<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 25, 1996
REGISTRATION NO. 333-10495
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
AMENDMENT NO. 4
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 SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP
2300 N STREET, N.W. 919 THIRD AVENUE
WASHINGTON, D.C. 20037 NEW YORK, NEW YORK 10022
TEL: (202) 663-8175 TEL: (212) 735-3000
FAX: (202) 663-8007 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 10 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:
. Significant decline in interest rates could have an adverse effect on the
Company's cash flow;
. Series A Preferred Shares may be exchanged for Bank Preferred Shares when
the Bank is experiencing financial difficulties; the Bank Preferred Shares
will not be listed on the NYSE and therefore will be an illiquid
investment;
. Federal regulators of the Bank could 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;
. The Company may not qualify as a REIT for federal income tax purposes and
would therefore be subject to regular corporate income tax; and
. The Company may make distributions to the Bank in certain circumstances,
which will reduce the assets of the Company available to make payments to
the holders of Preferred Stock;
. 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 and even if the Bank is not
"undercapitalized," 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. In addition, the Bank's
Debentures (as defined herein) would rank senior to the Bank Preferred Shares.
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
PrA." 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 real estate investment trust ("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
Benefits to the Bank...................................................... 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
Geographic Concentration.................................................. 11
No Credit Enhancement or Special Hazard Insurance......................... 11
Real Estate Market Conditions............................................. 12
Delays in Liquidating Defaulted Mortgage Loans............................ 12
Legal Considerations...................................................... 12
Special Risks Relating to Commercial Mortgage Loans....................... 12
Environmental Considerations.............................................. 13
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
</TABLE>
<TABLE>
<S> <C>
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
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
</TABLE>
i
<PAGE>
<TABLE>
<S> <C>
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
</TABLE>
<TABLE>
<S> <C>
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>
ii
<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.
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
established pursuant to the Federal Deposit Insurance Corporation Improvement
Act of 1991, as amended ("FDICIA"), (ii) the Bank is placed into
conservatorship or receivership or (iii) the appropriate federal regulatory
agency, in its sole discretion and even if the Bank is not "undercapitalized,"
anticipates the Bank becoming "undercapitalized" in the near term (the
"Exchange Event"). (The term "Directive" is simply a defined term for purposes
of this Prospectus and is not a regulatory definition. A letter from the staff
of the OTS would constitute a Directive.) 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%. Tier 1 or core capital consists of
common shareholders' equity, noncumulative perpetual preferred stock, and
minority interests in consolidated subsidiaries, less certain intangible assets
and investments in certain subsidiaries. Total capital consists of core capital
plus supplementary capital (which includes cumulative perpetual preferred
stock, qualifying subordinated debt, and a limited amount of the allowances for
loan and lease losses) to the extent such supplementary capital does not exceed
100% of core capital, less certain
<PAGE>
equity investments. For purposes of the prompt corrective action regulations,
the Bank's capital category is determined as of the most recent date (i)
certain quarterly financial reports are required to be filed with the
regulators; (ii) a final report of examination has been delivered to the Bank;
or (iii) the Bank is notified in writing by the OTS of its capital category or
a change in such category. 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 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 by managing its growth following the Offering to maintain its
core capital ratio at or above 6% (compared to the 5% standard for "well-
capitalized" institutions under the prompt corrective action regulations), 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 "Debentures"). 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 10. 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
2
<PAGE>
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 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."
. 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.
. 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.
. 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.
. The Company is a newly organized corporation with no operating history.
. 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.
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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 PrA."
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:
[LOGO OF BENEFITS TO THE BANK APPEARS HERE]
BENEFITS TO THE BANK
The Bank expects to realize the following benefits (which are described in
more detail under "Certain Transactions Constituting the Formation--Benefits to
the Bank") in connection with the Offering and other transactions constituting
the formation of the Company:
. 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.
. 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.
. 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 Debentures as supplementary capital of the Bank for purposes of
computing the Bank's total risk-based capital.
. 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).
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. 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 approximately .
. 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.
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. 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
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<PAGE>
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
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
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<PAGE>
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."
The par value of the Series A Preferred Shares is $5.00 per share. Net proceeds
received by the Company from the Offering in excess of the aggregate par value
of the Series A Preferred Shares is considered additional paid-in capital and
may be used by the Company for various corporate purposes, including the
payment of dividends. The par value of the Series A Preferred Shares is
unrelated to the liquidation preference or the redemption price of such shares.
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."
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
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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.
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 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
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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.
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."
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
12
<PAGE>
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.
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
13
<PAGE>
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 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.
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<PAGE>
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 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."
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 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>
NO OPERATING HISTORY
The Company is a newly organized corporation with no operating history and
no revenues to date.
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, 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."
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<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.
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<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. The Company's distributable funds will
consist primarily of interest payments on the Mortgage Assets held by it, and
the Company anticipates that most of such assets will bear interest at
adjustable rates. Accordingly, if there is a decline in interest rates, the
Company will experience a decrease in income available to be distributed to
its stockholders. In a period of declining interest rates, the Company also
may find it difficult to purchase additional Mortgage Assets bearing rates
greater than the then-current market interest rates. Consequently, a decline
in interest rates could have an adverse affect on the Company's ability to pay
dividends on the Series A Preferred Shares. 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, 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. As indicated below
under "Description of Initial Portfolio," as of October 31, 1996, the weighted
average interest rate of the Residential Mortgage Loans included in the
Initial Portfolio was approximately 7.79% per annum. The weighted average
interest rate of the Initial Portfolio would have to be less than
approximately 5.5% for the Company to have less than $15.0 million of net
interest income, after payment of servicing and advisory fees. Fifteen million
dollars would be sufficient to pay an annual dividend on the Series A
Preferred Shares at the rate of 10.0%. Such calculation assumes 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. At current interest rates
and based on the assumptions in the preceding sentence, 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 $[15.0] million, the Company anticipates,
based on the foregoing, that $[7.1] million would be available for payment of
dividends on the shares of Common Stock held by the Bank during such 12-month
period. 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. 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
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<PAGE>
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 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.
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<PAGE>
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.
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
22
<PAGE>
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.
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 mortgage loan purchase agreement with the Bank (the
"Mortgage Loan Purchase Agreement"). Each Residential Mortgage Loan in the
Initial Portfolio will be assigned to the Company pursuant to the Mortgage
Loan Purchase Agreement. Each Residential Mortgage Loan will be identified in
a schedule appearing as an exhibit to the Mortgage Loan Purchase Agreement
(the "Mortgage Loan Schedule"). The 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
23
<PAGE>
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 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
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<PAGE>
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 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.
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<PAGE>
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 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
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<PAGE>
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.
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
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<PAGE>
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.
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>
28
<PAGE>
"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). 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.
29
<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.
30
<PAGE>
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. Approximately 98% of the residential real estate
properties underlying the Company's Residential Mortgage Loans included in the
Initial Portfolio are 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
31
<PAGE>
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.
32
<PAGE>
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.
33
<PAGE>
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
34
<PAGE>
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
35
<PAGE>
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.
36
<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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. 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 raise 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>
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- --------
(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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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 Norwest Bank Minnesota, N.A. 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 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,
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<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 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.
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 established pursuant to FDICIA, (ii) the Bank is
placed into conservatorship or receivership or (iii) the appropriate federal
regulatory agency, in its sole discretion and even if the Bank is not
"undercapitalized," 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. 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 of the 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
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<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.
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
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<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
Articles of Incorporation exempt 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 (except, with respect to the tax year of any trust
that begins after December 31, 1996, a United States Stockholder shall mean a
trust whose administration is subject to the primary supervision of a United
States court and which has one or more United States fiduciaries who have
authority to control all substantial decisions of the trust).
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 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.
60
<PAGE>
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.
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<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.
63
<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
64
<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
65
<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 generally 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.
66
<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
67
<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.
68
<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."
69
<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.
70
<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
71
<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-- % Subordinated
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.
72
<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 PrA."
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.
The trading of the Series A Preferred Shares on the NYSE is expected to
commence within 30 days after the initial delivery of the Series A Preferred
Shares.
73
<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.
74
<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.
75
<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 established pursuant to FDICIA, (ii) the Bank is placed into
conservatorship or receivership or (iii) the appropriate federal regulatory
agency, in its sole discretion and even if the Bank is not "undercapitalized,"
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.
76
<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 Loan Purchase Agreement" means the residential mortgage loan
purchase agreement between the Company and the Bank.
"Mortgage Loans" means whole loans secured by single-family (one- to four-
unit) residential real estate properties or by commercial real estate
properties.
"Mortgage Loan Schedule" means the schedule appearing as an exhibit to the
Mortgage Loan Purchase Agreement which identifies the Residential Mortgage
Loans in the Initial Portfolio.
"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.
77
<PAGE>
"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.
"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.
"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.
78
<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.
79
<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, which will
approximate their estimated fair values. 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, 10 and 64 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. See-- " Offering
Circular Summary--Chevy Chase Bank, F.S.B.--REIT Preferred Offering". 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.
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<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."
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<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. 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. Specifically, the Bank has securitized financial assets,
including credit card, home equity credit line, home loan and automobile loan
receivables, because such securitizations provide the Bank with a source of
financing at competitive rates and assist the Bank in maintaining compliance
with regulatory capital requirements. Additionally, the securitizations have
permitted the Bank to limit the credit risk associated with these assets while
continuing to earn servicing fees and other income associated with the
securitized assets.
Since 1988, the Bank has securitized approximately $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."
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<PAGE>
The Bank's securitization transactions transfer the risk or repayment on
securitized assets to a trust which holds the receivables and issues the asset-
backed certificates and ultimately the risk or repayment is transferred to the
holders of those certificates. The Bank retains risk with respect to the assets
transferred to the trust only to the extent that it retains recourse based on
the performance of the assets or holds certificates issued by the trust (such
as a "seller certificate"). In its securitizations, the Bank typically retains
a limited amount of recourse through one or more means. Most often, limited
recourse is retained through the establishment of "spread accounts."
Occasionally other structures, such as overcollateralization, are used. Spread
accounts are funded by initial deposits, if required, and by amounts generated
by the securitized assets over and above the amount required to pay interest,
defaults and other charges and fees on the investors' interest in the
securitization transaction. Because amounts on deposit in the spread accounts
are at risk depending upon performance of the securitized receivables, those
amounts represent recourse to the Bank.
Pursuant to the OTS's "low level recourse rule" (which sets capital
requirements for assets sold with recourse at the lower of the applicable
capital requirement or the amount of recourse retained), the Bank maintains
dollar-for-dollar capital against the securitized assets in the amount of the
recourse retained up to the otherwise applicable capital requirement. Even if
defaults on outstanding receivables significantly exceed projected and
historical levels so that a "pay out event" is triggered, the immediate
consequence is that investors will begin receiving payments of principal from
the securitized assets earlier than originally scheduled. Even if payments are
insufficient to repay investors in full, the Bank's assets are not exposed to
risk of loss beyond the relevant amount of recourse retained (including amounts
outstanding in the spread accounts and the amount of any subordinated
interest), which, as noted above, constitute a dollar-for-dollar capital
requirement for the Bank. The Bank also retains risk through the Bank's
interest in any seller certificate. Seller certificates share collections on
the securitized assets on an unsubordinated basis with the investor
certificates (unless and to the extent recourse is retained through an express
subordination) and are on-balance sheet assets against which the Bank must
maintain capital. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Financial Condition--Liquidity" 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
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Liquidity" 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.
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.
REIT Preferred Offering. A registration statement has been filed with the SEC
for the public issuance of $150 million of noncumulative perpetual preferred
stock (the "Preferred Capital Shares") by a new real estate investment trust
("REIT") subsidiary of the Bank (the "REIT Subsidiary"). The Preferred Capital
Shares which would be automatically exchanged for a new series of preferred
stock of the Bank (the "Series B Preferred Shares") upon the occurrence of
certain trigger events (specifically, 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 established pursuant to FDICIA, (ii) the
Bank is placed into conservatorship or receivership, or (iii) the appropriate
federal regulatory agency, in its sole discretion and even if the Bank is not
"undercapitalized," anticipates the Bank becoming "undercapitalized" in the
near term), is designed to qualify as core capital of the Bank under the
regulatory capital requirements applicable to the Bank. The automatic exchange
feature was designed to ensure that the Preferred Capital Shares
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<PAGE>
provide the same level of capital support to the Bank on a consolidated basis
as other forms of core capital by making the capital represented by the
Preferred Capital Shares directly available to creditors of the Bank in certain
circumstances. Proceeds from the issuance of the Preferred Capital Shares,
together with capital contributions from the Bank to the REIT Subsidiary, will
be used by the REIT subsidiary to purchase certain REIT-qualified assets from
the Bank's mortgage loan portfolio. Because the REIT Subsidiary will elect to
qualify as a REIT for federal income tax purposes, dividends payable on the
REIT Preferred Stock will be deductible by the REIT Subsidiary for income tax
purposes. The treatment of the REIT Preferred Stock as core capital of the Bank
and the REIT Subsidiary's ability to deduct, for income tax purposes, the
dividends payable on the REIT Preferred Stock will provide the Bank with a more
cost-effective means of obtaining regulatory capital than if the Bank were to
issue preferred stock itself.
The mortgage loans expected to be transferred to the REIT Subsidiary by the
Bank have been selected from the Bank's existing portfolio of adjustable-rate
mortgage loans. The Bank will determine the values of the selected mortgage
loans using discounted cash flow analyses based on current market conditions.
FOR UNAUDITED FINANCIAL INFORMATION REGARDING THE BANK AT SEPTEMBER 30, 1996,
SEE "RECENT DEVELOPMENTS."
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<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-8
<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 There is currently no public market for the
Market...................... 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.
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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 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.
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<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-11
<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-12
<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."
OC-13
<PAGE>
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 overall financial condition or its future prospects. A
thrift generally 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-14
<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-15
<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 appropriate federal regulatory agency, in its sole discretion and
even if the Bank is not "undercapitalized," anticipates the Bank becoming
"undercapitalized" in the near term, (iii) in which the Bank is placed into
conservatorship or receivership. 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 "adequately capitalized"
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-16
<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-17
<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. 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-18
<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-19
<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.
The issuance of the Debentures, the principal amount of which will qualify
as supplementary (tier 2) capital under applicable regulatory capital
requirements, together with the increase in the Bank's regulatory capital that
will result from the treatment of the Preferred Capital Shares as core
capital, will enable the Bank to expand its business by allowing it to
increase its total assets while maintaining its capital levels above those
established for well-capitalized institutions under the prompt corrective
action standards.
OC-20
<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-21
<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 Norwest Bank Minnesota, N.A. 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
OC-22
<PAGE>
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
OC-23
<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
OC-24
<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 established
pursuant to FDICIA, (ii) the Bank is placed into conservatorship or
receivership or (iii) the appropriate federal regulatory agency, in its sole
discretion and even if the Bank is not "undercapitalized," 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-25
<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>
<CAPTION>
Page
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)
<PAGE>
<TABLE>
<CAPTION>
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)
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<TABLE>
<CAPTION>
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>
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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."
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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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<PAGE>
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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<PAGE>
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
-5-
<PAGE>
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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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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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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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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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.
-18-
<PAGE>
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.
-19-
<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).
-20-
<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.
-21-
<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.
-22-
<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
-24-
<PAGE>
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.
-25-
<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.
-26-
<PAGE>
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
-27-
<PAGE>
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.
-28-
<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.
-29-
<PAGE>
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
-30-
<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.
-31-
<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
-32-
<PAGE>
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
-33-
<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.
-34-
<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.
-36-
<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>
-37-
<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.
-38-
<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
-41-
<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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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
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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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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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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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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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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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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>
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<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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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.
-53-
<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."
-55-
<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.
-56-
<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."
-57-
<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
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<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
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<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
-87-
<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.
-89-
<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.
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<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.
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<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.
-93-
<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.
-98-
<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
-99-
<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
-100-
<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.
-101-
<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>
-102-
<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>
-103-
<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............................................................... 10
The Company................................................................ 17
Use of Proceeds............................................................ 18
Capitalization............................................................. 19
Business and Strategy...................................................... 20
Management................................................................. 34
Certain Transactions Constituting the Formation............................ 37
Description of Series A Preferred Shares................................... 40
Description of Capital Stock............................................... 45
Federal Income Tax Considerations.......................................... 48
ERISA Considerations....................................................... 57
Certain Information Regarding the Bank..................................... 59
Underwriting............................................................... 73
Experts.................................................................... 74
Ratings.................................................................... 74
Legal Matters.............................................................. 74
Available Information...................................................... 74
Glossary................................................................... 75
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............................................ $ 81,100
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
--Consent of Shaw, Pittman, Potts & Trowbridge (included in
23(d) Exhibit 8)
--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
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 22, 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 22, 1996 BY THE FOLLOWING
PERSONS IN THE CAPACITIES INDICATED.
SIGNATURE TITLE
--------- -----
/s/ Alexander R. M. Boyle Director
- -------------------------------------
ALEXANDER R. M. BOYLE
/s/ Joel A. Friedman Senior Vice
- ------------------------------------- President and
JOEL A. FRIEDMAN Controller
(Principal
Accounting Officer)
/s/ Stephen R. Halpin, Jr. Executive Vice
- ------------------------------------- President, Chief
STEPHEN R. HALPIN, JR. Financial Officer,
Treasurer and
Director (Principal
Financial Officer)
/s/ Leslie A. Nicholson Executive Vice
- ------------------------------------- President, General
LESLIE A. NICHOLSON Counsel and
Director
/s/ B. Francis Saul II Chairman of the
- ------------------------------------- Board and President
B. FRANCIS SAUL II and Chief Executive
Officer (Principal
Executive Officer)
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
--Consent of Shaw, Pittman, Potts & Trowbridge (included in
23(d) Exhibit 8)
--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
II-5
<PAGE>
Exhibit 8
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 federal income 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
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 2
change, both retroactively or prospectively, and to possibly different
interpretations. We assume no obligation to update the opinion set forth in this
letter. We believe that the 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/
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/ While the Bank is a financial institution, 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). 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 the Company having its own officers, 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 -- or certain entities treated as 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 held" prohibition, all classes of stock,
- --------
/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
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/ By reason of these rules, it is our opinion that the
ownership of the Bank is taken into account in determining whether the Company
is closely held. 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; and (ii) the Bank's preferred stock
will remain outstanding and currently represents at least 10 percent of the
value of the Bank, although that percentage is expected to decline as the Bank
has earnings.
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 (together with the ownership of the
Common Stock) 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;
- --------
/6/Treas. Reg. (S) 1.544-1(c).
/7/Section 544.
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 6
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 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 with the
objective of causing the value of the Common Stock not to exceed approximately
52 percent of the total value of the Company. Such distributions, when made,
will 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. If the value of the
Common Stock does not exceed approximately 52 percent of the total value of the
Company, then, given (i) the Ownership Limit and other limitations imposed upon
the ownership of the Preferred Shares and (ii) the assumed pattern of ownership
of the Bank described above, the Company will satisfy the requirement that its
stock not be 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.
It is our opinion that the Company is organized so as to satisfy the
requirement that its stock not be closely held.
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 7
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 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 IRS 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 must become "undercapitalized" under prompt
corrective action regulations, 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 in writing 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
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 8
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 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/
- --------
/8/ Section 856(c)(3).
/9/ Section 856(c)(2).
/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
The Company has represented 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 will not engage 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
-----------
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
--------------------------------
- --------
/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).
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 10
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 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.
- --------
/16/Section 857(a)(1)(A).
/17/Section 858(a).
<PAGE>
Chevy Chase Preferred Capital Corporation
November [__], 1996
Page 11
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
"Federal Income Tax Considerations" in the prospectuses.
Very truly yours,
SHAW, PITTMAN, POTTS & TROWBRIDGE
<PAGE>
November [__], 1996
Shaw, Pittman, Potts & Trowbridge
2300 N Street, N.W.
Washington, D.C. 20037-1128
Re: Chevy Chase Preferred Capital Corporation Offering
--------------------------------------------------
Ladies and Gentlemen:
In connection with your opinion letter dated November [__], 1996, you
have requested certain representations from Chevy Chase Preferred Capital
Corporation (the "Company") with respect to its assets, methods of operations
and other matters. Your opinion has been requested in connection with the filing
of a Registration Statement on Form S-11, file number 333-10495 with the
Securities and Exchange Commission, and the amendments thereto. Such
registration statement (the "Registration Statement") contains a prospectus (the
"Prospectus"). All capitalized terms used but not otherwise defined herein shall
have the respective meanings given to them in the Registration Statement.
In this regard, the Company, intending that you shall rely on the
contents of this letter, represents to you as follows:
<PAGE>
Shaw, Pittman, Potts & Trowbridge
November [_], 1996
Page 2
1. The Company has been and will be operated in accordance with the
terms and provisions of the First Amended and Restated Articles of Incorporation
of Chevy Chase Preferred Capital Corporation, as amended from time to time.
2. The Company will be organized and operated as described in the
Prospectus.
3. The Company will adopt December 31 as its taxable year-end for U.S.
federal income tax purposes.
4. The Company will make a timely election, pursuant to section
856(c)(1) of the Internal Revenue Code of 1986, as amended (the "Code"), to be
taxed as real estate investment trust ("REIT") commencing with its 1996 taxable
year.
5. The Company will not be organized or operated as any type of entity
that would be treated as a financial institution under the Code.
6. The Company will be operated as a separate entity with its own
officers, books and records.
7. At all times after December 31, 1996, the beneficial ownership
(without reference to any rules of attribution) of the stock of the Company will
be held by 100 or more persons.
8. The Company will not impose and is not aware of any transfer
restrictions on its shares of stock other than those restrictions (i) contained
in or allowed by the Articles which are intended to enable the Company to comply
with certain REIT qualification requirements, or (ii) contained in certain
agreements which limit the ability of certain shareholders of the Company to
transfer their interests for a limited period.
<PAGE>
Shaw, Pittman, Potts & Trowbridge
November [_], 1996
Page 3
9. For all future taxable years, the Company will not be closely held
within the meaning of sections 856(a)(6) and 856(h) of the Code.
10. For its current and all future taxable years, at least 75 percent
of the Company's gross income will consist of amounts described in section
856(c)(3) of the Code.
11. For its current and all future taxable years, at least 95 percent
of the Company's gross income will consist of amounts described in section
856(c)(3) of the Code.
12. For its current and all future taxable years, less than 30 percent
of the Company's gross income will consist of income from the sale or other
disposition of (i) stock or securities held for less than one year, (ii)
property in a transaction which is a prohibited transaction, as defined in
section 857(b)(6) of the Code, and (iii) real property (including interests in
real property and interests in mortgages on real property) held for less than
four years, other than property compulsorily or involuntarily converted within
the meaning of section 1033 of the Code and property which is "foreclosure
property" within the meaning of section 856(e) of the Code.
13. At the end of the current and all future calendar quarters, at
least 75 percent of the total value of the assets of the Company will consist of
real estate assets within the meaning of section 856(c)(6)(B) of the Code, cash
and cash items (including receivables), and U.S. government securities.
14. At the end of the current and all future calendar quarters, the
Company will not beneficially own securities in any one issuer (excluding any
"qualified REIT subsidiary" within the meaning of section 856(i)(2) of the Code)
having an aggregate value in excess of 5 percent of the total value of the
assets of the Company as determined in accordance with section 1.856-2(d)(2) of
the Treasury Regulations.
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Shaw, Pittman, Potts & Trowbridge
November [_], 1996
Page 4
15. At the end of the current and all future calendar quarters, the
Company will not beneficially own securities of any one issuer (except for any
"qualified REIT subsidiary" within the meaning of section 856(i)(2) of the Code)
representing in excess of 10 percent of the outstanding voting securities of
such issuer.
16. The Company will revalue its assets at the end of each quarter of
each taxable year in which securities or other property are acquired and will
eliminate within 30 days after the end of each such quarter any discrepancy
between the value of its various investments and the requirements of section
856(c)(5) of the Code to the extent attributable in whole or in part to
acquisitions during such quarter. The Company will keep and retain sufficient
records so as to be able to show that the Company has complied during each of
its taxable years with the gross asset tests contained in section 856(c)(5) of
the Code and described in paragraphs 12, 13 and 14 above.
17. For all future taxable years, the Company will comply with the
record-keeping requirements prescribed by section 1.857-8 of the Treasury
Regulations.
18. The Company will make timely distributions to its shareholders for
its current and all future taxable years of at least 95 percent of its "real
estate investment trust taxable income" (determined consistent with section
857(a)(1)(A)(i) of the Code) plus at least 95 percent of the excess of any "net
income from foreclosure property" over the tax imposed by the Code on such net
income, if any, as such terms are defined in sections 857(b)(2) and
857(b)(4)(B), respectively, of the Code.
19. The Company will at all times beneficially hold all of its assets
for investment purposes and not as (i) stock in trade or other property of a
kind which would properly be
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Shaw, Pittman, Potts & Trowbridge
November [_], 1996
Page 5
includible in inventory if on hand at the close of the taxable year, or (ii)
property held primarily for sale to customers in the ordinary course of the
Company's trade or business.
20. The Company will not make any distributions to its shareholders
with respect to any class or series of capital stock unless such distribution is
pro rata with respect to such class or series, with no preference to any share
of stock as compared with other shares of the same class or series, and will not
make any distributions that give a preference to one class or series of stock as
compared with another class or series except to the extent that the former is
entitled (without reference to waivers of their rights by shareholders) to such
preference.
This letter is being furnished to you solely for your benefit and for
use in rendering your opinion.
CHEVY CHASE PREFERRED CAPITAL CORPORATION., a Maryland corporation
By:______________________________
Name: Joel Friedman Title: Senior Vice President and Controller
