior to
commencing foreclosure proceedings, the Servicer shall notify the Purchaser in
writing of the Servicer's intention to do so, and the Servicer shall not
commence foreclosure proceedings if the Purchaser objects to such action within
ten (10) Business Days of receiving such notice or, if the provisions of the
next two paragraphs apply, in any event without the prior written consent of
Purchaser. In such connection, the Servicer shall from its own funds make all
necessary and proper Servicing Advances, provided, however, that the Servicer
shall not be required to expend its own funds in connection with any foreclosure
or towards the restoration or preservation of any Mortgaged Property, unless it
shall determine (a) that such preservation, restoration and/or foreclosure will
increase the proceeds of liquidation of
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the Mortgage Loan to Purchaser after reimbursement to itself for such expenses
and (b) that such expenses will be recoverable by it either through Liquidation
Proceeds (in respect of which it shall have priority for purposes of withdrawals
from the Custodial Account pursuant to Section 2.05) or through Insurance
Proceeds (in respect of which it shall have similar priority).
Notwithstanding anything to the contrary contained herein, in connection with a
foreclosure, in the event the Servicer has reasonable cause to believe that a
Mortgaged Property is contaminated by hazardous or toxic substances or wastes,
or if the Purchaser otherwise requests an environmental inspection or review of
such Mortgaged Property to be conducted by a qualified inspector, the Servicer
shall cause the Mortgaged Property to be so inspected at the expense of the
Purchaser. Upon completion of the inspection, the Servicer shall promptly
provide the Purchaser with a written report of the environmental inspection.
After reviewing the environmental inspection report, the Purchaser shall
determine how the Servicer shall proceed with respect to the Mortgaged Property.
In the event (a) the environmental inspection report indicates that the
Mortgaged Property is contaminated by hazardous or toxic substances or wastes
and (b) the Purchaser directs the Servicer to proceed with foreclosure or
acceptance of a deed in lieu of foreclosure, the Servicer shall be reimbursed
for all reasonable costs associated with such foreclosure or acceptance of a
deed in lieu of foreclosure and any related environmental clean up costs, as
applicable, from the related Liquidation Proceeds, or if the Liquidation
Proceeds are insufficient to fully reimburse the Servicer, the Servicer shall be
entitled to be reimbursed from amounts in the Custodial Account pursuant to
Section 2.05 hereof and to the extent amounts in the Custodial Account are
insufficient to fully reimburse the Servicer, the Servicer shall be entitled to
be reimbursed by the Purchaser for such deficiencies (upon presentation of
evidence of such deficiency). In the event the Purchaser directs the Servicer
not to proceed with foreclosure or acceptance of a deed in lieu of foreclosure,
the Servicer shall be reimbursed for all Servicing Advances made with respect to
the related Mortgaged Property from the Custodial Account pursuant to Section
2.05 hereof.
SECTION 2.03. COLLECTION OF MORTGAGE LOAN PAYMENTS. Continuously from the
Closing Date, the Servicer shall proceed diligently to collect all payments due
under each of the Mortgage Loans when the same shall become due and payable and
shall take special care in ascertaining and estimating Escrow Payments and all
other charges that will become due and payable with respect to the Mortgage
Loans and each related Mortgaged Property, to the end that the installments
payable by the Mortgagors will be sufficient to pay such charges ma and when
they become due and payable.
SECTION 2.04. ESTABLISHMENT OF AND DEPOSITS TO CUSTODIAL ACCOUNT. The Servicer
shall segregate and hold all funds collected and received pursuant to the
Mortgage Loans separate and apart from any of its own funds and general assets
and shall establish and maintain one or more Custodial Accounts, in the form of
time deposit or demand accounts, titled "Chevy Chase Bank, F.S.B. in trust for
Purchaser of Conventional Residential Mortgage Loans, and various Mortgagors".
The Custodial Account shall be established with a Qualified Depository
acceptable to the Purchaser. Any funds deposited in the Custodial Account shall
at all times be fully insured to the full extent permitted under applicable law.
Funds deposited in the Custodial Account may be drawn on by the Servicer in
accordance with Section 2.05. The creation of any Custodial Account shall be
evidenced by a certification in the form of Exhibit 2 hereto, in the case of an
account established with the Servicer, or by a letter agreement in the form of
Exhibit 3 hereto, in the case of an account held by a depository other than the
Servicer. A copy of such certification or letter agreement shall be furnished to
the Purchaser and, upon request, to any subsequent Purchaser.
The Servicer shall deposit in the Custodial Account within one Business Day of
receipt, and retain therein, the following collections received by the Servicer
and payments made by the Servicer after the Cut-off Date, other than payments of
principal and interest due on or before the Cut-off Date, or received by the
Servicer prior to the Cut-off Date but allocable to a period subsequent thereto:
a. all payments on account of principal on the Mortgage Loans, including all
Principal Prepayments;
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b. all payments on account of interest on the Mortgage;
c. all Liquidation Proceeds and any amount received with respect to REO
Property;
d. all insurance Proceeds including amounts required to be deposited pursuant
to Section 2.10 (other than proceeds to be held in the Escrow Account and
applied to the restoration or repair of the Mortgaged Property or released
to the Mortgagor in accordance with Section 2.14), and Section 2.11;
e. all Condemnation Proceeds which are not applied to the restoration or repair
of the Mortgaged Property or released to the Mortgagor in accordance with
Section 2.14;
f. any amount required to be deposited in the Custodial Account pursuant to
Section 2.01, 2.09, 2.15, 2.17, 3.01, 3.03 or 4.02;
g. any amounts payable in connection with the repurchase of any Mortgage Loan
pursuant to Section 8.03 of the Purchase Agreement; and
h. any amounts required to be deposited by the Servicer pursuant to section
2.11 in connection with the deductible clause in any blanket hazard
insurance policy.
The foregoing requirements for deposit into the Custodial Account shall be
exclusive, it being understood and agreed that, without limiting the generality
of the foregoing, Ancillary Income need not be deposited by the Servicer into
the Custodial Account. Any interest paid on funds deposited in the Custodial
Account by the depository institution shall accrue to the benefit of the
Servicer and the Servicer shall be entitled to retain and withdraw such interest
from the Custodial Account pursuant to Section 2.05.
SECTION 2.05. PERMITTED WITHDRAWALS FROM CUSTODIAL ACCOUNT. Subject to Section
2.17 hereof, the Servicer shall, from time to time, withdraw funds from the
Custodial Account for the following purposes:
a. to make payments to the Purchaser in the amounts and in the manner provided
for in Section 3.01;
b. to pay to itself the Servicing Fee;
c. to reimburse itself for advances of the Servicers funds made pursuant to
Section 3.03, the Servicer's right to reimburse itself pursuant to this
subclause c being limited to amounts received on the related Mortgage Loan
which represent late payments of principal and/or interest in respect of
which any such advance was made, it being understood that, in the case of
any such reimbursement, the Servicer's right thereto shall be prior to the
rights of Purchaser, except that, where the Seller or the Servicer is
required to repurchase a Mortgage Loan pursuant to Section 8.03 of the
Purchase Agreement or Section 4.02 of this Agreement, respectively, the
Servicer'- right to such reimbursement shall be subsequent to the payment to
the Purchaser of the Repurchase Price pursuant to such sections and all
other amounts required to be paid to the Purchaser with respect to such
Mortgage Loan;
d. to reimburse itself for unreimbursed Servicing Advances (except to the
extent reimbursed pursuant to Section 2.07), any accrued but unpaid
Servicing Fees and for unreimbursed advances of Servicer funds made pursuant
to Sections 2.15, 2.17 or 3.03, the Servicer's right to reimburse itself
pursuant to this subclause (iv) with respect to any Mortgage Loan being
limited to related Liquidation Proceeds, Condemnation Proceeds, Insurance
proceeds and such other amounts as may be collected by the Servicer from the
Mortgagor or otherwise relating to the Mortgage Loan, it being understood
that, in the case of any such reimbursement, the Servicer' a right thereto
shall be prior to the right. of the Purchaser except that, where the Seller
or the Servicer is required to repurchase a Mortgage Loan pursuant to
Section 8.03 of the Purchase Agreement or Section 4.02 of this Agreement,
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respectively, the Servicer's right to such reimbursement shall be subsequent
to the payment to the Purchaser of the Repurchase Price pursuant to such
sections and all other amounts required to be paid to the Purchaser with
respect to such Mortgage Loan;
e. to pay itself any interest earned on funds deposited in the Custodial
Account (all such interest to be withdrawn monthly not later than each
Remittance Date); and
f. to clear and terminate the Custodial Account upon the termination of this
Agreement.
In the event that the Custodial Account is interest bearing, on each Remittance
Date, the Servicer shall withdraw all funds from the Custodial Account except
for those amounts which, pursuant to Section 3.01, the Servicer is not obligated
to remit on such Remittance Date. The Servicer may use such withdrawn funds only
for the purposes described in this Section 2.05.
SECTION 2.06. ESTABLISHMENT OF AND DEPOSITS TO ESCROW ACCOUNT. The Servicer
shall segregate and hold all funds collected and received pursuant to a Mortgage
Loan constituting Escrow payments separate and apart from any of its own funds
and general assets and shall establish and maintain one or more Escrow Accounts,
in the form of time deposit or demand accounts. The Escrow Account or Accounts
shall be established with a Qualified Depositary, in a manner which shall
provide maximum available insurance thereunder. Funds deposited in the Escrow
Accounts may be drawn on by the Servicer in accordance with Section 2.07. The
creation of any Escrow Account shall be evidenced by a certification in the form
of Exhibit 2 hereto, in the case of an account established with the Servicer, or
by a letter agreement in the form of Exhibit 5 hereto, in the case of an account
held by a depository other than the Servicer. A copy of such certification shall
be furnished to the Purchaser and, upon request, to any subsequent Purchaser.
The Servicer shall deposit in the Escrow Account or Accounts within one Business
Day of receipt, and retain therein:
a. all Escrow payments collected on account of the Mortgage Loans, for the
purpose of effecting timely payment of any such items as required under the
terms of this Agreement; and
b. all amounts representing Insurance Proceeds or Condemnation proceeds which
are to be applied to the restoration or repair of any Mortgaged Property.
The Servicer shall make withdrawals from the Escrow Account only to effect such
payments as are required under this Agreement, as set forth in Section 2.07. The
Servicer shall be entitled to retain any interest paid on funds deposited in the
Escrow Account by the depository institution, other than interest on escrowed
funds required by law to be paid to the Mortgagor. To the extent required by
law, the Servicer shall pay from its own funds interest on escrowed funds to the
Mortgagor notwithstanding that the Escrow Account may be noninterest bearing or
that interest paid thereon is insufficient for such purposes.
SECTION 2.07. PERMITTED WITHDRAWALS FROM ESCROW ACCOUNT. Withdrawals from each
Escrow Account may be made by the Servicer only:
a. to effect timely payments of ground rents, taxes, assessments, water rates,
mortgage insurance premiums, condominium charges, fire and hazard insurance
premiums or other items constituting Escrow Payments for the related
Mortgage;
b. to reimburse the Servicer for any Servicing Advance made by the Servicer
pursuant to Section 2.08 (except with respect to any expenses incurred in
procuring or transferring Tax Service Contracts) with respect to a related
Mortgage Loan, but only from amounts received on the related Mortgage Loan
which represent late collections of Escrow Payments thereunder;
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c. to refund to the related Mortgagor any funds found to be in excess of the
amounts required under the terms of the related Mortgage Loan or applicable
federal or state law or judicial or administrative ruling;
d. for transfer to the Custodial Account and application to reduce the
principal balance of the Mortgage Loan in accordance with the terms of the
related Mortgage and Mortgage Note;
e. for application to restoration or repair of the related Mortgaged Property
in accordance with the procedures outlined in Section 2.14;
f. to pay to the Servicer, or any Mortgagor to the extent required by law, any
interest paid on the funds deposited in the Escrow Account; and
g. to clear and terminate the Escrow Account on the termination of this
Agreement.
SECTION 2.08. PAYMENT OF TAXES, INSURANCE AND OTHER CHARGES, TAX CONTRACTS.
With respect to each Mortgage Loan, the Servicer shall maintain accurate records
reflecting the status of ground rents, taxes, assessments, water rates, sewer
rents, and other charges, as applicable, which are or may become a lien upon the
Mortgaged Property and the statue of PMI Policy premiums and fire and hazard
insurance coverage and shall obtain, from time to time, all bills for the
payment of such charges (including renewal premiums) and shall effect payment
thereof prior to the applicable penalty or termination date, employing for such
purpose deposits of the Mortgagor in the Escrow Account which shall have been
estimated and accumulated by the Servicer in amounts sufficient for such
purposes, as allowed under the terms of the Mortgage. To the extent that a
Mortgage does not provide for Escrow Payments, the Servicer shall determine that
any such payments relating to taxes or maintaining insurance policies are made
by the Mortgagor at the time they first become due. The Servicer assumes full
responsibility for the timely payment of all such bills to the extent it has or
should have notice of such bills and shall effect timely payment of all such
charges irrespective of each Mortgagor's faithful performance in the payment of
same or the making of the Escrow Payments, and the Servicer shall make advances
from its own funds to effect such payments, such advances to be reimbursable to
the same extent as Servicing Advances.
The Servicer shall ensure that each of the Mortgage Loans shall be covered by a
Tax Service Contract which shall be assigned to the Purchaser or the Purchaser's
designee at the Servicer's expense in the event that the Servicer is terminated
as servicer of the related Mortgage Loan(s) hereunder. To the extent that a
Mortgage Loan does not have a Tax Service Contract, the Purchaser shall procure
a Tax Service Contract for such Mortgage Loan and the Servicer shall reimburse
the Purchaser upon request for reasonable expenses incurred in connection
therewith.
SECTION 2.09. PROTECTION OF ACCOUNTS. The Servicer may transfer the Custodial
Account or the Escrow Account to a different Qualified Depository from time to
time. Such transfer shall be made only upon obtaining the consent of the
Purchaser, which consent shall not be withheld unreasonably.
The Servicer shall bear any expenses, losses or damages sustained by the
Purchaser because the Custodial Account and/or the Escrow Account are not demand
deposit accounts.
SECTION 2.10. MAINTENANCE OF HAZARD INSURANCE. The Servicer shall cause to be
maintained for each Mortgage Loan, hazard insurance such that all buildings upon
the Mortgaged Property are insured by a generally acceptable insurer rated A:VI
or better in the current Best's against loss by fire, hazards of extended
coverage and such other hazards as are required to be insured pursuant to the
FNMA Guides or the FHLMC Guide, in an amount which is at least equal to the
lesser of (i) the maximum insurable value of the improvements securing such
Mortgage Loan and (ii) the greater of (a) the outstanding principal balance of
the Mortgage Loan and (b) an amount such that the proceeds thereof shall be
sufficient to prevent the Mortgagor or the loss payee from becoming a co-
insurer.
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If required by the Flood Disaster Protection Act of 1973, as amended, each
Mortgage Loan is covered by a flood insurance policy meeting the requirements of
the current guidelines of the Federal Insurance Administration in effect with a
generally acceptable insurance carrier rated A:VI or better in Best's in an
amount representing coverage not less than the lesser of (i) the outstanding
principal balance of the related Mortgage Loan and (ii) the maximum amount of
insurance which is available under the Flood Disaster Protection Act of 1973, as
amended. If at any time during the term of the Mortgage Loan, the Servicer
determines in accordance with applicable law and pursuant to the FNMA Guides
that a Mortgaged Property is located in a special flood hazard area and is not
covered by flood insurance or is covered in an amount less than the amount
required by the Flood Disaster Protection Act of 1973, as amended, the Servicer
shall notify the related Mortgagor that the Mortgagor must obtain such flood
insurance coverage, and if said Mortgagor fails to obtain the required flood
insurance coverage within forty five (45) days after such notification, the
Servicer shall immediately purchase the required flood insurance on the
Mortgagor's behalf.
If a Mortgage is secured by a unit in a condominium project, the Servicer shall
verify that the coverage required of the owner's association, including hazard,
flood, liability, and fidelity coverage, is being maintained in accordance with
then current MAMA requirements, and secure from the owner Is association its
agreement to notify the Servicer promptly of any change in the insurance
coverage or of any condemnation or casualty loss that may have a material effect
on the value of the Mortgaged Property as security.
The Servicer shall cause to be maintained on each Mortgaged Property such other
or additional insurance as may be required pursuant to such applicable laws and
regulations as shall at any time be in force and as shall require such
additional insurance, or pursuant to the requirements of any primary mortgage
guaranty insurer.
All policies required hereunder shall name the Servicer and its successors and
assigns as mortgagee and shall be endorsed with non-contributory standard New
York mortgagee clauses which shall provide for at least thirty (30) days' prior
written notice of any cancellation, reduction in amount or material change in
coverage.
The Servicer shall not interfere with the Mortgagor's freedom of choice in
selecting either his insurance carrier or agent, provided, however, that the
Servicer shall not accept any such insurance policies from insurance companies
unless such companies are rated A:VI or better in Best's and are licensed to do
business in the jurisdiction in which the Mortgaged Property is located. The
Servicer shall determine that such policies provide sufficient risk coverage and
amounts as required pursuant to the FNMA Guides or the FHLMC Guide, that they
insure the property owner, and that they properly describe the property address.
To the extent reasonably possible the Servicer shall furnish to the Mortgagor a
formal notice of expiration of any such insurance in sufficient time for the
Mortgagor to arrange for renewal coverage by the expiration date; provided,
however, that in the event that no such notice is furnished by the Servicer, the
Servicer shall ensure that replacement insurance policies are in place in the
required coverages and the Servicer shall be solely liable for any losses in the
event such coverage is not provided.
Pursuant to Section 2.04, any amounts collected by the Servicer under any such
policies (other than amounts to be deposited in the Escrow Account and applied
to the restoration or repair of the related Mortgaged Property, or property
acquired in liquidation of the Mortgage Loan, or to be released to the
Mortgagor, in accordance with the Servicer's normal servicing procedures as
specified in Section 2.14) shall be deposited in the Custodial Account subject
to withdrawal pursuant to Section 2.05.
SECTION 2.11. MAINTENANCE OF MORTGAGE IMPAIRMENT INSURANCE. In the event that
the Servicer shall obtain and maintain a blanket policy insuring against losses
arising from fire and hazards covered under extended coverage on all of the
Mortgage Loans, then, to the extent such policy provides coverage in an amount
equal to the amount required pursuant to Section 2.10 and otherwise complies
with all other requirements of Section 2.10, it shall conclusively be deemed to
have satisfied its obligations as set forth in Section 2.10. Any amounts
collected by the Servicer under any such policy relating to a Mortgage Loan
shall be deposited in the Custodial Account subject to withdrawal pursuant to
Section 2.05. Such policy may contain a deductible clause, in which case, in the
event that there shall not have been maintained on the related Mortgaged
Property a policy complying with Section 2.10, and there shall have been a loss
which would have been covered by such policy, the Servicer shall deposit in the
Custodial
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Account at the time of such loss the amount not otherwise payable under the
blanket policy because of such deductible clause, such amount to be deposited
from the Servicer's funds, without reimbursement therefor. Upon request of the
Purchaser, the Servicer shall cause to be delivered to the Purchaser a certified
true copy of such policy and a statement from the insurer thereunder that such
policy shall in no event be terminated or materially modified without thirty
(30) days' prior written notice to the Purchaser.
SECTION 2.12. MAINTENANCE OF FIDELITY BOND AND ERRORS AND OMISSIONS INSURANCE.
The Servicer shall maintain with responsible companies, at its own expense, a
blanket Fidelity Bond and an Errors and Omissions Insurance Policy, with broad
coverage on all officers, employees or other persons acting in any capacity
requiring such persons to handle funds, money, documents or papers relating to
the Mortgage Loans ("Servicer Employees"). Any such Fidelity Bond and Errors and
Omissions Insurance Policy shall be in the form of the Mortgage Banker's Blanket
Bond and shall protect and insure the Servicer against losses, including
forgery, theft, embezzlement, fraud, errors and omissions and negligent acts of
such Servicer Employees. Such Fidelity Bond and Errors and Omissions Insurance
Policy also shall protect and insure the Servicer against losses in connection
with the release or satisfaction of a Mortgage Loan without having obtained
payment in full of the indebtedness secured thereby. No provision of this
Section 2.12 requiring such Fidelity Bond and Errors and Omissions Insurance
Policy shall diminish or relieve the Servicer from its duties and obligations as
set forth in this Agreement. The minimum coverage under any such Fidelity Bond
and Errors and Omissions Insurance Policy shall be at least equal to the
corresponding amounts required by FLEA in the FNMA Mortgage-Backed Securities
Selling and Servicing Guide or by FHLMC in the FHLMC Guide. Upon the request of
the Purchaser, the Servicer shall cause to be delivered to the Purchaser a
certified true copy of such Fidelity Bond and Errors and Omissions Insurance
Policy and a statement from the surety and the insurer that such Fidelity Bond
and Errors and Omissions Insurance Policy shall in no event be terminated or
materially modified without thirty (30) days' prior written notice to the
Purchaser. In the event that the surety or insurer charges the Servicer a fee
for providing such evidence, the Purchaser shall reimburse the Servicer for the
reasonable expense incurred by the Servicer in furnishing such evidence.
SECTION 2.13. INSPECTIONS. The Servicer shall inspect the Mortgaged Property as
often as deemed necessary by the Servicer to assure itself that the value of the
Mortgaged Property is being preserved. In addition, if any Mortgage Loan is more
than sixty (60) days delinquent, the Servicer immediately shall inspect the
Mortgaged Property and shall conduct subsequent inspections in accordance with
Accepted Servicing Practices or as may be required by the primary mortgage
guaranty insurer. The Servicer shall keep a written report of each such
inspection.
SECTION 2.14. RESTORATION OF MORTGAGED PROPERTY. The Servicer need not obtain
the approval of the Purchaser prior to releasing any Insurance Proceeds or
Condemnation Proceeds to the Mortgagor to be applied to the restoration or
repair of the Mortgaged Property if such release is in accordance with Accepted
Servicing Practices and the terms of this Agreement. At a minimum, the Servicer
shall comply with the following conditions in connection with any such release
of Insurance Proceeds or Condemnation Proceeds:
a. the Servicer shall receive satisfactory independent verification of
completion of repairs and issuance of any required approvals with respect
thereto;
b. the Servicer shall take all steps necessary to preserve the priority of the
lien of the Mortgage, including, but not limited to requiring waivers with
respect to mechanics' and materialmen's liens;
c. the Servicer shall verify that the Mortgage Loan is not in default; and
d. pending repairs or restoration, the Servicer shall place the Insurance
Proceeds or Condemnation Proceeds in the Escrow Account.
If the Purchaser is named as an additional mortgagee, the Servicer is hereby
empowered to endorse any loss draft issued in respect of such a claim in the
name of the Purchaser.
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SECTION 2.15. MAINTENANCE OF PMI POLICY, CLAIMS. With respect to each Mortgage
Loan with an LTV in excess of 85%, the Servicer shall, without any cost to the
Purchaser, maintain or cause the Mortgagor to maintain in full force and effect
a PMI Policy insuring that portion of the Mortgage Loan in excess of 75% of
value, and shall pay or shall cause the Mortgagor to pay the premium thereon on
a timely basis, until the LTV of such Mortgage Loan is reduced to 85%. In the
event that such PMI Policy shall be terminated, the Servicer shall obtain from
another Qualified Insurer a comparable replacement policy, with a total coverage
equal to the remaining coverage of such terminated PMI Policy. If the insurer
shall cease to be a Qualified Insurer, the Servicer shall determine whether
recoveries under the PMI Policy are jeopardized for reasons related to the
financial condition of such insurer, it being understood that the Servicer shall
in no event have any responsibility or liability for any failure to recover
under the PMI Policy for such reason. If the Servicer determines that recoveries
are so jeopardized, it shall notify the Purchaser and the Mortgagor, if
required, and obtain from another Qualified Insurer a replacement insurance
policy. The Servicer shall not take any action which would result in noncoverage
under any applicable PMI Policy of any loss which, but for the actions of the
Servicer, would have been covered thereunder. In connection with any assumption
or substitution agreement entered into or to be entered into pursuant to Section
4.01, the Servicer shall promptly notify the insurer under the related PMI
Policy, if any, of such assumption or substitution of liability in accordance
with the terms of such PMI Policy and shall take all actions which may be
required by such insurer as a condition to the continuation of coverage under
such PMI Policy. If such PMI Policy is terminated as a result of such assumption
or substitution of liability, the Servicer shall obtain a replacement PMI Policy
as provided above.
In connection with its activities as servicer, the Servicer agrees to prepare
and present, on behalf of itself and the Purchaser, claims to the insurer under
any PMI Policy in a timely fashion in accordance with the terms of such PMI
Policy and, in this regard, to take such action as shall be necessary to permit
recovery under any PMI Policy with respect to a defaulted Mortgage Loan.
Pursuant to Section 2.04, any amounts collected by the Servicer under any PMI
Policy shall be deposited in the Custodial Account, subject to withdrawal
pursuant to Section 2.05.
SECTION 2.16. DETERIORATING MORTGAGE LOANS. If, in the course of carrying out
its obligations under this Agreement, the Servicer discovers that a Mortgage
Loan (or an interest therein) (i) is or has been, at any time during the
preceding twelve months, (a) classified, (b) in nonaccrual status or (c)
renegotiated due to the financial deterioration of the Mortgagor or (ii) has
been, more than once during the preceding twelve months, more than 30 days past
due in the payment of principal and interest, the Servicer shall notify the
Purchaser as soon as possible and cooperate with the Purchaser in the
disposition of any such Mortgage Loan as soon as possible.
SECTION 2.17. TITLE, MANAGEMENT AND DISPOSITION OF REO PROPERTY. In the event
that title to any Mortgaged Property is acquired in foreclosure or by deed in
lieu of foreclosure, the deed or certificate of sale shall be taken in the name
of the Purchaser, or in the event the Purchaser is not authorized or permitted
to hold title to real property in the state where the REO Property is located,
or would be adversely affected under the "doing business or tax laws of such
state by so holding title, the deed or certificate of sale shall be taken in the
name of such Person or Persons as shall be consistent with an Opinion of Counsel
obtained by the Servicer from any attorney duly licensed to practice law in the
state where the REO Property is located. The Person or Persons holding such
title other than the Purchaser shall acknowledge in writing that such title is
being held as nominee for the Purchaser.
The Servicer shall manage, conserve, protect and operate each REO Property for
the Purchaser solely for the purpose of its prompt disposition and sale. The
Servicer, either itself or through an agent selected by the Servicer and
reasonably acceptable to the Purchaser, shall manage, conserve, protect and
operate the REO Property in the same manner that it manages, conserves, protects
and operates other foreclosed property for its own account, and in the same
manner that similar property in the same locality as the REO Property is
managed. The Servicer shall attempt to sell the same (and may temporarily rent
the same for a period not greater than one (1) year, except as otherwise
provided below) on such terms and conditions as the Servicer deems to be in the
best interest of the Purchaser.
The Servicer shall use its best efforts to dispose of the REO Property as soon
as possible and shall sell such REO Property in any event within one year after
title has been taken to such REO Property, unless the Servicer determines,
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and gives an appropriate notice to the Purchaser to such effect, that a longer
period is necessary for the orderly liquidation of such REO Property. If a
period longer than one (1) year is permitted under the foregoing sentence and is
necessary to sell any REO Property, the Servicer shall report monthly to the
Purchaser as to the progress being made in selling such REO Property.
The Servicer shall also maintain on each REO Property fire and hazard insurance
with extended coverage in an amount which is at least equal to the maximum
insurable value of the improvements which are a part of such property, liability
insurance and, to the extent required and available under the Flood Disaster
Protection Act of 1973, as amended, flood insurance in the amount required
above.
The disposition of REO Property shall be carried out by the Servicer at such
price, and upon such terms and conditions, as the Servicer deems to be in the
best interests of the Purchaser. The proceeds of sale of the REO Property shall
be promptly deposited in the Custodial Account. As soon as practical thereafter
the expenses of such sale shall be paid and the Servicer shall reimburse itself
pursuant to Section 2.05(iii) or 2.05(iv) hereof, as applicable, for any related
unreimbursed Servicing Advances, unpaid Servicing Fees and unreimbursed advances
made pursuant to this Section, and on the Remittance Date immediately following
the Due Period in which such sale proceeds are received the net cash proceeds of
such sale remaining in the Custodial Account shall be distributed to the
Purchaser; provided that such distribution shall, in any event, be made within
ninety (90) days from and after the closing of the sale of such REO Property.
In addition to the Servicer's obligations set forth in this Section 2.17, the
Servicer shall deliver written notice to the Purchaser whenever title to any
Mortgaged Property is acquired in foreclosure or by deed in lieu of foreclosure
together with a copy of the drive-by appraisal of the related Mortgaged Property
obtained by the Servicer on or prior to the date of such acquisition.
Notwithstanding anything to the contrary contained herein, the Purchaser may, at
the Purchaser's sole option, terminate the Servicer as servicer of any such REO
Property without payment of any Termination Fee with respect thereto, provided
that (i) the Purchaser gives the Servicer notice of such termination within ten
(10) Business Days of receipt of said written notice from the Servicer which
termination shall be effective no more than fifteen (15) Business Days from and
after the date of said notice from the Purchaser and (ii) the Servicer shall on
the date said termination takes effect be reimbursed by Purchaser for any
unreimbursed advances of the Servicer's funds made pursuant to section 3.02 and
any unreimbursed Servicing Advances in each case relating to the Mortgage Loan
underlying such REO Property. In the event of any such termination, the
provisions of Section 8.06 hereof shall apply to said termination and the
transfer of servicing responsibilities with respect to such REO Property to the
Purchaser or its designee.
With respect to each REO Property, the Servicer shall deposit all funds
collected and received in connection with the operation of the REO Property in
the Custodial Account. The Servicer shall cause to be deposited on a daily basis
upon the receipt thereof in the Custodial Account all revenues received with
respect to the conservation and disposition of the related REO Property.
SECTION 2.18. PERMITTED WITHDRAWALS WITH RESPECT TO REO PROPERTY. For so long
as the Servicer is acting as servicer of any Mortgage Loan relating to any REO
Property, the Servicer shall withdraw funds on deposit in the Custodial Account
with respect to each related REO Property necessary for the proper operation,
management and maintenance of the REO Property, including the cost of
maintaining any hazard insurance pursuant to Section 2.10 and the fees of any
managing agent acting on behalf of the Servicer. The Servicer shall make monthly
distributions on each Remittance Date to the Purchaser of the net cash flow from
the REO Property (which shall equal the revenues from such REO Property net of
the expenses described in Section 2.17 and of any reserves reasonably required
from time to time to be maintained to satisfy anticipated liabilities for such
expenses).
SECTION 2.19. REAL ESTATE OWNED REPORTS. For so long as the Servicer is acting
as servicer of any Mortgage Loan relating to any REO Property, the Servicer
shall furnish to the Purchaser on or before the 15th day of each month a
statement with respect to any REO Property covering the operation of such REO
Property for the
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previous month and the Servicer's efforts in connection with the sale of such
REO Property and any rental of such REO Property incidental to the sale thereof
for the previous month. That statement shall be accompanied by such other
information as the Purchaser shall reasonably request.
SECTION 2.20. LIQUIDATION REPORTS. For so long as the Servicer is acting as
servicer of any Mortgage Loan relating to any REO Property, upon the foreclosure
sale of any Mortgaged Property or the acquisition thereof by the Purchaser
pursuant to a deed in lieu of foreclosure, the Servicer shall submit to the
Purchaser a liquidation report with respect to such Mortgaged Property.
SECTION 2.21. REPORTS OF FORECLOSURES AND ABANDONMENTS. For so long as the
Servicer is acting as servicer of any Mortgage Loan relating to any REO
Property, following the foreclosure sale or abandonment of any Mortgaged
Property, the Servicer shall report such foreclosure or abandonment as required
pursuant to Section 6050J of the Code.
SECTION 2.22. NOTIFICATION OF ADJUSTMENTS. With respect to each ARM Loan, the
Servicer shall adjust the Mortgage Interest Rate on the related Interest Rate
Adjustment Date and shall adjust the Monthly Payment accordingly in compliance
with the requirements of applicable law and the related Mortgage and Mortgage
Note. If, pursuant to the terms of the Mortgage Note, another index is selected
for determining the Mortgage Interest Rate, the same index will be used with
respect to each Mortgage Note which requires a new index to be selected,
provided that such selection does not conflict with the terms of the related
Mortgage Note. The Servicer shall execute and deliver any and all necessary
notices required under applicable law and the terms of the related Mortgage Note
and Mortgage regarding the Mortgage Interest Rate and the Monthly Payment
adjustments. The Servicer shall promptly upon written request therefor, deliver
to the Purchaser such notifications and any additional applicable data regarding
such adjustments and the methods used to calculate and implement such
adjustments. Upon the discovery by the Servicer or the Purchaser that the
Servicer has failed to adjust a Mortgage Interest Rate or a Monthly Payment
pursuant to the terms of the related Mortgage Note and Mortgage, the Servicer
shall immediately deposit in the Custodial Account from its own funds the amount
of any interest loss caused the Purchaser thereby.
SECTION 2.23. NOTIFICATION OF MATURITY DATE. With respect to each Fixed Rate
Mortgage Loan, the Purchaser shall execute and deliver to the Mortgagor any and
all necessary notices required under applicable law and the terms of the related
Mortgage Note and Mortgage regarding the maturity date if required under
applicable law.
ARTICLE III
PAYMENTS TO PURCHASER
SECTION 3.01. REMITTANCES. On each Remittance Date the Servicer shall remit by
wire transfer of immediately available funds to the Purchaser (a) all amounts
deposited in the Custodial Account as of the close of business on the
Determination Date, except Principal Prepayments received on or after the first
day of the month in which the Remittance Date occurs which shall be remitted to
the Purchaser on the next following Remittance Date; plus (b) an amount
representing compensating interest (up to a maximum amount equal to the
aggregate Servicing Fee for the Mortgage Loans held by the Purchaser with
respect to such Mortgage Loans) which, when added to all amounts allocable to
interest received in connection with such Principal Prepayment equals thirty
(30) days' interest at the Mortgage Interest Rate net of the Servicing Fee on
the amount of principal so prepaid (net of charges against or withdrawals from
the Custodial Account pursuant to Section 2.05), plus (c) all amounts, if any,
which the Servicer is obligated to distribute pursuant to Section 3.03 and minus
(d) any amounts attributable to Monthly Payments collected but due on a Due Date
or Dates subsequent to the first day of the month of the Remittance Date, which
amounts shall be remitted on the Remittance Date next succeeding the Due Period
for such amounts.
With respect to any remittance received by the Purchaser after the second
Business Day following the Business Day on which such payment was due, the
Servicer shall pay to the Purchaser interest on any such late payment at an
annual rate equal to the Prime Rate, adjusted as of the date of each change,
plus one (1) percentage point, but in no event
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greater than the maximum amount permitted by applicable law. Such interest shall
be deposited in the Custodial Account by the Servicer on the date such late
payment is made and shall cover the period commencing with and including the day
following such second Business Day and ending with the Business Day on which
such payment is made, exclusive of such Business Day; provided, however, that in
the event that the Servicer remits such amounts after 11:00 A.M. (New York City
time) on any day, such period shall include such day. Such interest shall be
remitted along with the distribution payable on the next succeeding Remittance
Date. The payment by the Servicer of any such interest shall not be deemed an
extension of time for payment or a waiver of any Event of Default by the
Servicer.
SECTION 3.02. STATEMENTS TO PURCHASER. Not later than the twentieth day of each
month, the Servicer shall furnish by modem and/or diskette to the Purchaser or
its designee a listing of the outstanding Mortgage Loans, including with respect
to each Mortgage Loan: the Mortgage Loan number, the actual balance, the actual
paid-through dates and the Mortgage Interest Rate and principal and interest
payment, and with respect to ARM Loans, the next Interest Rate Adjustment Date,
the Mortgage Interest Rate and the principal and interest payment effective as
of the next Interest Rate Adjustment Date (if available), and shall furnish to
the Purchaser manually a Monthly Remittance Advice, with a trial balance report
attached thereto, in the form of Exhibit 1 annexed hereto as to the preceding
remittance and the period ending on the preceding Determination Date.
In addition, not more than sixty (60) days after the end of each calendar year,
the Servicer shall furnish to each Person who was a Purchaser at any time during
such calendar year an annual statement in accordance with the requirements of
applicable federal income tax law as to the aggregate of remittances for the
applicable portion of such year.
Such obligation of the Servicer shall be deemed to have been satisfied to the
extent that substantially comparable information shall be provided by the
Servicer pursuant to any requirements of the Code as from time to time are in
force.
The Servicer shall prepare and file, with respect to each Mortgage Loan, any and
all tax returns, information statements or other filings required to be
delivered to any governmental taxing authority or to the Purchaser pursuant to
any applicable law with respect to the Mortgage Loans and the transactions
contemplated hereby. In addition, the Servicer shall provide the Purchaser with
such information concerning the Mortgage Loans as is necessary for the Purchaser
to prepare its federal income tax return as the Purchaser may reasonably request
from time to time.
SECTION 3.03. ADVANCES BY SERVICER. On the Business Day immediately preceding
each Remittance Date, the Servicer shall deposit in the Custodial Account from
its own funds an amount equal to all Monthly Payments which were due on the
Mortgage Loans during the applicable Due Period and which were delinquent at the
close of business on the immediately preceding Determination Date or which were
deferred pursuant to Section 2.01, provided that the Servicer shall only be
required to make such advances with respect to a Mortgage Loan until such
advances are, in the Servicer's good faith determination as evidenced by an
Officer's Certificate of the Servicer delivered to the Purchaser on the Business
Day next following the Determination Date on or prior to which said
determination is or was made, deemed to be a Nonrecoverable Advance. The
Servicer's obligation to make such advances as to any Mortgage Loan will
continue through the earlier of (i) the disposition of such Mortgage Loan and
(ii) the date of foreclosure sale with respect to such Mortgage Loan. Except as
otherwise provided herein, the Servicer shall be entitled to first priority
reimbursement pursuant to Section 2.05 hereof for principal and interest
advances and for servicing advances from recoveries from the related mortgagor
or from all Liquidation Proceeds and other payments or recoveries (including
Insurance Proceeds and Condemnation Proceeds) with respect to the related
Mortgage Loan.
ARTICLE IV
GENERAL SERVICING PROCEDURES
SECTION 4.01. TRANSFERS OF MORTGAGED PROPERTY. The Servicer shall be required
to enforce any 'due-on-sale" provision contained in any Mortgage or Mortgage
Note and to deny assumption by the person to whom
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the Mortgaged Property has been or is about to be sold whether by absolute
conveyance or by contract of sale, whether or not the Mortgagor remains liable
on the Mortgage and the Mortgage Note. When the Mortgaged Property has been
conveyed by the Mortgagor, the Servicer shall, to the extent it has knowledge of
such conveyance, exercise its rights to accelerate the maturity of such Mortgage
Loan under the 'due-on-sale" clause applicable thereto, provided, however, that
the Servicer shall not exercise such rights if prohibited by law from doing so
or if the exercise of such rights would impair or threaten to impair any
recovery under the related PMI Policy, if any.
If the Servicer reasonably believes it is unable under applicable law to enforce
such "due-on-sale" clause, the Servicer, in the Purchaser's name, shall, to the
extent permitted by applicable law, enter into (i) an assumption and
modification agreement with the person to whom such property has been conveyed,
pursuant to which such person becomes liable under the Mortgage Note and the
original Mortgagor remains liable thereon or (ii) in the event the Servicer is
unable under applicable law to require that the original Mortgagor remain liable
under the Mortgage Note and the Servicer has the prior consent of the primary
mortgagee guaranty insurer, a substitution of liability agreement with the
purchaser of the Mortgaged Property pursuant to which the original Mortgagor is
released from liability and the purchaser of the Mortgaged Property is
substituted as Mortgagor and becomes liable under the Mortgage Note. In
connection with any such assumption, neither the Mortgage Interest Rate borne by
the related Mortgage Note, the term of the Mortgage Loan nor the outstanding
principal amount of the Mortgage Loan shall be changed.
To the extent that any Mortgage Loan is assumable, the Servicer shall inquire
diligently into the creditworthiness of the proposed transferee, and shall use
the underwriting criteria for approving the credit of the proposed transferee
which are used by FNMA with respect to underwriting mortgage loans of the same
type as the Mortgage Loans. If the credit of the proposed transferee does not
meet such underwriting criteria, the Servicer diligently shall, to the extent
permitted by the Mortgage or the Mortgage Note and by applicable law, accelerate
the maturity of the Mortgage Loan.
SECTION 4.02. SATISFACTION OF MORTGAGES AND RELEASE OF MORTGAGE FILES. Upon the
payment in full of any Mortgage Loan, or the receipt by the Servicer of a
notification that payment in full will be escrowed in a manner customary for
such purposes, the Servicer shall notify the Purchaser in the Monthly Remittance
Advice as provided in Section 3.02, and may request the release of any Mortgage
Loan Documents from the Purchaser in accordance with this Section 4.02 hereof.
The Servicer shall obtain discharge of the related Mortgage Loan as of record
within any related time limit required by applicable law.
If the Servicer satisfies or releases a Mortgage without first having obtained
payment in full of the indebtedness secured by the Mortgage or should the
Servicer otherwise prejudice any rights the Purchaser may have under the
mortgage instruments, upon written demand of the Purchaser, the Servicer shall
repurchase the related Mortgage Loan at the Repurchase Price by deposit thereof
in the Custodial Account within two (2) Business Days of receipt of such demand
by the Purchaser. Upon such repurchase, all funds maintained in the Escrow
Account with respect to such repurchased Mortgage Loan shall be transferred to
the Servicer. The Servicer shall maintain the Fidelity Bond and Errors and
Omissions Insurance Policy as provided for in Section 2.12 insuring the Servicer
against any loss it may sustain with respect to any Mortgage Loan not satisfied
in accordance with the procedures set forth herein.
SECTION 4.03. SERVICING COMPENSATION. As consideration for servicing the
Mortgage Loans hereunder, the Servicer shall withdraw the Servicing Fee with
respect to each Mortgage Loan from the Custodial Account pursuant to Section
2.05 hereof. Such Servicing Fee shall be payable monthly, computed on the basis
of the same principal amount and period in respect of which any related interest
payment on a Mortgage Loan is computed. The Servicing Fee shall be pro-rated
when servicing is for less than one month. The obligation of the Purchaser to
pay, and the Servicer's right to withdraw, the Servicing Fee is limited to, and
the Servicing Fee is payable solely from, the interest portion (including
recoveries with respect to interest from Liquidation Proceeds, to the extent
permitted by Section 2.05), of such Monthly Payment collected by the Servicer,
or as otherwise provided under Section 2.05.
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Additional servicing compensation in the form of Ancillary Income shall be
retained by the Servicer. The Servicer shall be required to pay all expenses
incurred by it in connection with its servicing activities hereunder and shall
not be entitled to reimbursement thereof except as specifically provided for
herein.
SECTION 4.04. ANNUAL STATEMENT AS TO COMPLIANCE. The Servicer shall deliver to
the Purchaser: on or before March 31 each year beginning March 31, 1997, an
Officer's Certificate, stating that (i) a review of the activities of the
Servicer during the preceding calendar year and of performance under this
Agreement has been made under such officer's supervision, and (ii) the Servicer
has complied in all material respects with the provisions of Article II and
Article IV, and (iii) to the best of such officer's knowledge, based on such
review, the Servicer has fulfilled all its obligations under this Agreement
throughout such year or part thereof, or, if there has been a default in the
fulfillment of any such obligation, specifying each such default known to such
officer and the nature and status thereof and the action being taken by the
Servicer to cure such default.
SECTION 4.05. ANNUAL INDEPENDENT PUBLIC ACCOUNTANTS' SERVICING REPORT. On or
before March 31 of each year, beginning with the first March 31 that occurs at
least six months after the Closing Date, the Servicer at its expense shall cause
a firm of independent public accountants (who may also render other services to
the Servicer or any affiliate thereof) which is a member of the American
Institute of Certified Public Accountants to furnish a statement to the
Purchaser to the effect that such firm has, as part of their examination of the
financial statements of the Servicer performed tests embracing the records and
documents relating to mortgage loans serviced by the Servicer in accordance with
the requirements of the Uniform Single Audit Program for Mortgage Bankers and
that their examination disclosed no exceptions that, in their opinion were
material, relating to mortgage loans serviced by the Servicer.
SECTION 4.06. RIGHT TO EXAMINE SERVICER RECORDS. The Purchaser, upon reasonable
notice, shall have the right to examine and audit any and all of the books,
records, or other information of the Servicer, whether held by the Servicer or
by another on its behalf, with respect to or concerning this Agreement or the
Mortgage Loans, during business hours or at such other times as may be
reasonable under applicable circumstances, upon reasonable advance notice.
ARTICLE V
SERVICER TO COOPERATE
SECTION 5.01. PROVISION OF INFORMATION. During the term of this Agreement, the
Servicer shall furnish to the Purchaser such periodic, special, or other reports
or information, whether or not provided for herein, as shall be necessary,
reasonable, or appropriate with respect to the Purchaser or the purposes of this
Agreement. All such reports or information shall be provided by and in
accordance with all reasonable instructions and directions which the Purchaser
may give. The Servicer shall execute and deliver all such instruments and take
all such action as the Purchaser may reasonably request from time to time, in
order to effectuate the purposes and to carry out the terms of this Agreement.
SECTION 5.02. FINANCIAL STATEMENTS; SERVICING FACILITIES. In connection with
disposition of Mortgage Loans, the Purchaser may make available to a prospective
purchaser audited financial statements of the Servicer for the most recently
completed two (2) fiscal years for which such statements are available, as well
as a Consolidated Statement of Condition at the end of the last two (2) fiscal
years covered by any Consolidated Statement of Operations. If it has not already
done so, the Servicer shall furnish promptly to the Purchaser or a prospective
purchaser copies of the statements specified above; provided, however, that
prior to furnishing such statements or information to any prospective purchaser,
the Servicer may require such prospective purchaser to execute a confidentiality
agreement in form reasonably satisfactory to it.
The Servicer shall make available to the Purchaser or any prospective Purchaser
a knowledgeable financial or accounting officer for the purpose of answering
questions with respect to recent developments affecting the Servicer
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or the financial statements of the Servicer, and to permit any prospective
purchaser to inspect the Servicer's servicing facilities for the purpose of
satisfying such prospective purchaser that the Servicer has the ability to
service the Mortgage Loans as provided in this Agreement.
ARTICLE VI
TERMINATION
SECTION 6.01. AGENCY SUSPENSION. Should the Servicer at any time during the
term of this Agreement have its right to service temporarily or permanently
suspended by FNMA or FHLMC or otherwise cease to be an approved seller/servicer
of conventional residential mortgage loans for FNMA or FRANC, then the Purchaser
may immediately terminate this Agreement and accelerate performance of the
provisions of the Purchase Agreement to require immediate transfer of the
Servicing Rights.
SECTION 6.02. DAMAGES. The Purchaser shall have the right at any time to seek
and recover from the Servicer any damages or losses suffered by it as a result
of any failure by the Servicer to observe or perform any duties, obligations,
covenants or agreements herein contained, or as a result of a party's failure to
remain an approved FNMA mortgage servicer.
SECTION 6.03. TERMINATION. The respective obligations and responsibilities of
the Servicer shall terminate upon: (i) the later of the final payment or other
liquidation (or any advance with respect thereto) of the last Mortgage Loan
serviced by the Servicer or the disposition of all REO Property serviced by the
Servicer and the remittance of all funds due hereunder; or (ii) by mutual
consent of the Servicer and the Purchaser in writing, unless earlier terminated
pursuant to this Agreement.
SECTION 6.04. TERMINATION WITHOUT CAUSE. The Purchaser may, at its sole option,
upon not less than thirty (30) days' prior written notice to the Servicer
terminate any rights the Servicer may have hereunder with respect to any or all
of the Mortgage Loans, without cause, upon written notice, provided that the
Servicer shall have an additional period of not more than sixty (60) days from
and after the date of said notice from the Purchaser within which to effect the
related transfer of servicing. Any such notice of termination shall be in
writing and delivered to the Servicer as provided in Section 12.01 of this
Agreement. In the event of such termination, the Servicer shall be entitled to a
Termination Fee, equal to 2.0% of the then current aggregate unpaid principal
balance of the related Mortgage Loans; provided, however, that the successor
servicer is not an Affiliate of the Servicer.
ARTICLE VII
BOOKS AND RECORDS
SECTION 7.01. POSSESSION OF SERVICING FILES. The contents of each Servicing
File are and shall be held in trust by the Servicer for the benefit of the
Purchaser as the owner thereof. The Servicer shall maintain in the Servicing
File a copy of the contents of each Mortgage File and the originals of the
documents in each Mortgage File not delivered to the Purchaser. The possession
of the Servicing File by the Servicer is at the will of the Purchaser for the
sole purpose of servicing the related Mortgage Loan, pursuant to this Agreement,
and such retention and possession by the Servicer is in its capacity as Servicer
only and at the election of the Purchaser. The Servicer shall release its
custody of the contents of any Servicing File only in accordance with written
instructions from the Purchaser or other termination of the Servicer with
respect to the related Mortgage Loans, unless such release is required as
incidental to the Servicer's servicing of the Mortgage Loans pursuant to this
Agreement, or is in connection with a repurchase of any Mortgage Loan pursuant
to Section 8.03 of the Purchase Agreement or Section 4.02 of this Agreement.
The Servicer shall be responsible for maintaining, and shall maintain, a
complete set of books and records for each Mortgage Loan which shall be marked
clearly to reflect the ownership of each Mortgage Loan by the Purchaser. In
particular, the Servicer shall maintain in its possession, available for
inspection by the Purchaser or its designee during
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normal business hours, and shall deliver to the Purchaser or its designee upon
reasonable notice, evidence of compliance with all federal, state and local
laws, rules and regulations, and requirements of FNMA or FHLMC, including but
not limited to documentation as to the method used in determining the
applicability of the provisions of the Flood Disaster Protection Act of 1973, as
amended, to the Mortgaged Property, documentation evidencing insurance coverage
and eligibility of any condominium project for approval by FNMA and periodic
inspection reports as required by Section 2.13 and the FNMA Guides.
To the extent that original documents are not required for purposes of
realization of Liquidation Proceeds or Insurance Proceeds, documents maintained
by the Servicer may be in the form of microfilm or microfiche so long as the
Servicer complies with the requirements of the FNMA Guides.
The Servicer shall keep at its servicing office books and records in which,
subject to such reasonable regulations as it may prescribe, the Servicer shall
note transfers of Mortgage Loans. No transfer of a Mortgage Loan may be made
unless such transfer is in compliance with the terms hereof. For the purposes of
this Agreement, the Servicer shall be under no obligation to deal with any
person with respect to this Agreement or the Mortgage Loans unless the books and
records show such person as the owner of the Mortgage Loan. The Purchaser may,
subject to the terms of this Agreement, sell or transfer one or more of the
Mortgage Loans. The Purchaser also shall advise the Servicer of the transfer.
Upon receipt of notice of the transfer, the Servicer shall mark its books and
records to reflect the ownership of the Mortgage Loans of such assignee, and
shall release the Purchaser from its obligations hereunder with respect to the
Mortgage Loans sold or transferred.
ARTICLE VIII
INDEMNIFICATION AND ASSIGNMENT
SECTION 8.01. INDEMNIFICATION. The Servicer agrees to indemnify and hold the
Purchaser harmless from any liability, claim, loss or damage (including, without
limitation, any reasonable legal fees, judgments or expenses relating to such
liability, claim, loss or damage) to the Purchaser directly or indirectly
resulting from the Servicer's failure to observe and perform any or all of
Servicer's duties, obligations, covenants, agreements, warranties or
representations contained in this Agreement or in the Purchase Agreement or the
Servicer's failure to comply with all applicable requirements with respect to
the transfer of Servicing Rights as set forth herein.
The Servicer shall notify the Purchaser as soon as reasonably possible if a
claim is made by a third party with respect to this Agreement.
SECTION 8.02. LIMITATION ON LIABILITY OF SERVICER AND OTHERS. Neither the
Servicer nor any of the directors, officers, employees or agents of the Servicer
shall be under any liability to the Purchaser for any action taken or for
refraining from the taking of any action in good faith pursuant to this
Agreement, or for errors in judgment, provided, however, that this provision
shall not protect the Servicer or any such person against any breach of
warranties or representations made herein, or failure to perform its obligations
in material compliance with any standard of care set forth in this Agreement, or
any liability which would otherwise be imposed by reason of any breach of the
terms and conditions of this Agreement. The Servicer and any director, officer,
employee or agent of the Servicer may rely in good faith on any document of any
kind prima facie properly executed and submitted by any Person with respect to
any matter arising hereunder. The Servicer shall not be under any obligation to
appear in, prosecute or defend any legal action which is not incidental to its
duties to service the Mortgage Loans in accordance with this Agreement and which
in its opinion may involve it in any expense or liability, provided, however,
that the Servicer may, with the prior written consent of the Purchaser,
undertake any such action which it may deem necessary or desirable in respect to
this Agreement and the rights and duties of the parties hereto. In such event,
the Servicer shall be entitled to reimbursement from the Purchaser of the
reasonable legal expenses and costs of such action.
SECTION 8.03. LIMITATION ON REGISTRATION AND ASSIGNMENT BY SERVICER. The
Purchaser has entered into this Agreement with the Servicer in reliance upon the
independent status of the Servicer, and the
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representations as to the adequacy of its servicing facilities, plant,
personnel, records and procedures, its integrity, reputation and financial
standing, and the continuance thereof. Therefore, the Servicer shall not (i)
assign this Agreement or the servicing hereunder or (ii) delegate any
substantial part of its rights or duties hereunder without the prior written
consent of the Purchaser, which consent shall not be unreasonably withheld or
conditioned provided that (a) any delegation of such rights or duties shall not
release the Servicer from its obligations hereunder and the Servicer shall
remain responsible hereunder for all acts and omissions of any delegee as if
such acts or omissions were those of the Servicer and (b) any such assignee or
designee shall satisfy the requirements for a successor or surviving Person set
forth in Section 8.05 and Section 8.06 hereof. The Servicer shall notify the
Purchaser in writing at least 30 days prior to selling or otherwise disposing of
all or substantially all of its assets and receipt of such notice shall entitle
the Purchaser to terminate this Agreement except as set forth in Section 8.05
hereof.
The Servicer shall not resign from the obligations and duties hereby imposed on
it except by mutual consent of the Servicer and the Purchaser or upon the
determination that its duties hereunder are no longer permissible under
applicable law and such incapacity cannot be cured by the Servicer. Any such
determination permitting the resignation of the Servicer shall be evidenced by
an Opinion of Counsel to such effect delivered to the Purchaser which Opinion of
Counsel shall be in form and substance acceptable to the Purchaser. No such
resignation shall become effective until a successor shall have assumed the
Servicer's responsibilities and obligations hereunder in the manner provided in
Section 8.06.
Without in any way limiting the generality of this Section 8.03, in the event
that the Servicer either shall assign this Agreement or the servicing
responsibilities hereunder or delegate its duties hereunder or any portion
thereof without (i) satisfying the requirements set forth herein or (ii) the
prior written consent of the Purchaser, then the Purchaser shall have the right
to terminate this Agreement as set forth in Section 6.04, without any payment of
any penalty or damages and without any liability whatsoever to the Servicer
(other than with respect to accrued but unpaid Servicing Fees and Servicing
Advances remaining unpaid) or any third party.
SECTION 8.04. ASSIGNMENT BY PURCHASER. The Purchaser shall have the right
without the consent of the Servicer, to assign, in whole or in part, its
interest under this Agreement with respect to some or all of the Mortgage Loans
and designate any person to exercise any rights of the Purchaser hereunder, by
executing an Assignment and Assumption Agreement substantially in the form of
Exhibit G to the Purchase Agreement and the assignee or designee shall accede to
the rights and obligations hereunder of the Purchaser with respect to such
Mortgage Loans. All references to the Purchaser in this Agreement shall be
deemed to include its assignee or designee. Notwithstanding the foregoing, at
any one time there shall not be more than fifteen (15) separate Purchasers under
this Agreement.
SECTION 8.05. MERGER OR CONSOLIDATION OF THE SERVICER. The Servicer will keep
in full effect its existence, rights and franchises as a corporation under the
laws of the state of its incorporation except as permitted herein, and will
obtain and preserve its qualification to do business as a foreign corporation in
each jurisdiction in which such qualification is or shall be necessary to
protect the validity and enforceability of this Agreement, or any of the
Mortgage Loans and to perform its duties under this Agreement.
Any Person into which the Servicer may be merged or consolidated, or any
corporation resulting from any merger, conversion or consolidation to which the
Servicer shall be a party, or any Person succeeding to the business of the
Servicer, shall be the successor of the Servicer hereunder, without the
execution or filing of any paper or any further act on the part of any of the
parties hereto, anything herein to the contrary notwithstanding; provided,
however, that the successor or surviving Person shall be an institution whose
deposits are insured by FDIC or a company whose business includes the
origination and servicing of mortgage loans, shall be qualified to service
mortgage loans on behalf of FLEA or FHLMC and shall satisfy the requirements of
Section 8.06 with respect to the qualifications of a successor to the Servicer.
SECTION 8.06. SUCCESSOR TO THE SERVICER. Prior to termination of Servicer's
responsibilities and duties under this Agreement pursuant to Sections 2.17,
6.04, 8.03 or 11.01, the Purchaser shall (i) succeed to and assume
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all of the Servicer's responsibilities, rights, duties and obligations under
this Agreement, or (ii) appoint a successor having a tangible net worth of not
less than $30,000,000 and which shall succeed to all rights and assume all of
the responsibilities, duties and liabilities of the Servicer under this
Agreement prior to the termination of Servicer's responsibilities, duties and
liabilities under this Agreement. Any successor to the Servicer shall be a FLEA-
or FHLMC-approved servicer in good standing. In connection with such appointment
and assumption, the Purchaser may make such arrangements for the compensation of
such successor out of payments on Mortgage Loans as it and such successor shall
agree. In the event that the Servicer's duties, responsibilities and liabilities
under this Agreement should be terminated pursuant to the aforementioned
sections, the Servicer shall discharge such duties and responsibilities during
the period from the date it acquires knowledge of such termination until the
effective date thereof with the same degree of diligence and prudence which it
is obligated to exercise under this Agreement, and shall take no action
whatsoever that might impair or prejudice the rights or financial condition of
its successor. The resignation or removal of Servicer pursuant to the
aforementioned Sections shall not become effective until a successor shall be
appointed pursuant to Article X hereof this Section and shall in no event
relieve the Servicer of the representations, warranties and covenants made
pursuant to and the remedies available to the Purchaser with respect thereto, it
being understood and agreed that the provisions of such Article X shall be
applicable to the Servicer notwithstanding any such resignation or termination
of the Servicer, or the termination of this Agreement.
Any successor appointed as provided herein shall execute, acknowledge and
deliver to the Servicer and to the Purchaser, an instrument accepting such
appointment, whereupon such successor shall become fully vested with all the
rights, powers, duties, responsibilities, obligations and liabilities of the
Servicer, with like effect as if originally named as a party to this Agreement.
Any termination of this Agreement pursuant to Section 2.17, 6.04, 8.03 or 11.01
shall not affect any claims that the Purchaser may have against the Servicer
arising prior to any such termination or resignation.
The Servicer shall timely deliver to the successor the funds in the Custodial
Account and the Escrow Account and the Mortgage Files and related documents and
statements held by it hereunder and the Servicer shall account for all funds.
The Servicer shall execute and deliver such instruments and do such other things
all as may reasonably be required to more fully and definitely vest and confirm
in the successor all such rights, powers, duties, responsibilities, obligations
and liabilities of the Servicer. The successor shall make arrangements as it may
deem appropriate to reimburse the Servicer for amounts the Servicer actually
expended pursuant to this Agreement which the successor is entitled to retain
hereunder and which would otherwise have been recovered by the Servicer pursuant
to this Agreement but for the appointment of the successor servicer.
Upon a successor's acceptance of appointment as such, the Servicer shall notify
by mail the Purchaser of such appointment.
ARTICLE IX
REPRESENTATIONS, WARRANTIES AND COVENANTS OF PURCHASER
As of the Closing Date, the Purchaser warrants and represents to, and covenants
and agrees with, the Servicer as follows:
SECTION 9.01. DUE ORGANIZATION AND AUTHORITY. The Purchaser is a corporation
duly organized, validly existing and in good standing under the laws of the
state of Delaware. The Purchaser has the full corporate power and authority to
execute and deliver this Agreement and to perform in accordance herewith; the
execution, delivery and performance of this Agreement by the Purchaser and the
consummation of the transactions contemplated hereby have been duly and validly
authorized; this Agreement evidences the valid, binding and enforceable
obligation of the Purchaser; and all requisite corporate action has been taken
by the Purchaser to make this Agreement valid and binding upon the Purchaser in
accordance with its terms;
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SECTION 9.02. NO CONFLICTS. Neither the execution and delivery of this
Agreement, nor the fulfillment of or compliance with the terms and conditions of
this Agreement, will conflict with or result in a breach of any of the terms,
conditions or provisions of the Purchaser's charter or by-laws or any legal
restriction or any agreement or instrument to which the Purchaser is now a party
or by which it is bound, or constitute a default or result in an acceleration
under any of the foregoing, or result in the violation of any law, rule,
regulation, order, judgment or decree to which the Purchaser or its property is
subject;
SECTION 9.03. ABILITY TO PERFORM. The Purchaser does not believe, nor does it
have any reason or cause to believe, that it cannot perform each and every
covenant made by it in this Agreement.
SECTION 9.04. NO LITIGATION PENDING. There is no action, suit, proceeding or
investigation pending or threatened against the Purchaser, before any court,
administrative agency or other tribunal asserting the invalidity of this
Agreement, seeking to prevent the consummation of any of the transactions
contemplated by this Agreement or which, either in any one instance or in the
aggregate, may result in any material adverse change in the business,
operations, financial condition, properties or assets of the Purchaser, or in
any material impairment of the right or ability of the Purchaser to carry on its
business substantially as now conducted, or in any material liability on the
part of the Purchaser, or which would draw into question the validity of this
Agreement or of any action taken or to be taken in connection with the
obligations of the Purchaser contemplated herein.
SECTION 9.05. NO CONSENT REQUIRED. No consent, approval, authorization or order
of any court or governmental agency or body is required for the execution,
delivery and performance by the Purchaser of, or compliance by the Purchaser
with, this Agreement as evidenced by the consummation of the transactions
contemplated by this Agreement, or if required, such approval has been obtained
prior to the Closing Date.
SECTION 9.06. ASSISTANCE. To the extent reasonably possible, the Purchaser
shall cooperate with and assist the Servicer as requested by the Servicer, in
carrying out Servicer's covenants, agreements, duties and responsibilities under
the Purchase Agreement and in connection therewith shall execute and deliver all
such papers, documents and instruments as nay be necessary and appropriate in
furtherance thereof.
ARTICLE X
REPRESENTATIONS AND WARRANTIES OF SERVICER
As of the Closing Date, the Servicer warrants and represents to, and covenants
and agrees with, the Purchaser as follows:
SECTION 10.01. DUE ORGANIZATION AND AUTHORITY. The Servicer is a corporation
duly organized, validly existing and in good standing under the laws of the
State of Delaware as now being conducted and is licensed, qualified and in good
standing in each state where a mortgaged property is located if the laws of such
state require licensing or qualification in order to conduct business of the
type conducted by the Servicer, and in any event the Servicer is in compliance
with the laws of any such state to the extent necessary to ensure the
enforceability of the related mortgage loan in accordance with the terms of this
agreement; the Servicer has the full corporate power and authority to execute
and deliver this agreement and to perform in accordance herewith; the execution,
delivery and performance of this Agreement (including all instruments of
transfer to be delivered pursuant to this Agreement) by the Servicer and the
consummation of the transactions contemplated hereby have been duly and validly
authorized; this Agreement evidences the valid, legal, binding and enforceable
obligation of the Servicer subject to bankruptcy laws and other similar laws of
general application affecting rights of creditors and subject to the application
of the rules of equity, including those respecting the availability of specific
performance, none of which will materially interfere with the realization of the
benefits provided thereunder, regardless of whether such enforcement is sought
in a proceeding in equity or at law; and all requisite corporate action has been
taken by the Servicer to make this Agreement valid and binding upon the Servicer
in accordance with its terms.
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SECTION 10.02. ORDINARY COURSE OF BUSINESS. The consummation of the
transactions contemplated by this Agreement are in the ordinary course of
business of the Servicer.
SECTION 10.03. NO CONFLICTS. Neither the execution and delivery of this
Agreement, nor the fulfillment of or compliance with the terms and conditions of
this Agreement, will conflict with or result in a breach of any of the terms,
conditions or provisions of the Servicer's charter or by-laws or any legal
restriction or any agreement or instrument to which the Servicer is now a party
or by which it is bound, or constitute a default or result in an acceleration
under any of the foregoing, or result in the violation of any law, rule,
regulation, order, judgment or decree to which the Servicer or its property is
subject, or impair the ability of the Purchaser to realize on the Mortgage
Loans, impair the value of the Mortgage Loans, or impair the ability of the
Purchaser to realize the full amount of any mortgage insurance benefits accruing
pursuant to this Agreement.
SECTION 10.04. ABILITY TO SERVICE. The Servicer is an approved seller/servicer
of conventional residential mortgage loans for FLEA and FHLMC, with the
facilities, procedures, and experienced personnel necessary for the sound
servicing of mortgage loans of the same type as the Mortgage Loans. The Servicer
is duly qualified, licensed, registered and otherwise authorized under all
applicable federal, state and local laws, and regulations, if applicable, meets
the minimum capital requirements set forth by the OTS, the OCC or the FDIC, and
is in good standing to enforce, originate, sell mortgage loans to, and service
mortgage loans in the jurisdiction wherein the Mortgaged Properties are located
for, either FNMA or FHLMC, and no event has occurred, including but not limited
to a change in insurance coverage, which would make the Servicer unable to
comply with either FNMA or FHLMC eligibility requirements or which would require
notification to FNMA or FHLMC.
SECTION 10.05. ABILITY TO PERFORM. The Servicer does not believe, nor does it
have any reason or cause to believe, that it cannot perform each and every
covenant contained in this Agreement.
SECTION 10.06. NO LITIGATION PENDING. There is no action, suit, proceeding or
investigation pending or threatened against the Servicer, before any court,
administrative agency or other tribunal asserting the invalidity of this
Agreement, seeking to prevent the consummation of any of the transactions
contemplated by this Agreement or which, either in any one instance or in the
aggregate, may result in any material adverse change in the business,
operations, financial condition, properties or assets of the Servicer, or in any
material impairment of the right or ability of the Servicer to carry on its
business substantially as now conducted, or in any material liability on the
part of the Servicer, or which would draw into question the validity of this
Agreement or the Mortgage Loans or of any action taken or to be taken in
connection with the obligations of the Servicer contemplated herein, or which
would be likely to impair materially the ability of the Servicer to perform
under the terms of this Agreement.
SECTION 10.07. NO CONSENT REQUIRED. No consent, approval, authorization or
order of any court or governmental agency or body is required for the execution,
delivery and performance by the Servicer of or compliance by the Servicer with
this Agreement or the servicing of the Mortgage Loans as evidenced by the
consummation of the transactions contemplated by this Agreement, or if required,
such approval has been obtained prior to the Closing Date.
SECTION 10.08. NO UNTRUE INFORMATION. Neither this Agreement nor any statement,
tape, diskette, form, report or other document furnished or to be furnished
pursuant to this Agreement or in connection with the transactions contemplated
hereby contains any untrue statement of fact or omits to state a fact necessary
to make the statements contained therein not misleading.
SECTION 10.09. REASONABLE SERVICING FEE. The Servicer acknowledges and agrees
that the Servicing Fee represents reasonable compensation for performing such
services and that the entire Servicing Fee shall be treated by the Servicer, for
accounting and tax purposes, as compensation for the servicing and
administration of the Mortgage Loans pursuant to this Agreement.
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SECTION 10.10. FINANCIAL STATEMENTS. The Servicer has delivered to the
Purchaser financial statements as to its last two complete fiscal years. All
such financial statements fairly present the pertinent results of operations and
changes in financial position for each of such periods and the financial
position at the end of each such period of the Servicer and its subsidiaries and
have been prepared in accordance with generally accepted accounting principles
consistently applied throughout the periods involved, except as set forth in the
notes thereto. There has been no change in the business, operations, financial
condition, properties or assets of the Servicer since the date of the Servicer's
financial statements that would have a material adverse effect on its ability to
perform its obligations under this Agreement.
SECTION 10.11. CONFLICT OF INTEREST. The Servicer agrees that it shall services
the Mortgage Loans hereunder solely with a view toward the interests of the
Purchaser, and without regard to the interests of the Seller or its other
affiliates.
ARTICLE XI
DEFAULT
SECTION 11.01. EVENTS OF DEFAULT. The following shall constitute an Event of
Default under this Agreement on the part of the Servicer:
a. any failure by the Servicer to remit to the Purchaser any payment required
to be made under the terms of this Agreement which continues unremedied for
a period of five (5) Business Days after the date upon which written notice
of such failure, requiring the same to be remedied, shall have been given to
the Servicer by the Purchaser; or
b. the failure by the Servicer duly to observe or perform in any material
respect any other of the covenants or agreements on the part of the Servicer
set forth in this Agreement which continues unremedied for a period of
thirty (30) days (except that such number of days shall be fifteen (15) in
the case of a failure to pay any premium for any insurance policy required
to be maintained under this Agreement) after the date on which written
notice of such failure, requiring the same to be remedied, shall have been
given to the Servicer by the Purchaser; or
c. a decree or order of a court or agency or supervisory authority having
jurisdiction for the appointment of a conservator or receiver or liquidator
in any insolvency, bankruptcy, readjustment of debt, marshaling of assets
and liabilities or similar proceedings, or for the winding-up or liquidation
of its affairs, shall have been entered against the Servicer and such decree
or order shall have remained in force undischarged or unstayed for a period
of sixty (60) days; or
d. the Servicer shall consent to the appointment of a conservator or receiver
or liquidator in any insolvency, bankruptcy, readjustment of debt marshaling
of assets and liabilities or similar proceedings of or relating to the
Servicer or of or relating to all or substantially all of its property; or
e. the Servicer shall admit in writing its inability to pay its debts generally
as they become due, file a petition to take advantage of any applicable
insolvency or reorganization statute, make an assignment for the benefit of
its creditors, or voluntarily suspend payment of its obligations; or
f. the Servicer ceases to meet the qualifications of a FNMA or FHLMC
seller/servicer which continues unremedied for a period of thirty (30) days
after the date of such cessation; or
g. the Servicer, without the consent of the Purchaser, attempts to assign this
Agreement or the servicing responsibilities hereunder or to delegate any
substantial part of its duties hereunder or any portion thereof; or
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h. the Servicer fails to maintain its license to do business or service
residential mortgage loans in any jurisdiction where the Mortgaged
Properties are located and such failure results in a material adverse effect
on the Mortgage Loans, the servicing of the Mortgage Loans, or the
Purchaser's rights with respect to the Mortgage Loans.
In each and every such case, so long as an Event of Default shall not have been
remedied, in addition to whatsoever rights the Purchaser may have at law or
equity to damages, including injunctive relief and specific performance, the
Purchaser, by notice in writing to the Servicer, may terminate without
compensation or reimbursement (other than Servicing Fees previously earned but
remaining unpaid and Servicing Advances remaining unreimbursed) all the rights
and obligations of the Servicer under this Agreement and in and to the Mortgage
Loans and the proceeds thereof.
Upon receipt by the Servicer of such written notice, all authority and power of
the Servicer under this Agreement, whether with respect to the Mortgage Loans or
otherwise, shall pass to and be vested in the successor appointed pursuant to
Section 8.06. Upon written request from the Purchaser, the Servicer shall
prepare, execute and deliver any and all documents and other instruments
reasonably requested by the Purchaser, place in such successor's possession all
Mortgage Files (to the extent not properly delivered to the Purchaser by the
Servicer previously), and do or accomplish all other acts or things necessary or
appropriate to effect the purposes of such notice of termination, whether to
complete the transfer and endorsement or assignment of the Mortgage Loans and
related documents, or otherwise, at the Servicer's sole expense. The Servicer
agrees to reasonably cooperate with the Purchaser and such successor in
effecting the termination of the Servicer's responsibilities and rights
hereunder, including, without limitation, the transfer to such successor for
administration by it of all cash amounts which shall at the time be credited by
the Servicer to the custodial Account or Escrow Account or thereafter received
with respect to the Mortgage Loans.
SECTION 11.02. WAIVER OF DEFAULTS. The Purchaser may waive any default by the
Servicer in the performance of its obligations hereunder and its consequences.
Upon any such waiver of a past default, such default shall cease to exist, and
any Event of Default arising therefrom shall be deemed to have been remedied for
every purpose of this Agreement. No such waiver shall extend to any subsequent
or other default or impair any right consequent thereon except to the extent
expressly so waived.
ARTICLE XII
MISCELLANEOUS PROVISIONS
SECTION 12.01. NOTICES. All notices, requests, demands and other communications
which are required or permitted to be given under this Agreement shall be in
writing and shall be deemed to have been duly given upon the delivery or mailing
thereof, as the case may be, sent by registered or certified mail, return
receipt requested:
a. If to Purchaser to:
Chevy Chase Preferred Capital Corporation
270 Park Avenue
New York, N.Y. 10017
Attention: Neila B. Radin
b. If to Servicer to:
Chevy Chase Bank, F.S.B.
Attention:
SECTION 12.02. WAIVERS. Either the Servicer or the Purchaser may upon consent
of all parties, by written notice to the others:
a. Waive compliance with any of the terms, conditions or covenants required to
be complied with by the others hereunder; and
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b. Waive or modify performance of any of the obligations of the others
hereunder.
The waiver by any party hereto of a breach of any provision of this Agreement
shall not operate or be construed as a waiver of any other subsequent breach.
SECTION 12.03. ENTIRE AGREEMENT; AMENDMENT. This Agreement and the Purchase
Agreement constitute the entire agreement between the parties with respect to
servicing of the Mortgage Loans. This Agreement may be amended and any provision
hereof waived, but, only in writing signed by the party against whom such
enforcement is sought.
SECTION 12.04. EXECUTION; BINDING EFFECT. This Agreement may be executed in one
or more counterparts and by the different parties hereto on separate
counterparts, each of which, when so executed, shall be deemed to be an
original; such counterparts, together, shall constitute one and the same
agreement. Subject to Sections 8.03 and 8.04, this Agreement shall inure to the
benefit of and be binding upon the Servicer and the Purchaser and their
respective successors and assigns.
SECTION 12.05. HEADINGS. Headings of the Articles and Sections in this
Agreement are for reference purposes only and shall not be deemed to have any
substantive effect.
SECTION 12.06. APPLICABLE LAW. This Agreement shall be construed in accordance
with the laws of the State of New York and the obligations, rights and remedies
hereunder shall be determined in accordance with the substantive laws of the
State of New York (without regard to conflicts of laws principles), except to
the extent preempted by Federal law.
SECTION 12.07. RELATIONSHIP OF PARTIES. Nothing herein contained shall be
deemed or construed to create a partnership or joint venture between the
parties. The duties and responsibilities of the Servicer shall be rendered by it
as an independent contractor and not as an agent of the Purchaser. The Servicer
shall have full control of all of its acts, doings, proceedings, relating to or
requisite in connection with the discharge of its duties and responsibilities
under this Agreement.
SECTION 12.08. SEVERABILITY OF PROVISIONS. If any one or more of the covenants,
agreements, provisions or terms of this Agreement shall be held invalid for any
reason whatsoever, then such covenants, agreements, provisions or terms shall be
deemed severable from the remaining covenants, agreements, provisions or terms
of this Agreement and shall in no way affect the validity or enforceability of
the other provisions of this Agreement.
SECTION 12.09. RECORDATION OF ASSIGNMENTS OF MORTGAGE. To the extent permitted
by applicable law, each of the Assignments of Mortgage is subject to recordation
in all appropriate public offices for real property records in all the counties
or other comparable jurisdictions in which any or all of the Mortgaged
Properties are situated, and in any other appropriate public recording office or
elsewhere, such recordation to be effected by the Purchaser or the Purchasers
designee, but in any event, at the Servicer's expense for a single recordation
relating to each Assignment of Mortgage in the event recordation is either
necessary under applicable law or requested by the Purchaser at its sole option.
SECTION 12.10. EXHIBITS. The exhibits to this Agreement are hereby incorporated
and made a part hereof and are integral parts of this Agreement.
IN WITNESS WHEREOF, the parties have executed this Agreement under seal as of
the date and year first above written.
CHEVY CHASE PREFERRED CAPITAL CORPORATION (the Purchaser)
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By:
Name:
Title:
CHEVY CHASE BANK, F.S.B.
(the Servicer)
By:
Name:
Title:
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EXHIBIT 1
MONTHLY REMITTANCE ADVICE
<PAGE>
EXHIBIT 2
CUSTODIAL ACCOUNT CERTIFICATION
____________, 1996
______ ________ hereby certifies that it has established the account
described below as a Custodial Account pursuant to Section 2.04 of the Servicing
Agreement, dated as of ***, 1996.
Title of Account: "Chevy Chase Bank, F.S.B., in trust for Purchaser of
Residential Mortgage Loans, and various Mortgagors."
Account Number:
Address of office or branch of the Servicer at which Account is maintained:
CHEVY CHASE BANK, F.S.B.
By: Name: Title:
<PAGE>
EXHIBIT 3
CUSTODIAL ACCOUNT LETTER AGREEMENT
_______________1996
To:
(the "Depository")
As Servicer under the Servicing Agreement, dated as of ****, 1996, Adjustable
and Fixed Rate Mortgage Loans (the "Agreement"), we hereby authorize and request
you to establish an account, as a Custodial Account pursuant to Section 2.04 of
the Agreement, to be designated as Chevy Chase Bank, F.S.B., in trust for
Purchaser of Residential Mortgage Loans, and various Mortgagors." All deposits
in the account shall be subject to withdrawal therefrom by order signed by the
Servicer. You may refuse any deposit which would result in violation of the
requirement that the account be fully insured as described below. This letter is
submitted to you in duplicate. Please execute and return one original to us.
CHEVY CHASE BANK, F.S.B.
By: Name: Title:
The undersigned, as Depository, hereby certifies that the above described
account has been established under Account Number ****, at the office of the
Depository indicated above, and agrees to honor withdrawals on such account as
provided above. The full amount deposited at any time in the account will be
insured by the Federal Deposit Insurance Corporation through the Bank Insurance
Fund ("BIF") or the Savings Association Insurance Fund ("SAIF").
Depository
By: Name: Title: Date:
<PAGE>
EXHIBIT 4
ESCROW ACCOUNT CERTIFICATION
_____, 1996
______ hereby certifies that it has established the account described below as
an Escrow Account pursuant to Section 2.06 of the Servicing Agreement, dated as
of ****, 1996, Conventional Residential Mortgage Loans.
Title of Account: "Chevy Chase Bank, F.S.B., in trust for Purchaser of
Residential and various Mortgagors.'
Account Number:
Address of office or branch of the Servicer at which Account is maintained:
CHEVY CHASE BANK, F.S.B.
By: Name: Title:
<PAGE>
EXHIBIT 5
ESCROW ACCOUNT LETTER AGREEMENT
________________, 1996
To:
(the "Depository")
As Servicer under the Servicing Agreement, dated as of ****, 1996, Conventional
Residential Mortgage Loans (the "Agreement'), we hereby authorize and request
you to establish an account, as an Escrow Account pursuant to Section 2.06 of
the Agreement, to be designated as "Chevy Chase Bank, F.S.B., in trust for the
Purchasers of Residential Mortgage Loans, and various Mortgagors." All deposits
in the account shall be subject to withdrawal therefrom by order signed by the
Servicer. You may refuse any deposit which would result in violation of the
requirement that the account be fully insured as described below. This letter is
submitted to you in duplicate. Please execute and return one original to us.
CHEVY CHASE BANK, F.S.B.
By: Name:
Title: -
Date:
The undersigned, as Depository, hereby certifies that the above described
account has been established under Account Number ****, at the office of the
Depository indicated above, and agrees to honor withdrawals on such account as
provided above. The full amount deposited at any time in the account will be
insured by the Federal Deposit Insurance Corporation through the Bank Insurance
Fund ("BIF") or the Savings Association Insurance Fund ("SAIF").
Depository
By: Name: Title: Date:
<PAGE>
EXHIBIT 10(C)
ADVISORY AGREEMENT
THIS ADVISORY AGREEMENT ("Agreement") is made this ____ day of
_____________, 1996 by and between CHEVY CHASE PREFERRED CAPITAL CORPORATION, a
Maryland corporation (the "Company"), and CHEVY CHASE BANK, F.S.B., a federally
chartered and federally insured stock savings bank (the "Advisor"). Capitalized
terms used herein shall have the meanings set forth in Section 1 of this
Agreement.
WHEREAS, the Company intends to qualify as a "real estate investment
trust" ("REIT") under the Internal Revenue Code of 1986, as amended (the
"Code"); and
WHEREAS, the Company desires to avail itself of the experience and
assistance of the Advisor and to have the Advisor undertake, on the Company's
behalf, the duties and responsibilities hereinafter set forth, subject to the
control and supervision of the Board of Directors of the Company (the "Board of
Directors") as provided for herein; and
WHEREAS, the Advisor desires to render such services to the Company
subject to the control and supervision of the Board of Directors, on the terms
and conditions hereinafter set forth.
NOW THEREFORE, the parties hereto agree as follows:
SECTION 1. DEFINITIONS.
As used herein, the following terms shall have the respective meanings
set forth below:
"Advisor" has the meaning set forth in the forepart of this Agreement.
"Advisor Termination Date" means the date on which this Agreement
terminates.
"Agreement" means this Advisory Agreement, as amended, modified and
supplemented from time to time.
"Board of Directors" has the meaning set forth in the forepart of this
Agreement.
"Code" has the meaning set forth in the forepart of this Agreement.
"Company" has the meaning set forth in the forepart of this Agreement.
"Independent Directors" means the members of the Board of Directors
who are not current officers or employees of the Company or current directors,
employees or officers of the Advisor or any affiliate of the Advisor.
<PAGE>
"Operating Expenses" for any period means all of the operating
expenses of the Company (with the exception of those expenses to be borne by the
Advisor in accordance with Section 4 hereof), including without limitation the
following:
a) interest, taxes and other expenses incurred in connection with the
real estate mortgage assets of the Company;
b) expenses related to the officers, directors and employees of the
Company, including without limitation any fees or expenses of the directors;
c) fees and expenses payable to accountants, appraisers, auditors,
consultants, attorneys, collection and paying agents and all other Persons who
contract with or are retained by the Company or by the Advisor on behalf of the
Company;
d) legal and other expenses incurred in connection with advice
concerning, obtaining or maintaining the Company's status as a REIT, the
determination of the Company's taxable income, any formal or informal
administrative action or legal proceedings which involve a challenge to the REIT
status of the Company or any claim that the activities of the Company, any
member of the Board of Directors or any officer were improper;
e) expenses relating to communications and reports to stockholders of
the Company, including without limitation the costs of preparing, printing,
duplicating and mailing the certificates for the stock of the Company, proxy
solicitation materials and reports to stockholders, and the costs of arranging
meetings of stockholders;
f) the costs of insurance described in Section 2 hereof, including
directors and officers liability insurance covering the directors and officers
of the Company;
g) expenses relating to the acquisition, disposition and ownership of
real estate mortgage assets, including, without limitation and to the extent not
paid by others, legal fees and other expenses for professional services and
fees;
h) expenses connected with the payments of dividends or interest or
distributions in cash or any other form made or caused to be made by the Board
of Directors to the stockholders of the Company;
i) expenses connected with any office or office facilities maintained
by the Company separate from the office of the Advisor, including without
limitation rent, telephone, utilities, office furniture and equipment and
machinery; an d
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j) other miscellaneous expenses of the Company which are not expenses
of the Advisor under Section 4 hereof.
"Person" means and includes individuals, corporations, limited
partnerships, general partnerships, joint stock companies or associations,
limited liability companies, joint ventures, associations, consortia, companies,
trusts, banks, trust companies, land trusts, common law trusts, business trusts
or other entities, governments and agencies and political subdivisions thereof.
"REIT" has the meaning set forth in the forepart of this Agreement.
SECTION 2. DUTIES OF THE ADVISOR.
The Advisor shall consult with the Board of Directors and the officers
of the Company and shall, at the request of the Board of Directors and/or the
officers of the Company, furnish advice and recommendations with respect to all
aspects of the business and affairs of the Company. Subject to the control and
discretion and at the request of the Board of Directors, the Advisor shall:
a) administer the day-to-day operations and affairs of the Company,
including without limitation the performance or supervision of the functions
described in this Section 2;
b) monitor the credit quality of the real estate mortgage assets held
by the Company;
c) advise the Company with respect to the acquisition, management,
financing and disposition of the Company's real estate mortgage assets;
d) represent the Company in its day-to-day dealings with Persons with
whom the Company interacts, including without limitation stockholders of the
Company, the transfer agent of the Company, consultants, accountants, attorneys,
servicers of the Company's mortgage loans, custodians, insurers and banks;
e) establish and provide necessary services for the Company, including
executive, administrative, accounting, stockholder relations, secretarial,
recordkeeping, copying, telephone, mailing and distribution facilities;
f) provide the Company with office space, conference room facilities,
office equipment and personnel necessary for the services to be performed by the
Advisor hereunder;
g) arrange, schedule and coordinate the regular and special meetings
of the Board of Directors required for the conduct of the affairs of the Company
or for timely action on any matters the Company is required to act upon and
implement all decisions of the Board of Directors, unless otherwise instructed,
with regard to the Company and its assets;
h) maintain communications and relations with the stockholders of the
Company, including, but not limited to, responding to inquiries, proxy
solicitations, providing reports to stockholders and arranging and coordinating
all meetings of stockholders;
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i) arrange for the investment and management of any short-term
investments of the Company;
j) arrange for the services of third parties to collect and distribute
funds of the Company and to perform such functions as the Board of Directors
shall from time to time require;
k) monitor and supervise the performance of all parties who have
contracts to perform services for the Company, provided that the Advisor shall
have no duty to assume the obligations or guarantee the performance of such
parties under such contracts;
l) establish and maintain such bank accounts in the name of the
Company as may be required by the Company and approved by the Board of Directors
and ensure that all funds collected by the Advisor in the name or on behalf of
the Company shall be held in trust and shall not be commingled with the
Advisor's own funds or accounts;
m) make payment on behalf of the Company of all Operating Expenses;
n) arrange for the execution and delivery of such documents and
instruments by the officers of the Company as may be required in order to
perform the functions herein described and to take any other required action
contemplated by the terms of this Agreement;
o) arrange for insurance for the Company, including liability
insurance, errors and omissions policies and officers and directors policies,
which shall cover and insure the Company, members of the Board of Directors and
the officers of the Company in amounts and with deductibles and insurers
approved by the Board of Directors;
p) maintain proper books and records of the Company's affairs and
furnish or cause to be furnished to the Board of Directors such periodic reports
and accounting information as may be required from time to time by the Board of
Directors, including, but not limited to, quarterly reports of all income,
expenses and distributions of the Company;
q) consult and work with legal counsel for the Company in implementing
Company decisions and undertaking measures consistent with all pertinent
Federal, state and local laws and rules or regulations of governmental or quasi-
governmental agencies, including, but not limited to, Federal and state
securities laws, the Code, as it relates to the Company's qualification as a
REIT, and the regulations promulgated under each of the foregoing;
r) consult and work with accountants for the Company in connection
with the preparation of financial statements, annual reports and tax returns;
s) arrange for an annual audit of the books and records of the Company
by the accounting firm designated for such purposes by the Board of Directors;
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t) prepare and distribute in consultation with the accountants for the
Company, annual reports to stockholders which will contain audited financial
statements;
u) furnish reports to the Board of Directors and provide research,
economical and statistical data in connection with the Company's investments;
and
v) as reasonably requested by the Company, make reports to the Company
of its performance of the foregoing services and furnish advice and
recommendations with respect to other aspects of the business of the Company.
SECTION 3. COMPENSATION OF THE ADVISOR.
The Company shall pay to the Advisor, for services rendered by the
Advisor hereunder, an advisory fee equal to Two Hundred Thousand Dollars
($200,000.00) per year, payable in equal quarterly installments.
SECTION 4. EXPENSES OF THE ADVISOR.
a) Without regard to the compensation received pursuant to Section 3
hereof, the Advisor shall bear the following expenses:
(i) employment expenses of the personnel employed by the Advisor,
including without limitation salaries, wages, payroll taxes and the cost of
employee benefit plans; and
(ii) rent, telephone equipment, utilities, office furniture and
equipment and machinery and other office expenses of the Advisor incurred in
connection with the maintenance of any office facility of the Advisor.
b) The Company shall reimburse the Advisor within 30 days of a written
request by the Advisor for any Operating Expenses paid or incurred by the
Advisor on behalf of the Company.
SECTION 5. RECORDS.
The Advisor shall maintain appropriate books of account and records
relating to services performed hereunder, and such books of account and records
shall be accessible for inspection by the Board of Directors and representatives
of the Company at all times.
SECTION 6. REIT QUALIFICATION AND COMPLIANCE.
The Advisor shall consult and work with the Company's legal counsel in
maintaining the Company's qualification as a REIT. Notwithstanding any other
provisions of this Agreement to the contrary, the Advisor shall refrain from any
action which, in its reasonable judgment or in the judgment of the Board of
Directors (of which the Advisor has received written notice), would
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adversely affect the qualification of the Company as a REIT or which would
violate any law, rule or regulation of any governmental body or agency having
jurisdiction over the Company or its securities, or which would otherwise not be
permitted by the articles of incorporation or by-laws of the Company.
Furthermore, the Advisor shall take any action which, in its judgment or the
judgment of the Board of Directors (of which the Advisor has received written
notice), may be necessary to maintain the qualification of the Company as a REIT
or prevent the violation of any law or regulation of any governmental body or
agency having jurisdiction over the Company or its securities.
SECTION 7. TERM; TERMINATION.
This Agreement shall be in full force and effect for a term beginning
on the date hereof with an initial term of three years, and will be renewed
automatically for additional one-year periods unless the Company delivers a
notice of nonrenewal to the Advisor not less than 60 days prior to the
expiration of the initial term of this Agreement or 60 days prior to the
expiration of any renewal term. Notwithstanding the foregoing, at any time
after the initial term, the Company may terminate this Agreement at any time
upon 60 days' prior written notice; provided, however, that as long as any
shares of the Company's ___% Noncumulative Exchangeable Preferred Stock, Series
A, par value $5.00 per share, remain outstanding, any decision by the Company
either not to renew this Agreement or to terminate this Agreement must be
approved by a majority of the Board of Directors, as well as by a majority of
the Independent Directors.
SECTION 8. OTHER ACTIVITIES OF THE ADVISOR.
a) Nothing herein contained shall prevent the Advisor, an affiliate of
the Advisor or an officer, director, employee or stockholder of the Advisor from
engaging in any activity, including without limitation originating, purchasing
and managing real estate mortgage assets, rendering of services and investment
advice with respect to real estate investment opportunities to any other Person
(including other REITs) and managing other investments (including the
investments of the Advisor and its affiliates).
b) Officers, directors, employees, stockholders and agents of the
Advisor or of any affiliate of the Advisor may serve as officers, directors,
employee or agents of the Company, but shall receive no compensation (other than
reimbursement for expenses) from the Company for such service.
SECTION 9. BINDING EFFECT; ASSIGNMENT.
This Agreement shall inure to the benefit of and shall be binding upon
the parties hereto and their respective successors and assigns. Neither party
may assign this Agreement or any of its respective rights hereunder (other than
an assignment to a successor organization which acquires substantially all of
the property of such party or, in the case of the Advisor, to an affiliate of
the Advisor) without the prior written consent of the other party to this
Agreement.
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SECTION 10. SUBCONTRACTING.
The Advisor may at any time subcontract all or a portion of its
obligations under this Agreement to one or more affiliates of the Advisor that
are involved in the business of managing real estate mortgage assets without the
consent of the Company. If no affiliate of the Advisor is engaged in the
business of managing real estate mortgage assets, the Advisor may, with the
approval of a majority of the Board of Directors, as well as a majority of the
Independent Directors, subcontract all or a portion of its obligations under
this Agreement to unrelated third parties. Notwithstanding the foregoing, the
Advisor will not, in connection with subcontracting any of its obligations under
this Agreement, be discharged or relieved in any respect from its obligations
under this Agreement.
SECTION 11. LIABILITY AND INDEMNITY OF THE ADVISOR.
The Advisor assumes no responsibilities under this Agreement other
than to perform the services called for hereunder in good faith. Neither the
Advisor nor any of its affiliates, stockholders, directors, officers or
employees will have any liability to the Company, stockholders of the Company or
others except by reason of acts or omissions constituting gross negligence or
willful breach of any of the Advisor's material obligations under this
Agreement. The Company shall indemnify and reimburse (if necessary) the
Advisor, its stockholders, directors, officers, employees and agents for any and
all expenses (including without limitation attorneys' fees and expenses),
losses, damages, liabilities, demands and charges of any nature whatsoever in
respect of or arising from any acts or omissions by the Advisor pursuant to this
Agreement, provided that the conduct against which the claim is made was
determined by such Person, in good faith, to be in the best interests of the
Company and was not the result of gross negligence by such Person or willful
breach of any of such Person's material obligations by such Person. The Advisor
agrees that any such indemnification is recoverable only from the assets of the
Company and not from the stockholders.
SECTION 12. ACTION UPON NOTICE OF NON-RENEWAL OR TERMINATION.
Forthwith upon giving of notice of non-renewal of this Agreement by
the Company or of termination of this Agreement by the Company, the Advisor
shall not be entitled to compensation after the Advisor Termination Date for
further services under this Agreement, but shall be paid all compensation
accruing to the Advisor Termination Date and shall be reimbursed for all
expenses of the Company paid or incurred by the Advisor as of the Advisor
Termination Date which are reimbursable by the Company under this Agreement.
The Advisor shall promptly after the Advisor Termination Date:
(i) deliver to the Company all assets and documents of the Company
then in the custody of the Advisor; and
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(ii) cooperate with the Company and take all reasonable steps
requested to assist the Board of Directors in making an orderly transfer of the
administrative functions of the Company.
SECTION 13. NO JOINT VENTURE OR PARTNERSHIP.
Nothing in this Agreement shall be deemed to create a joint venture or
partnership between the parties, whether for purposes of taxation or otherwise.
SECTION 14. NOTICES.
Unless expressly provided otherwise herein, all notices, requests,
demands and other communications required or permitted under this Agreement
shall be in writing and shall be made by hand delivery, certified mail,
overnight courier service, telex or telecopier. Any notice shall be duly
addressed to the parties as follows:
If to the Company:
Chevy Chase Preferred Capital Corporation
8401 Connecticut Avenue
Chevy Chase, Maryland 20815
Telephone: (301) 986-7000
Telecopy: (301) 986-7401
Attention: Stephen R. Halpin, Jr.
If to the Advisor:
Chevy Chase Bank, F.S.B.
8401 Connecticut Avenue
Chevy Chase, Maryland 20815
Telephone: (301) 986-7000
Telecopy: (301) 986-7401
Attention: Stephen R. Halpin, Jr.
Either party may alter the address to which communications or copies
are to be sent by giving notice of such change of address in conformity with the
provisions of this Section 14 for the giving of notice.
SECTION 15. SEVERABILITY.
If any term or provision of this Agreement or the application thereof
with respect to any Person or circumstance shall, to any extent, be invalid or
unenforceable, the remainder of this
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Agreement, or the application of that term or provision to persons or
circumstances other than those as to which it is held invalid or unenforceable,
shall not be affected thereby, and each term and provision of this Agreement
shall be valid and be enforced to the fullest extent permitted by law.
SECTION 16. GOVERNING LAW.
This Agreement and all questions relating to its validity,
interpretation, performance and enforcement shall be governed by and construed,
interpreted and enforced in accordance with the laws of the State of Maryland,
notwithstanding any Maryland choice of law rules that would apply the
substantive law of any other jurisdiction.
SECTION 17. AMENDMENTS.
This Agreement shall not be amended, changed, modified, terminated or
discharged in whole or in part except by an instrument in writing signed by both
parties hereto or their respective successors or assigns, or otherwise as
provided herein.
SECTION 18. HEADINGS.
The section headings herein have been inserted for convenience of
reference only and shall not be construed to affect the meaning, construction or
effect of this Agreement.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to
be executed by their officers thereunto duly authorized as of the date first
above written.
CHEVY CHASE PREFERRED CAPITAL
CORPORATION
By: _______________________________
Name: _________________________
Title: ________________________
CHEVY CHASE BANK, F.S.B.
By: _______________________________
Name: _________________________
Title: ________________________
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Exhibit 23(c)
ARTHUR ANDERSEN LLP
Consent of Independent Public Accountants
As independent public accountants, we hereby consent to the use of our report
dated November 5, 1996, and to all references to our Firm included in this
Prospectus.
Arthur Andersen LLP
Washington, D.C.
November 13, 1996
<PAGE>
EXHIBIT 99(a)
CHEVY CHASE PREFERRED CAPITAL CORPORATION
CONSENT OF DIRECTOR NOMINEE
The undersigned, John J. O'Connor III, does hereby consent to being named
in the Registration Statement on Form S-11 (File No. 333-10495) filed with the
Securities and Exchange Commission by Chevy Chase Preferred Capital Corporation
as a nominee for election to the Board of Directors of Chevy Chase Preferred
Capital Corporation and to serve if elected.
/s/ John J. O'Connor III
------------------------
John J. O'Connor III
Dated: November 14, 1996
<PAGE>
EXHIBIT 99(b)
CHEVY CHASE PREFERRED CAPITAL CORPORATION
CONSENT OF DIRECTOR NOMINEE
The undersigned, N. Alexander MacColl, Jr., does hereby consents to being
named in the Registration Statement on Form S-11 (File No. 333-10495) filed with
the Securities and Exchange Commission by Chevy Chase Preferred Capital
Corporation as a nominee for election to the Board of Directors of Chevy Chase
Preferred Capital Corporation and to serve if elected.
/s/ N. Alexander MacColl, Jr.
-------------------------------
N. Alexander MacColl, Jr.
Dated: November 14, 1996
