CHEVY CHASE
PREFERRED CAPITAL CORPORATION
FORM 10-Q
March 31, 1998
<PAGE>
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
Commission File Number: 333-10495
CHEVY CHASE PREFERRED CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
Maryland 52-1998335
(State or other jurisdi(I.R.S. Employer
incorporation or organiIdentification 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
was 100 shares, $1 par value, as of April 30, 1998.
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page
Item 1. Financial Statements:...................... 1
(a)Statements of Financial Condition at March 31, 1998
and December 31, 1997........................ 2
(b)Statements of Operations for the Three Months Ended
March 31, 1998 and 1997 ................... 3
(c)Statement of Stockholders' Equity for the Three Months
Ended March 31, 1998....................... 4
(d)Statements of Cash Flows for the Three Months Ended
March 31, 1998 and 1997.................... 5
(e)Notes to Financial Statements................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations......... 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk 12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings ......................... 12
Item 2. Changes in Securities...................... 12
Item 3. Defaults Upon Senior Securities............ 12
Item 4. Submission of Matters to a Vote of Security Holders 12
Item 5. Other Information.......................... 12
Item 6. Exhibits and Reports on Form 8-K .......... 12
i
<PAGE>
PART I
ITEM 1. FINANCIAL STATEMENTS
The following unaudited financial statements and notes of Chevy Chase Preferred
Capital Corporation (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information. In
the opinion of management, all adjustments necessary for a fair presentation of
the financial position and the results of operations for the interim period
presented have been included. Such unaudited financial statements and notes
should be read in conjunction with the Company's financial statements and notes
for the year ended December 31, 1997, included in the Company's Annual Report on
Form 10-K (File No. 333- 10495) filed with the Securities and Exchange
Commission on March 30, 1998.
1
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
STATEMENTS OF FINANCIAL CONDITION
(Unaudited)
March 31, December 31,
1998 1997
------------- -------------
ASSETS
Cash and interest-bearing deposits $ 2,675,810 $ 3,894,269
Residential mortgage loans (net of allowance for
losses of $40,333 and $39,999, respectively) 286,123,624 290,382,131
Real estate acquired in settlement of loans, net 370,846 173,738
Accounts receivable from parent 14,383,537 10,374,891
Accrued interest receivable 1,605,604 1,562,478
Prepaid expenses 412,376 435,809
------------- -------------
Tottal assets $ 305,571,797 $ 306,823,316
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable to parent $ 182,354 $ 163,793
Accounts payable - others - 3,749
Dividends payable to parent 350,000 2,850,000
Dividends payable - others ,890,625 3,890,625
Accrued expenses 8,047 -
-------------- --------------
Total liabilities 4,431,026 6,908,167
-------------- --------------
103/8% Noncumulative Exchangeable Preferred Stock,
Series A, $5 par value, 10,000,000 shares authorized,
3,000,000 shares issued and outstanding(liquidation
value of $50 per share plus accrued and
unpaid dividends) 15,000,000 15,000,000
Common stock, $1 par value,
1,000 shares authorized, 100 shares
issued and outstanding 100 100
Capital contributed in excess of par 284,999,900 284,915,049
Retained earnings 1,140,771 -
-------------- ------------
Total stockholders' equity 301,140,771 299,915,149
-------------- ------------
Total liabilities and stockholders' equity $ 305,571,797 $306,823,316
============== ============
The Notes to Financial Statements are an integral part of these statements.
2
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CHEVY CHASE PREFERRED CAPITAL CORPORATION
STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
March 31,
1998 1997
------------- -------------
Interest income
Residential mortgage loans $ 5,701,251 $ 5,651,469
Other 45,337 10,042
------------- -------------
Total interest income 5,746,588 5,661,511
Gain on sale of real estate acquired in
settlement of loans, net 960 -
------------- -------------
Total income 5,747,548 5,661,511
------------- ------------
Operating expenses
Loan servicing fees paid to parent 272,065 297,305
Advisory fees paid to parent 50,000 50,000
Directors fees 7,000 5,000
General and administrative 37,087 25,247
------------- -------------
Total operating expenses 366,152 377,552
------------- --------------
NET INCOME $ 5,381,396 $ 5,283,959
============= ==============
PREFERRED STOCK DIVIDENDS 3,890,625 3,890,625
------------- --------------
EARNINGS AVAILABLE TO
COMMON STOCKHOLDER $ 1,490,771 $ 1,393,334
============= ==============
EARNINGS PER COMMON SHARE $ 14,907.71 $ 13,933.34
============= ==============
The Notes to Financial Statements are an integral part of these statements.
3
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
For the Three Months Ended March 31, 1998
<TABLE>
Capital
Contributed Total
Preferred Common in Excess Retained Stockholders'
Stock Stock of Par Earnings Equity
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ 15,000,000 $ 100 $ 284,915,049 $ - $ 299,915,149
Net income - - - 5,381,396 5,381,396
Capital contribution from
common stockholder - - 84,851 - 84,851
Dividends on 103/8%
Noncumulative Exchangeable
Preferred Stock, Series A - - - (3,890,625) (3,890,625)
Dividends on Common stock - - - (350,000) (350,000)
------------------------------------------------------------------------
Balance, March 31, 1998 $ 15,000,000 $ 100 $ 284,999,900 $ 1,140,771 $ 301,140,771
========================================================================
</TABLE>
The Notes to Financial Statements are an integral part of this statement.
4
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CHEVY CHASE PREFERRED CAPITAL CORPORATION
STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
--------------------------------
1998 1997
------------- -------------
Cash flows from operating activities:
Net income $ 5,381,396 $ 5,283,959
Adjustments to reconcile net income
to net cash provided by operating
activities:
Gain on sale of real estate acquired in
settlement of loans, net (960) -
(Increase) decrease in accounts receivable
from parent (4,008,646) 2,191,197
Increase in accrued interest receivable (43,126) (8,846)
(Increase) decrease in prepaid expenses 23,433 (500,466)
Increase in accrued expenses 8,047 -
Increase in accounts payable to parent 18,561 122,116
Decrease in accounts payable - others (3,749) (3,334)
-------------- --------------
Net cash provided by operating activities 1,374,956 7,084,626
-------------- --------------
Cash flows from investing activities:
Purchases of residential mortgage loan (41,413,498) (17,564,254)
Repayments of residential mortgage loans 45,329,341 14,745,697
Net proceeds on sale of real estate acquired
in settlement of loans 146,516 -
-------------- --------------
Net cash provided by (used in) investing
activities 4,062,359 (2,818,557)
-------------- --------------
Cash flows from financing activities:
Capital contribution from common stockholder 84,851 6,515
Dividends paid on preferred stock (3,890,625) (1,253,640)
Dividends paid on common stock (2,850,000) (584,749)
Net cash used in financing activities (6,655,774) (1,831,874)
-------------- --------------
Net increase (decrease) in cash and cash
equivalents (1,218,459) 2,434,195
Cash and cash equivalents at beginning of period 3,894,269 365,175
-------------- --------------
Cash and cash equivalents at end of period $ 2,675,810 $ 2,799,370
=============== ==============
Supplemental disclosures of non-cash activities:
Loans receivable transferred to real estate
acquired in settlement of loans $ 342,664 $ -
=============== ==============
The Notes to Financial Statements are an integral part of this statement.
5
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CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION:
The Company is a Maryland corporation which acquires, holds and manages real
estate assets. Chevy Chase Bank, F.S.B. (the "Bank"), a federally insured stock
savings bank owns all of the Company's common stock.
The Bank is in compliance with its regulatory capital requirements.
NOTE 2 - RESIDENTIAL MORTGAGE LOANS:
Residential mortgage loans consist of one-year adjustable rate mortgages
("ARMs"), three-year ARMs and five-year and ten-year fixed-rate loans with
automatic adjustment to one-year ARMs after the respective fixed rate period,
and 30 year fixed-rate mortgages. Each of the mortgage loans is secured by a
mortgage, deed of trust or other security instrument which created a first lien
on the residential dwellings located in their respective jurisdictions. The
following table shows the residential mortgage loan portfolio by type at the
dates indicated:
March 31, December 31,
1998 1997
-------------- ---------------
One-year ARM $ 23,594,782 $ 27,657,820
Three-year ARMs 62,104,016 78,228,562
5/1 ARMs 142,979,901 165,785,490
10/1 ARMs 55,088,509 16,196,915
30 year fixed-rate 2,396,749 2,553,343
-------------- ---------------
Total 286,163,957 290,422,130
Less:
Allowance for loan losses 40,333 39,999
-------------- ---------------
Total $ 286,123,624 $ 290,382,131
============== ===============
NOTE 3 - PREFERRED STOCK
Cash dividends on the Company's 103/8% Noncumulative Exchangeable Preferred
Stock, Series A ("the Series A Preferred Shares") are payable quarterly in
arrears. The liquidation value of each Series A Preferred Share is $50 plus
accrued and unpaid dividends. The Series A Preferred Shares are not redeemable
until January 15, 2007 (except upon the occurrence of certain tax events), and
are redeemable thereafter at the option of the Company. Except under certain
limited circumstances, the holders of the Series A Preferred Shares have no
voting rights. The Series A Preferred Shares are automatically exchangeable for
a new series of preferred stock of the Bank upon the occurrence of certain
events relating to the Bank.
6
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CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
NOTE 4 - DIVIDENDS:
During the three months ended March 31, 1998, the Company's Board of Directors
declared $3,890,625 and $350,000 of preferred stock and common stock dividends,
respectively, out of the retained earnings of the Company. These dividends were
paid in April 1998.
7
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ITEM 2MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
Residential Mortgage Loans
At March 31, 1998, the Company had $286,123,624 invested in loans secured by
first mortgages or deeds of trust on single-family residential real estate
properties ("Residential Mortgage Loans"). The $4,258,507 decrease from the
balance at December 31, 1997, resulted from Residential Mortgage Loan principal
collections of $45,329,341, which were offset by purchases of $41,413,498. The
Company transferred two loans with an aggregate principal balance of $342,664 to
real estate acquired in settlement of loans during the quarter ended March 31,
1998. In addition, the Company received proceeds of $146,516 on the sale of one
property classified as real estate acquired in settlement of loans during the
three months ended March 31, 1998. Management intends to continue to reinvest
proceeds received from repayments of loans in additional Residential Mortgage
Loans to be purchased from either the Bank or its affiliates.
At March 31, 1998, the Company had three 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) with an aggregate principal
balance of $748,206.
At March 31, 1998, the Company had five delinquent loans (loans delinquent 30-89
days) with an aggregate principal balance of $1,078,817 (or 0.38% of loans).
Allowance for Loan Losses
Management reviews the loan portfolio to establish an allowance for estimated
losses if deemed necessary. An analysis of whether an allowance for loan losses
is required is performed periodically, and an allowance is provided after
considering such factors as the economy in lending areas, delinquency statistics
and past loss experience. The allowance for loan losses is based on estimates,
and ultimate losses may vary from current estimates. As adjustments to the
allowance become necessary, provisions for loan losses are reported in
operations in the periods they are determined to be necessary. No allowance was
recorded for the three months ended March 31, 1997. The activity in the
allowance for loan losses for the three months ended March 31, 1998 is as
follows:
Three Months
Ended
March 31, 1998
--------------
Balance at beginning of period $ 39,999
Net recoveries 334
------------
Balance at end of period $ 40,333
============
8
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Interest Rate Risk
The Company's income consists primarily of interest payments on Residential
Mortgage Loans. If there is a decline in interest rates (as measured by the
indices upon which the interest rates of the ARMs are based), then the Company
will experience a decrease in income available to be distributed to its
stockholders. In addition, certain ARM products which the Company holds allow
borrowers to convert an adjustable rate mortgage to a fixed rate mortgage, thus
"locking in" a fixed interest rate at a time when interest rates have declined.
In recent periods, primarily as a result of a decline in interest rates, the
Company has experienced an increase in prepayments on its Residential Mortgage
Loans. In response, the Company has begun to alter the mix of the loans that it
purchases. Specifically, the Company has purchased more 10/1 ARMs from the Bank,
which typically have higher yields than other adjustable rate loan types.
Based on the outstanding balance of the Company's Residential Mortgage Loans at
March 31, 1998 and the interest rate on such loans, anticipated annual interest
income, net of servicing fees, on the Company's loan portfolio was approximately
138.4% of the projected annual dividend on the Series A Preferred Shares. There
can be no assurance that an interest rate environment in which there is a
continued decline in interest rates would not adversely affect the Company's
ability to pay dividends on the Series A Preferred Shares. The Company, to date,
has not used any derivative instruments to manage its interest rate risk.
Significant Concentration of Credit Risk
Concentration of credit risk arises when a number of customers engage in similar
business activities, or activities in the same geographical region, or have
similar economic features that would cause their ability to meet contractual
obligations to be similarly affected by changes in economic conditions.
Concentration of credit risk indicates the relative sensitivity of the Company's
performance to both positive and negative developments affecting a particular
industry.
The Company's exposure to geographic concentrations directly affects the credit
risk of the Residential Mortgage Loans within the portfolio. Substantially all
of the Company's Residential Mortgage Loans are secured by residential real
estate properties located in the Washington, D.C. metropolitan area.
Consequently, these 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 and natural hazards in the region that may
affect the ability of residential property owners in the region to make payments
of principal and interest on the underlying mortgages.
Liquidity and Capital Resources
The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all of the Company's financial commitments. In
managing liquidity, the Company takes into account various legal limitations
placed on a real estate investment trust (a "REIT"), as discussed below in "Tax
Status of the Company."
9
<PAGE>
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 and
to pay dividends on the Series A Preferred Shares. The acquisition of such
additional mortgage assets held by the Company 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 principal and
interest 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 treated as a REIT for income tax purposes for the foreseeable
future. The Company may borrow funds as it deems necessary.
Tax Status of the Company
The Company has elected to be taxed as a REIT under Sections 856 through 860 of
the Internal Revenue Code of 1986, as amended. As a REIT, the Company generally
will not be subject to Federal income tax on its net income (excluding capital
gains) provided that it distributes annually 100 percent of its annual REIT
taxable income to its stockholders, and meets certain organizational, stock
ownership and operational requirements. 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 and state income tax (including any applicable alternative
minimum tax) on its taxable income at regular corporate rates. In addition, the
Company would also be disqualified from treatment as a REIT for the four taxable
years following the year during which qualification was lost.
RESULTS OF OPERATIONS
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31, 1997
During the three months ended March 31, 1998 and 1997, the Company reported net
income of $5,381,396 and $5,283,959, respectively.
Interest income on Residential Mortgage Loans totaled $5,701,251 and $5,651,469
for the three months ended March 31, 1998 and 1997, respectively, which
represents an average yield on such loans of 7.94% and 7.66%, respectively. The
average loan balance of the Residential Mortgage Loan portfolio was $287,187,664
and $295,043,738, for the three months ended March 31, 1998 and 1997,
respectively. The Company would have recorded an additional $26,094 and $4,902
in interest income for the three months ended March 31, 1998 and 1997,
respectively, had its non-accrual loans been current in accordance with their
original terms.
Other interest income of $45,337 and $10,042 was recognized on the Company's
interest bearing deposits during the three months ended March 31, 1998 and 1997,
respectively.
No provision for loan losses was recorded for the three months ended March 31,
1998 and 1997.
The Company recognized a gain of $960 on the sale of one property classified as
real estate acquired in settlement of loans during the three months ended March
31, 1998.
10
<PAGE>
Operating expenses totaling $366,152 and $377,552 for the three months
ended March 31, 1998 and1997, respectively, were comprised of loan servicing
fees paid to parent, advisory fees paid to parent, directors fees and general
and administrative expenses. Loan servicing fees paid to parent of $272,065 and
$297,305, for the three months ended March 31, 1998 and 1997, respectively, were
based on a servicing fee rate of 0.375% of the outstanding principal balances of
Residential Mortgage Loans, pursuant to a servicing agreement between the
Company and the Bank. Advisory fees paid to parent for the three months ended
March 31, 1998 and 1997 totaled $50,000 for each period. Directors fees totaled
$7,000 and $5,000 for the three months ended March 31, 1998 and 1997,
respectively, and represen compensation to the two independent members of the
Board of Directors. General and administrative expenses consist primarily of the
amortization of organizational costs.
On March 16, 1998, the Company declared, out of the retained earnings of the
Company, a cash dividend of $1.296875 per share on the outstanding shares of
Series A Preferred Stock. Dividends of $3,890,625 were subsequently paid on
April 15, 1998.
The Company also declared, out of the retained earnings of the Company, a cash
dividend of $3,500 per share of common stock. The $350,000 dividend was paid on
April 15, 1998.
11
<PAGE>
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
PART II - OTHER INFORMATION
Item 1. 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, is currently threatened with any material litigation with
respect to the Residential Mortgage Loans included in the portfolio, other than
routine litigation arising in the ordinary course of business, most of which is
covered by liability insurance.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits required by Item 601 of Regulation S-K are set forth below.
Exhibit
No. Exhibit
11 Computation of Earnings Per Common Share included in Part I, Item 1 of
this report
27 Financial Data Schedule
(b) No reports on Form 8-K were issued during the three months ended March 31,
1998.
12
<PAGE>
SIGNATURES
Pursuant to the requirements 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.
CHEVY CHASE PREFERRED CAPITAL CORPORATION
(Registrant)
May 15, 1998 By:/s/ Stephen R. Halpin, Jr.
--------------------------
Stephen R. Halpin, Jr.
Director,
Executive Vice President, Treasurer and
Chief Financial Officer
(Principal Financial Officer)
May 15, 1998 By:/s/ Joel A. Friedman
--------------------
Joel A. Friedman
Senior Vice President and
Controller
(Principal Accounting Officer)
13
<PAGE>
Exhibit Index
Exhibit
No. Exhibit
11 Computation of Earnings Per Common Share included in Part I,
Item 1 of this report.
27 Financial Data Schedule.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 5,209
<INT-BEARING-DEPOSITS> 2,670,601
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 286,123,624
<ALLOWANCE> 40,333
<TOTAL-ASSETS> 305,571,797
<DEPOSITS> 0
<SHORT-TERM> 4,422,979
<LIABILITIES-OTHER> 8,047
<LONG-TERM> 0
0
15,000,000
<COMMON> 100
<OTHER-SE> 284,999,900
<TOTAL-LIABILITIES-AND-EQUITY> 305,571,797
<INTEREST-LOAN> 5,701,251
<INTEREST-INVEST> 0
<INTEREST-OTHER> 45,337
<INTEREST-TOTAL> 5,746,588
<INTEREST-DEPOSIT> 0
<INTEREST-EXPENSE> 0
<INTEREST-INCOME-NET> 5,746,588
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 366,152
<INCOME-PRETAX> 5,381,396
<INCOME-PRE-EXTRAORDINARY> 5,381,396
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,381,396
<EPS-PRIMARY> 14,907.71
<EPS-DILUTED> 0
<YIELD-ACTUAL> 0
<LOANS-NON> 748,206
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 39,999
<CHARGE-OFFS> 0
<RECOVERIES> 334
<ALLOWANCE-CLOSE> 40,333
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
