CHEVY CHASE
PREFERRED CAPITAL CORPORATION
FORM 10-K
December 31, 1997
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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 jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
8401 Connecticut Avenue
Chevy Chase, Maryland 20815
(Address of principal executive office) (Zip Code)
(301) 986-7000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of Act:
Title of each class Name of each exchange on which registered
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103/8% Noncumulative Exchangeable New York Stock Exchange, Inc.
Preferred Stock, Series A
Securities registered pursuant to Section 12(g) of the Act:
N/A
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(Title of class)
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ___
The number of shares outstanding of the registrant's sole class of common stock
was 100 shares, $1.00 par value per share, as of March 15, 1998. All of such
shares were owned by Chevy Chase Bank, F.S.B.; therefore, no common stock was
held by non-affiliates.
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CHEVY CHASE PREFERRED CAPITAL CORPORATION
TABLE OF CONTENTS
PART I
Page
Item 1. BUSINESS .......................................................... 1
General ............................................................... 1
Mortgage Assets ....................................................... 1
Loan Portfolio Composition .......................................... 1
Investment Policy ................................................... 3
Credit Risk Management Policies ..................................... 4
Delinquencies ....................................................... 4
Geographic Distribution ............................................. 4
Servicing ............................................................. 4
Dividend Policy ....................................................... 5
The Bank .............................................................. 6
The Advisor ........................................................... 6
Capital and Leverage Policies ......................................... 7
Employees ............................................................. 8
Competition ........................................................... 8
Environmental Matters ................................................. 8
Tax Status of the Company ............................................. 8
Item 2. PROPERTIES ........................................................ 9
Item 3. LEGAL PROCEEDINGS ................................................. 9
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............... 9
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS ......................................... 10
Description of Common Stock .......................................... 10
General ............................................................ 10
Dividends .......................................................... 10
Voting Rights ...................................................... 10
Rights Upon Liquidation ............................................ 10
Description of Series A Preferred Shares ............................. 11
Market Information and Dividends ................................... 11
General ............................................................ 11
Automatic Exchange ................................................. 12
Voting Rights ...................................................... 12
Redemption ......................................................... 12
Rights Upon Liquidation ............................................ 12
Independent Director Approval ...................................... 13
Item 6. SELECTED FINANCIAL DATA........................................... 13
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PART II
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.......................... 14
Financial Condition................................................... 14
Residential Mortgage Loans.......................................... 14
Allowance for Loan Losses........................................... 14
Interest Rate Risk.................................................. 15
Significant Concentration of Credit Risk............................ 15
Liquidity and Capital Resources..................................... 15
Results of Operations................................................. 16
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISKS........................................... 16
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................... F-1
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE....................... 17
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............... 17
Directors and Executive Officers...................................... 17
Audit Committee....................................................... 19
Section 16(a) Beneficial Ownership Reporting Compliance............... 19
Item 11. EXECUTIVE COMPENSATION........................................... 19
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT........................................ 19
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................... 20
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K.......................................... 21
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PART I
ITEM 1. BUSINESS
General
Chevy Chase Preferred Capital Corporation (the "Company") is a Maryland
corporation organized on November 5, 1996, which acquires, holds and manages
real estate mortgage assets ("Mortgage Assets"). The Company has elected to be
treated as a real estate investment trust (a "REIT") under the Internal Revenue
Code of 1986, as amended (the "Code"), and generally will 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 services the Company's Residential
Mortgage Loans (as defined below) and administers the day-to-day operations of
the Company. The Company also has outstanding 3,000,000 shares of 103/8 %
Noncumulative Exchangeable Preferred Stock, Series A, par value $5.00 per share
(the "Series A Preferred Shares"). The Series A Preferred Shares are publicly
held.
Mortgage Assets
Loan Portfolio Composition. The Company's current portfolio of Mortgage Assets
consists of whole loans ("Mortgage Loans") secured by first mortgages or deeds
of trust on single-family residential real estate properties ("Residential
Mortgage Loans"). The following table sets forth information concerning the
Company's Residential Mortgage Loans, all of which were acquired from the Bank,
as of December 31, 1997 and December 31, 1996. A description of the types of
Residential Mortgage Loans included in the Company's portfolio follows the
table.
Residential Mortgage Loan Portfolio
(Dollars in thousands)
December 31,
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1997 1996
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Aggregate Percentage by Aggregate Percentage by
Principal Aggregate Principal Aggregate
Type Balance Principal Balance Principal
One-Year ARMs $ 27,658 9.5% $ - - %
Three-Year ARMs 78,229 26.9% 105,412 35.8%
5/1 ARMs 165,785 57.1% 182,414 61.9%
10/1 ARMs 16,197 5.6% 6,678 2.3%
30-year fixed-rate 2,553 0.9% - - %
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290,422 100.0% 294,504 100.0%
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Less:
Allowance for loan losses (40) -
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Total $ 290,382 $ 294,504
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Principal repayments on the Company's loans during the year ended December 31,
1997 were $86,649,302, which were offset by additional purchases from the Bank
of Residential Mortgage Loans of $82,980,950. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Financial Condition
Residential Mortgage Loans."
A majority of the Residential Mortgage Loans included in the Company's portfolio
at December 31, 1997 bore interest at adjustable rates. The interest rate on an
"adjustable rate mortgage" or an "ARM" adjusts periodically based on an index
(such as the interest rate on United States Treasury Bills). ARMs are typically
subject to lifetime interest rate caps and periodic interest rate adjustment
caps. As of December 31, 1997, the interest rates on the Residential Mortgage
Loans included in the Company's portfolio ranged from 6.00% per annum to 9.625%
per annum and the weighted average interest rate was approximately 8.01% per
annum.
The interest rate on each type of ARM product included in the Company's
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 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 current portfolio only.
Residential Mortgage Loans purchased by the Company after December 31, 1997 may
be subject to different interest rates.
Each ARM bears interest at its initial interest rate until the first Rate
Adjustment Date. Effective with each Rate Adjustment Date, the monthly principal
and interest payment on an adjustable rate Residential Mortgage Loan will be
adjusted to an amount that will fully amortize the then-outstanding principal
balance of such 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 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 loan that is an ARM is converted into a fixed rate loan, the
interest rate on the fixed rate loan will be determined at the time of
conversion as specified in the mortgage note relating to such loan and will
remain fixed at such rate for the remaining term of such loan. The Company's
current policy is to retain these fixed rate loans in its portfolio. At December
31, 1997, all of the Company's $2.6 million of fixed-rated loans were the result
of converted ARMs. All the Residential Mortgage Loans included in the portfolio
allow the mortgagor to repay at any time some or all of the outstanding
principal balance of the 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 applicable treasury index 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.
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 as described for the
One-Year ARM, except that the treasury index is the weekly average yield on the
United States Treasury securities adjusted to a constant maturity of three
years.
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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 cap as specified in
the related mortgage note. There is no ability to continue at a fixed rate after
the first Rate Adjustment Date under the terms of this type of Residential
Mortgage Loan.
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 cap as specified in the
related mortgage note. There is no ability to continue at a fixed rate after the
first Rate Adjustment Date under the terms of this type of Residential Mortgage
Loan.
Investment Policy. General. The Company currently intends to maintain at least
95% of its portfolio in Mortgage Assets consisting of either Residential
Mortgage Loans or investment grade mortgage securities representing interests in
pools of Mortgage Loans ("Mortgage-Backed Securities") and may invest up to 5%
of its portfolio in Mortgage Loans secured by commercial real estate properties
or multi-family properties ("Commercial Mortgage 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) if the
Mortgage Loan (i) is delinquent in the payment of principal and 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
"non-accrual 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 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"). 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.
Mortgage-Backed Securities. While no mortgage-backed securities are included in
the current Mortgage Asset portfolio, the Company may from time to time in the
future acquire fixed-rate or variable-rate Mortgage-Backed Securities. A portion
of any Mortgage-Backed Securities that the Company may purchase 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 or principal-only
Mortgage-Backed Securities.
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Commercial Mortgage Loans. While no Commercial Mortgage Loans are included in
the current portfolio, the Company may from time to time in the future acquire
Commercial Mortgage Loans secured by industrial and warehouse properties,
recreational facilities, office buildings, retail space and shopping malls,
hotels and motels, hospitals, nursing homes or senior living centers. Unlike
Residential Mortgage Loans, Commercial Mortgage Loans generally lack
standardized terms. In addition, Commercial Mortgage Loans tend to be fixed rate
loans having shorter maturities than Residential Mortgage Loans. Commercial
Mortgage Loans may also not be fully amortizing, meaning that they may have a
significant principal balance or "balloon" payment due on maturity. Moreover,
commercial properties, particularly industrial and warehouse properties, are
generally subject to relatively greater environmental risks than non-commercial
properties, generally giving rise to increased costs of compliance with
environmental laws and regulations.
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. Such assets could
include Commercial Mortgage Loans, Mortgage Loans secured by multi-family
properties, cash, cash equivalents, securities and shares or interests in other
REITs.
Credit Risk Management Policies. The Company intends that each Mortgage Loan
that it acquires 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. The Company also intends that all
Mortgage Loans held by the Company will be serviced pursuant to the servicing
agreement between the Company and the Bank dated December 1, 1996 (the
"Servicing Agreement"). See "Servicing."
Delinquencies. 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, which is retained by the
Servicer (as defined below). The Bank and the Company follow practices customary
in the banking industry in attempting to cure delinquencies and in pursuing
remedies upon default.
Geographic Distribution. Substantially all of the Residential Mortgage Loans
included in the current loan portfolio are located in Washington D.C., Maryland,
and Virginia. Consequently, these loans may be subject to a greater risk of
default than other comparable 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 the principal and interest on the underlying mortgages. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Significant Concentration of Credit Risk."
Servicing
The Residential Mortgage Loans owned by the Company are serviced by the Bank
(the "Servicer") pursuant to the terms of the Servicing Agreement. The Servicer
receives a fee equal to 0.375% per annum on the principal balances of the
Mortgage Loans serviced. See "Certain Relationships and Related Transactions."
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 these loans solely with a
view toward the interests of the
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Company and without regard to the interests of the Bank or any of the Bank's
affiliates. The Servicer collects and remits principal and interest payments,
administers mortgage escrow accounts, submits and pursues insurance claims and
initiates and supervises foreclosure proceedings on the loans it services. The
Servicer also provides accounting and reporting services required by the Company
for such 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 is 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
Servicer is entitled to 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.
The Servicer is required to pay all expenses related to the performance of its
duties under the Servicing Agreement. The Servicer is 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.
The Company can terminate the Servicing Agreement without cause with at least
sixty days notice to the Servicer and payment of a termination fee.
Dividend Policy
The Company expects to pay an aggregate amount of dividends each year with
respect to its outstanding shares of stock equal to approximately 100% of the
Company's "REIT taxable income" for such year (excluding capital gains). The
Company anticipates that none of the dividends on the Series A Preferred Shares
and no material portion of the dividends on the Common Stock will constitute
non-taxable returns of capital. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Results of Operations."
Dividends are declared at the discretion of the Board of Directors of the
Company after considering the Company's distributable funds, financial
requirements, tax considerations and other factors. The Company's distributable
funds consist primarily of interest payments received in respect of the Mortgage
Assets held by it, and the Company anticipates that most of such assets will
bear interest at adjustable rates. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition - Interest
Rate Risk."
Under regulations promulgated by the Office of Thrift Supervision (the "OTS"),
the ability of thrift institutions such as the Bank to make "capital
distributions" (including the payment of dividends) varies depending on the
institutions' 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 subject to the
regulations, the OTS has indicated that it would not object to the
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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.
In January 1998, the OTS proposed to amend its capital distribution regulations
and specifically requested comment as to the application of the regulations to
dividends paid by operating subsidiaries of federal thrifts (such as the
Company). The Company is unable to determine at this time how the OTS would
treat dividends on the Series A Preferred Shares under any revised capital
distribution regulations. However, even if the OTS were to apply the revised
regulations to operating subsidiaries, the Company believes that such a revision
should not cause the OTS to alter its existing no-objection position with
respect to the Company's payment of dividends on the Series A Preferred Shares,
and that dividends on the Company's Common Stock (which is wholly owned by the
Bank) would not be restricted.
The Bank
The Bank is a federally chartered and federally insured stock savings bank which
at December 31, 1997 was conducting business from 133 full-service offices and
640 automated teller machines ("ATMs") primarily in Maryland, Virginia, and the
District of Columbia. The Bank's home office is located in McLean, Virginia and
its executive office is located in Chevy Chase, Maryland, which are both
suburban communities of Washington, D.C. The Bank also maintains 16 mortgage
loan production offices in the mid-Atlantic region, 15 of which are operated by
a wholly-owned mortgage banking subsidiary. At December 31, 1997, the Bank had
total assets of $6.2 billion, total deposits of $5.0 billion and total
stockholders' equity of $374.3 million. Based on total consolidated assets at
December 31, 1997, the Bank is the largest bank headquartered in the Washington,
D.C. metropolitan area.
Because the Company is a subsidiary of the Bank, federal regulatory authorities
have the right to examine the Company and its activities. Payment of dividends
on the Series A Preferred Shares could 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%. At December 31,
1997, the Bank's total risk-based capital ratio was 13.01%, its tier 1
risk-based capital ratio was 6.81% and its core capital (or leverage) ratio was
6.65%.
If the Exchange Event (as defined below under "Market for Registrant's Common
Equity and Related Stockholder Matters") occurs, the Bank would likely be
prohibited from paying dividends on the Bank Preferred Shares (as defined below
under "Market for Registrant's Common Equity and Related Stockholder Matters").
In all circumstances following the Exchange Event, 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.
The Advisor
On December 3, 1996, the Company entered into an advisory agreement (the
"Advisory Agreement") with the Bank (the "Advisor") to administer the day-to-day
operations of the Company. The Advisor principally is 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 and financing
of the Company's Mortgage Assets, and (iii)
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maintaining the 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.
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 December 31, 1997, the Advisor and its affiliates owned approximately
$1.1 billion of residential mortgage loans, including $290.4 million of the
Company's Residential Mortgage Loans. In their residential mortgage loan
business, the Advisor and its affiliates originate and purchase residential
mortgage loans. A portion of such loans are sold to investors, primarily in the
secondary market, generally on a servicing retained basis. The Advisor and its
affiliates also purchase servicing rights on residential mortgage loans. 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 $3.8 billion as of December 31, 1997.
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 to not 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 (as defined below under "Market for
Registrant's Common Equity and Related Stockholder Matters"). The Advisor is
entitled to receive an annual advisory fee equal to $200,000 payable in equal
quarterly installments with respect to the advisory and management services
provided to the Company. See "Certain Relationships and Related Transactions."
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, including capital gains), or a combination of these methods.
At December 31, 1997, the Company had no debt outstanding, 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, that the Company might incur. The
Company may not, without the approval of a majority of the Independent
Directors, incur debt for borrowed money in excess of 25% of the Company's total
stockholders' equity, including intercompany advances made by the Bank to the
Company.
The Company may also issue additional series of Preferred Stock (as defined
below under "Market for Registrant's Common Equity and Related Stockholder
Matters"). However, 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.
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Employees
The Company has eight officers. The executive officers of the Company are
described further below under "Directors and Executive Officers of the
Registrant - Directors and Officers." The Company does not anticipate that it
will require any additional employees because it has retained the Advisor to
administer the day-to-day activities of the Company pursuant to the Advisory
Agreement. Each officer of the Company currently is also an officer and/or
director of the Bank and/or affiliates of the Bank. The Company maintains
corporate records and audited financial statements that are separate from those
of the Bank or any of the Bank's affiliates.
Competition
The Company does not anticipate that it will engage in the business of
originating Residential Mortgage Loans. It does anticipate that it will purchase
Mortgage Assets in addition to those in the current loan portfolio and that all
these Mortgage Assets will be purchased from the Bank or 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.
Environmental Matters
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
waste, 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 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 Status of the Company
The Company has elected to be taxed as a REIT under Sections 856 through 860 of
the Code, commencing with its taxable year ended December 31, 1996. 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% of
its 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.
8
<PAGE>
ITEM 2. PROPERTIES
None.
ITEM 3. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders of the Company during the
fourth quarter of the year ended December 31, 1997.
9
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Description of Common Stock
General. In connection with the formation of the Company on November 5, 1996,
the Company issued 100 shares of Common Stock to the Bank for $1,000. These
shares of Common Stock were issued in reliance upon the exemption from
registration under Section 4(2) of the Securities Act of 1933, as amended. Thus,
there is no established public trading market for the Common Stock. As of March
15, 1998, there were 100 issued and outstanding shares of Common Stock held by
one stockholder, the Bank.
Dividends. The following table reflects the distributions declared by the
Company on the Common Stock for each quarter since the Company's formation on
November 5, 1996. For a discussion of the Company's distribution policy with
respect to the Common Stock, see "Business - Dividend Policy."
Period Distributions Payment Date
- ------------------------------------- ------------- ----------------
November 5, 1996 to December 31, 1996 $ 584,749 January 15, 1997
January 1, 1997 to March 31, 1997 - N/A
April 1, 1997 to June 30, 1997 - N/A
July 1, 1997 to September 30, 1997 3,300,000 October 15, 1997
October 1, 1997 to December 31, 1997 2,850,000 January 15, 1998
Holders of Common Stock are entitled to receive dividends when, as and if
declared by the Board of Directors out of funds legally available. 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 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 "Business - Tax
Status of the Company."
Voting Rights. Subject to the rights, if any, of the holders of any class or
series of Preferred Stock (as defined below), all voting rights are vested in
the Common Stock. The holders of Common Stock are entitled to one vote per
share.
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.
10
<PAGE>
Description of Series A Preferred Shares
Market Information and Dividends. The Series A Preferred Shares are listed on
the New York Stock Exchange under the trading symbol "CCP-PrA." As of March 15,
1998, there were 3,000,000 issued and outstanding Series A Preferred Shares held
by approximately 141 holders of record. The following table reflects the
respective high and low sales prices for the Series A Preferred Shares for each
quarter since the Company's formation on November 5, 1996. The table also
indicates the distributions declared by the Company during these periods. For a
discussion of the Company's distribution policy with respect to the Series A
Preferred Shares, see "Business - Dividend Policy."
Price
-------------
Period High Low Distributions Payment Date
- ------------------------------------- ------ ------ ----------- ----------------
November 5, 1996 to December 31, 1996 $52.50 $50.00 $1,253,640 January 15, 1997
January 1, 1997 to March 31, 1997 54.88 48.00 3,890,625 April 15, 1997
April 1, 1997 to June 30, 1997 54.25 46.75 3,890,625 July 15, 1997
July 1, 1997 to September 30, 1997 54.06 51.63 3,890,625 October 15, 1997
October 1, 1997 to December 31, 1997 53.50 50.25 3,890,625 January 15, 1998
Holders of Series A Preferred Shares are entitled to receive, if, when and as
declared by the Board of Directors of the Company out of assets of the Company
legally available, cash dividends at the rate of 103/8% per annum of the
liquidation preference (equivalent to $5.1875 per share per annum).
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.
General. The Series A Preferred Shares form a series of the preferred stock of
the Company (the "Preferred Stock"), 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 holders of the Series A Preferred Shares 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 are not 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 (as defined below) upon the
occurrence of the Exchange Event (as defined below).
11
<PAGE>
Automatic Exchange. 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 of the Bank
directs in writing (the "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, (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"). Upon the Exchange Event, each holder of Series A
Preferred Shares will be unconditionally obligated to surrender to the Bank the
certificates representing each Series A Preferred Share of such holder, and the
Bank will be unconditionally obligated to issue to such holder in exchange for
each such Series A Preferred Share a certificate representing one Bank Preferred
Share (the "Automatic Exchange"). Absent the occurrence of the Exchange Event,
no shares of Bank Preferred Shares will be issued.
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.
Redemption. The Series A Preferred Shares are not redeemable prior to January
15, 2007 (except upon the occurrence of certain tax events). 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. 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.
The Company will also have the right at any time, upon the occurrence of certain
tax events 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.
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
12
<PAGE>
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.
Independent Director Approval. As long as any Series A Preferred Shares are
outstanding, certain actions by the Company must be approved by a majority of
the independent directors (the "Independent Directors"). 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.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data of the Company herein has been derived from the
Financial Statements of the Company, which statements have been audited by
Arthur Andersen LLP, independent public accountants, as indicated by their
report with respect thereto included elsewhere in this Form 10-K. The data
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Financial Statements
included elsewhere herein.
As of or for the As of or for the
year ended period ended
OPERATING DATA: December 31, 1997 December 31, 1996
----------------- -----------------
Interest income ............................ $ 23,219,408 $ 1,943,288
Provision for loan losses .................. 65,195 -
Net interest income after
provision for loan losses ................ 23,154,213 1,943,288
Operating expenses ......................... 1,526,564 111,414
Net income ................................. 21,627,649 1,831,874
Earnings available to common stockholder ... 6,065,149 578,234
Earnings per common share .................. 60,651.49 5,782.34
DIVIDENDS DECLARED:
Dividends on common stock .................. $ 6,150,000 $ 584,749
Dividends on preferred stock ............... 15,562,500 1,253,640
BALANCE SHEET DATA:
Residential mortgage loans, net ............ $290,382,131 $294,504,138
Total assets ............................... 306,823,316 302,318,288
Total stockholders' equity ................. 299,915,149 299,993,485
Number of preferred shares outstanding ..... 3,000,000 3,000,000
Number of common shares outstanding ........ 100 100
Average yield on residential mortgage loans. 7.85% 7.79%
13
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
Residential Mortgage Loans
At December 31, 1997, the Company had $290,382,131 invested in Residential
Mortgage Loans compared to $294,504,138 at December 31, 1996. The $4,122,007
decrease represents a 1.4% decline from the balance at December 31, 1996, due
primarily to Residential Mortgage Loan principal collections of $86,649,302,
which were offset by purchases of $82,980,950. In addition, the Company received
proceeds of $214,722 on the sale of one property classified as real estate
acquired in settlement of loans during the year ended December 31, 1997.
Management intends to continue to reinvest proceeds received from repayments of
loans by purchasing additional Residential Mortgage Loans from either the Bank
or its affiliates.
At December 31, 1997, the Company had four 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 $807,028. There were no non-accrual Residential
Mortgage Loans at December 31, 1996.
At December 31, 1997, the Company had seven delinquent loans (loans delinquent
30-89 days) with an aggregate principal balance of $1,616,662 (or 0.56% of
loans). There were no delinquent Residential Mortgage Loans at December 31,
1996.
Allowance for Loan Losses
Management reviews the loan portfolio to establish an allowance for estimated
losses if deemed necessary. An analysis to determine 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, past loss experience and estimated future loan losses. 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. The activity in the allowance for loan losses for the year ended
December 31, 1997 is as follows:
Year Ended
December 31, 1997
-----------------
Balance at December 31, 1996 $ -
Provision for loan losses 65,195
Charge-offs (27,572)
Recoveries 2,376
-------------
Balance at December 31, 1997 $ 39,999
=============
14
<PAGE>
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 Residential Mortgage Loans 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 Residential Mortgage
Loans and may find it more difficult to purchase additional loans bearing
interest rates sufficient to support payment of dividends on the Series A
Preferred Shares. In addition, certain Residential Mortgage Loan 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.
Based on the outstanding balance of the Company's Residential Mortgage Loans at
December 31, 1997 and the interest rate on such loans, anticipated annual
interest income on the Company's loan portfolio was approximately 142.4% 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 significant
decline in interest rates would not adversely affect the Company's ability to
pay dividends on the Series A Preferred Shares.
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 loans 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 REIT as discussed in "Business - Tax Status of the Company."
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 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 as it deems necessary.
15
<PAGE>
RESULTS OF OPERATIONS
The Company reported net income of $21,627,649 and $1,831,874 for the year ended
December 31, 1997 (the "year ended 1997") and the period from inception
(November 5, 1996) to December 31, 1996 (the "period ended 1996"), respectively.
Interest income on Residential Mortgage Loans totaled $23,079,170 and $1,940,387
for the year ended 1997 and the period ended 1996, respectively, which
represents an average yield on such loans of 7.85% and 7.79%, respectively. The
average loan balance of the Residential Mortgage Loan portfolio for the year
ended 1997 was $294,094,062 and for the period ended 1996 was $299,032,490. The
Company would have recorded an additional $45,402 in interest income for the
year ended 1997 had its non-accrual loans made payments in accordance with their
original terms.
Other interest income of $140,238 and $2,901 was recognized on the Company's
interest bearing deposits during the year ended 1997 and the period ended 1996,
respectively.
A provision for loan losses of $65,195 was recorded on the Company's loan
portfolio during the year ended 1997. There was no provision for loan losses
during the period ended 1996.
Operating expenses totaling $1,526,564 and $111,414 were comprised of loan
servicing fees paid to its parent, advisory fees paid to its parent, directors
fees and general and administrative expenses during the year ended 1997 and the
period ended 1996, respectively. Loan servicing fees paid to its parent of
$1,137,487 and $91,413 for the year ended 1997 and the period ended 1996,
respectively, were based on a servicing fee rate of 0.375% of the outstanding
principal balances of Residential Mortgage Loans, pursuant to the Servicing
Agreement. See "Business - Servicing." Advisory fees paid to its parent for the
year ended 1997 and the period ended 1996 totaled $200,000 and $16,667,
respectively. See "Business - The Advisor." Directors fees totaled $25,500 and
$3,167 during the year ended 1997 and the period ended 1996, respectively, and
represent compensation to the two independent members of the Board of Directors.
See "Executive Compensation." General and administrative expenses consist
primarily of amortization of organizational costs and independent auditor
services.
During the year ended 1997, the Company declared cash dividends of $15,562,500,
representing $5.1875 per share on the outstanding shares of Series A Preferred
Shares, out of the retained earnings of the Company.
Also during the year ended 1997, the Company declared cash dividends of
$61,500.00 per share of Common Stock, $6,065,149 of which was paid out of the
retained earnings of the Company and $84,851 of which was treated as a return of
capital.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
16
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONTENTS
Page
(a) Report of Independent Public Accountants.............................. F-2
(b) Statements of Financial Condition at
December 31, 1997 and 1996 ................................... F-3
(c) Statements of Operations for the Year Ended
December 31, 1997 and the Period Ended December 31, 1996............. F-4
(d) Statements of Stockholders' Equity for the Year Ended
December 31, 1997 and the Period Ended December 31, 1996............. F-5
(e) Statements of Cash Flows for the Year Ended
December 31, 1997 and the Period Ended December 31, 1996............. F-6
(f) Notes to Financial Statements......................................... F-7
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Chevy Chase Preferred Capital Corporation:
We have audited the accompanying statements of financial condition of Chevy
Chase Preferred Capital Corporation (the "Company," a Maryland corporation) as
of December 31, 1997 and 1996, and the related statements of operations,
stockholders' equity and cash flows for the periods then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of December 31,
1997 and 1996, and the results of its operations and its cash flows for the
periods then ended in conformity with generally accepted accounting principles.
Arthur Andersen LLP
-------------------
Washington, D.C.,
March 10, 1998
F-2
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
STATEMENTS OF FINANCIAL CONDITION
December 31,
-----------------------------
1997 1996
-------------- --------------
ASSETS
Cash and interest-bearing deposits $ 3,894,269 $ 365,175
Residential mortgage loans (net of allowance
for loan losses of $39,999 at December 31, 1997) 290,382,131 294,504,138
Real estate acquired in settlement of loans 173,738 -
Accounts receivable from parent 10,374,891 5,844,149
Accrued interest receivable 1,562,478 1,604,826
Prepaid expenses 435,809 -
-------------- --------------
Total assets $ 306,823,316 $ 302,318,288
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable to parent $ 163,793 $ 483,080
Accounts payable - others 3,749 3,334
Dividends payable to parent 2,850,000 584,749
Dividends payable - others 3,890,625 1,253,640
-------------- --------------
Total liabilities 6,908,167 2,324,803
-------------- --------------
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 284,915,049 284,993,385
Retained earnings - -
-------------- --------------
Total stockholders' equity 299,915,149 299,993,485
-------------- --------------
Total liabilities and stockholders' equity $ 306,823,316 $ 302,318,288
============== ==============
The accompanying Notes to Financial Statements are an integral part of these
statements.
F-3
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
STATEMENTS OF OPERATIONS
Year Ended Period Ended
December 31, December 31,
1997 1996(1)
-------------- --------------
Interest income:
Residential mortgage loans $ 23,079,170 $ 1,940,387
Other 140,238 2,901
-------------- --------------
Total interest income 23,219,408 1,943,288
Provision for loan losses 65,195 -
-------------- --------------
Net interest income after provision
for loan losses 23,154,213 1,943,288
-------------- --------------
Operating expenses:
Loan servicing fees-parent 1,137,487 91,413
Advisory fees-parent 200,000 16,667
Directors fees 25,500 3,167
General and administrative 163,577 167
-------------- --------------
Total operating expenses 1,526,564 111,414
-------------- --------------
NET INCOME 21,627,649 1,831,874
PREFERRED STOCK DIVIDENDS 15,562,500 1,253,640
-------------- --------------
EARNINGS AVAILABLE TO
COMMON STOCKHOLDER $ 6,065,149 $ 578,234
============== ==============
EARNINGS PER COMMON SHARE $ 60,651.49 $ 5,782.34
============== ==============
- ------------------------------------
(1) For the period from inception (November 5, 1996) through December 31, 1996.
The accompanying Notes to Financial Statements are an integral part of these
statements.
F-4
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
Capital
Contributed
Preferred Common in Excess Retained Stockholders'
Stock Stock of Par Earnings Equity
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Issuance of Common Stock
on November 5, 1996 $ - $ 100 $ 900 $ - $ 1,000
Initial public offering of 103/8%
Noncumulative Exchangeable
Preferred Stock, Series A
on December 3, 1996 15,000,000 - 129,000,000 - 144,000,000
Capital contribution from
Common Stockholder
on December 3, 1996 - - 155,999,000 - 155,999,000
Net income - - - 1,831,874 1,831,874
Dividends on 103/8%
Noncumulative Exchangeable
Preferred Stock, Series A - - - (1,253,640) (1,253,640)
Dividends on
Common Stock - - (6,515) (578,234) (584,749)
------------- ------------- ------------- ------------- -------------
Balance, December 31, 1996 15,000,000 100 284,993,385 - 299,993,485
Capital contribution from
Common Stockholder - - 6,515 - 6,515
Net income - - - 21,627,649 21,627,649
Dividends on 103/8%
Noncumulative Exchangeable
Preferred Stock, Series A - - - (15,562,500) (15,562,500)
Dividends on
Common Stock - - (84,851) (6,065,149) (6,150,000)
------------- ------------- ------------- ------------- -------------
Balance, December 31, 1997 $ 15,000,000 $ 100 $284,915,049 $ - $299,915,149
============= ============= ============= ============= =============
</TABLE>
The accompanying Notes to Financial Statements are an integral part of these
statements.
F-5
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
STATEMENTS OF CASH FLOWS
Year Ended Period Ended
December 31, December 31,
1997 1996(1)
------------- -------------
Cash flows from operating activities:
Net income $ 21,627,649 $ 1,831,874
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for loan losses 65,195 -
Increase in accounts receivable from parent (4,530,742) (5,844,149)
(Increase) decrease in accrued interest receivable 42,348 (1,604,826)
Increase in prepaid expenses (435,809) -
Increase (decrease) in accounts payable to parent (319,287) 483,080
Increase in accounts payable - others 415 3,334
------------- -------------
Net cash provided by (used in) operating activities 16,449,769 (5,130,687)
------------- -------------
Cash flows from investing activities:
Purchases of residential mortgage loans (82,980,950) (301,637,523)
Repayments of residential mortgage loans 86,649,302 7,133,385
Net proceeds from sale of real estate acquired
in settlement of loans 214,722 -
------------- -------------
Net cash provided by (used in) investing activities 3,883,074 (294,504,138)
------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock - 1,000
Net proceeds from issuance of preferred stock - 144,000,000
Capital contribution from common stockholder 6,515 155,999,000
Dividends paid on preferred stock (12,925,515) -
Dividends paid on common stock (3,884,749) -
------------- -------------
Net cash provided by (used in) financing activities (16,803,749) 300,000,000
------------- -------------
Net increase in cash and cash equivalents 3,529,094 365,175
Cash and cash equivalents at beginning of year 365,175 -
------------- -------------
Cash and cash equivalents at end of year $ 3,894,269 $ 365,175
============= =============
Supplemental disclosures of non-cash activities:
Net transfer of loans receivable to real
estate acquired in settlement of loans $ 388,460 $ -
============= =============
- ------------------------------------
(1) From inception (November 5, 1996) through December 31, 1996.
The accompanying Notes to Financial Statements are an integral part of these
statements.
F-6
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 and 1996
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION:
Chevy Chase Preferred Capital Corporation (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 (as defined below). The Bank is in compliance with
its regulatory capital requirements.
On November 5, 1996, the Company was initially capitalized with the issuance to
the Bank of 100 shares of the Company's common stock (the "Common Stock"), $1.00
par value. On December 3, 1996, the Company commenced its operations upon
consummation of an initial public offering of 3,000,000 shares of the Company's
103/8% Noncumulative Exchangeable Preferred Stock, Series A (the "Series A
Preferred Shares"), $5.00 par value. These offerings, together with a separate
capital contribution made by the Bank on December 3, 1996, raised net capital of
$300 million.
The Company used the proceeds raised from the initial public offering of the
Series A Preferred Shares, the sale of Common Stock to the Bank and the
additional capital contribution to the Company by the Bank to pay the expenses
related to the offering and the formation of the Company and to purchase from
the Bank the Company's initial portfolio of residential mortgage loans at their
estimated fair value of approximately $300 million. Such loans were recorded in
the accompanying statements of financial condition at the Bank's historical cost
basis which approximated their estimated fair values. See Note 8.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Use of Estimates:
The financial statements have been prepared in conformity with generally
accepted accounting principles. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
liabilities as of the date of the statements of financial condition and income
and expenses for the reporting periods. Actual results could differ from those
estimates.
Cash and Cash Equivalents:
For purposes of reporting cash flows, cash and cash equivalents include cash and
interest-bearing deposits.
F-7
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):
Residential Mortgage Loans:
Residential mortgage loans are carried at the principal amount outstanding.
Interest income is accrued and recognized using the interest method or on a
basis approximating a level rate of return over the term of the loan.
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 and interest has
become unlikely. Uncollectible accrued interest receivable on non-accrual loans
is charged against current period income. The Company had four non-accrual loans
at December 31, 1997 totaling $807,029. At December 31, 1996, the Company had no
non-accrual loans.
Allowance for Loan Losses:
Management periodically reviews the residential mortgage loan portfolio to
establish an allowance for estimated losses if deemed necessary. An allowance is
provided after considering such factors as the economy in lending areas,
delinquency statistics, past loss experience and estimated future losses. The
allowance for losses is based on estimates, and ultimate losses may vary from
current estimates. As adjustments to the allowance become necessary, provisions
for losses are reported in operations in the periods they are determined to be
necessary.
Concentrations of Credit:
Substantially all of the Company's residential mortgage loans 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. Adverse changes in economic conditions could have a direct impact
on the timing and amounts of payments by borrowers.
Accounts Receivable from Parent:
Accounts receivable from parent represents principal and interest payments
received from borrowers by the Bank as servicer of the mortgage loans which are
being held by the servicer in a custodial account pending remittance to the
Company. The Company receives remittances from the servicer on the 10th day of
each month. See Note 7.
F-8
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):
Accounts Payable to Parent:
Accounts payable to parent represents fees owed to the Bank for managing the
operations of the Company, for servicing the Company's residential mortgage
loans and for expenses paid by the Bank on behalf of the Company. See Note 7.
Dividends:
Preferred Stock. Dividends on the Series A Preferred Shares are payable at a
rate of 103/8% per annum of the liquidation preference (an amount equal to
$5.1875 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.
Common Stock. The stockholder is entitled to receive dividends if, when and as
declared by the Board of Directors out of funds legally available after all
preferred dividends have been paid.
Earnings Per Common Share:
Dividends on preferred stock are deducted from earnings in the computation of
earnings per common share when declared by the Company's Board of Directors.
Earnings per common share assuming dilution equals the basic earnings per common
share.
Income Taxes:
The Company has elected, for Federal income tax purposes, to be treated as a
Real Estate Investment Trust ("REIT") and intends to comply with the provisions
of the Internal Revenue Code of 1986, as amended (the "IRC"). Accordingly, the
Company will not be subject to Federal corporate income taxes to the extent it
distributes at least 100% of its REIT taxable income to stockholders and as long
as certain asset, income and stock ownership tests are met in accordance with
the IRC. Because management of the Company believes it qualifies as a REIT for
Federal income tax purposes, no provision for income taxes is included in the
accompanying financial statements.
F-9
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):
Adoption Of Recently Issued Accounting Standards:
SFAS No. 129, "Disclosure of Information about Capital Structure," ("SFAS 129")
establishes standards for disclosing information about an entity's capital
structure. SFAS 129 supersedes capital structure disclosure requirements found
in previous accounting pronouncements and consolidates them into one statement
for ease of retrieval and greater visibility for non-public entities. SFAS 129
is effective for financial statements for periods ending after December 15,
1997. Because SFAS 129 addresses only disclosure-related issues, its adoption
did not have an impact on the Company's financial condition or its results of
operations.
Accounting Standards Issued But Not Yet Adopted:
SFAS No. 130, "Reporting Comprehensive Income" ("SFAS 130"), was issued in June
1997 and establishes accounting standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS 130 requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. SFAS 130 also requires an enterprise to classify
items of other comprehensive income by their nature in a financial statement and
to display the accumulated balance of other comprehensive income separately from
retained earnings and capital contributed in excess of par in the equity section
of a statement of financial position. SFAS 130 is effective for fiscal years
beginning after December 15, 1997 and will apply to the Company's reporting
beginning in the first quarter of 1998. Because SFAS 130 addresses only
financial statement presentation, its adoption will not have a material impact
on the Company's financial condition or results of operations.
F-10
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
NOTE 3 - RESIDENTIAL MORTGAGE LOANS:
Residential mortgage loans consist of one-year adjustable rate mortgages
("ARMs"), three-year ARMs, five-year and ten-year fixed-rate loans with
automatic adjustment to one-year ARMs after the respective fixed rate period and
conventional 30-year fixed-rate mortgages. The following table shows the
residential mortgage loan portfolio by type at the dates indicated:
December 31,
--------------------------------
1997 1996
-------------- --------------
One-year ARMs $ 27,657,820 $ -
Three-year ARMs 78,228,562 105,412,171
5/1 ARMs 165,785,490 182,414,336
10/1 ARMs 16,196,915 6,677,631
30 year fixed-rate 2,553,343 -
-------------- --------------
Total 290,422,130 294,504,138
Less:
Allowance for loan losses 39,999 -
-------------- --------------
Total $ 290,382,131 $ 294,504,138
============== ==============
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.
NOTE 4 - ALLOWANCE FOR LOAN LOSSES:
Activity in the allowance for loan losses on loans receivable is summarized as
follows:
Balance, December 31, 1996 $ -
Provision for losses 65,195
Charge-offs (27,572)
Recoveries 2,376
--------------
Balance, December 31, 1997 $ 39,999
==============
F-11
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
NOTE 5 - PREFERRED STOCK:
On December 3, 1996, the Company sold $150 million of Series A Preferred Shares,
$5.00 par value and received net cash proceeds of $144 million. Cash dividends
on the Series A Preferred Shares, if, when and as declared by the Board of
Directors, are payable quarterly in arrears at an annual rate of 103/8%. 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, and are redeemable thereafter at the option of the Company. Except
under certain 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.
NOTE 6 - DIVIDENDS:
During the year ended December 31, 1997, the Company's Board of Directors
declared $15,562,500 of preferred stock dividends out of retained earnings of
the Company and $6,150,000 of common stock dividends, $6,065,149 of which was
paid out of the retained earnings of the Company and $84,851 of which was
treated as a return of capital. Of these amounts, preferred stock dividends of
$3,890,625 and common stock dividends of $2,850,000 were paid subsequent to
December 31, 1997.
NOTE 7 - RELATED PARTY TRANSACTIONS:
The Company has entered into an advisory agreement (the "Advisory Agreement")
with the Bank (the "Advisor"). The Advisor provides advice to the Board of
Directors and manages the operations of the Company as defined in the Advisory
Agreement. The Advisory Agreement has an initial term of three years commencing
on December 3, 1996 and automatically renews for additional one-year periods
unless the Company delivers a notice of nonrenewal to the Advisor. The Advisory
Agreement may be terminated by the Company at any time upon sixty days' prior
written notice. The advisory fee is $200,000 per annum payable in equal
quarterly installments.
The Company also entered into a servicing agreement with the Bank for the
servicing of its residential mortgage loans (the "Servicing Agreement").
Pursuant to the Servicing Agreement, the Bank performs the servicing of the
residential mortgage loans owned by the Company, in accordance with normal
industry practice. The Servicing Agreement can be terminated without cause with
at least sixty days' notice to the servicer and payment of a termination fee.
The servicing fee rate is 0.375% of the outstanding principal balance of the
residential mortgage NOTE 7 - RELATED PARTY TRANSACTIONS (Continued):
loans. Servicing fees for the year ended December 31, 1997 and the period ended
December 31, 1996 totaled $1,137,487 and $91,413, respectively.
The Company had cash balances of $3,894,269 and $365,175 as of December 31, 1997
and 1996, respectively, held in various deposit accounts with the Bank. Interest
earned on these accounts was $140,238 for the year ended December 31, 1997 and
$2,901 for the period ended December 31, 1996.
F-12
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
NOTE 8 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS:
The majority of the Company'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 deriving the Company's fair values, resulting
in a degree of subjectivity inherent in the indicated fair value amounts. Since
the fair value is estimated as of the balance sheet date, the amount which will
actually be realized or paid upon settlement or maturity could be significantly
different. Comparability among REITs may be difficult due to the wide range of
permitted valuation techniques and the numerous estimates and assumptions which
must be made.
F-13
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
NOTE 8 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued):
The estimated fair value of the Company's financial instruments at December 31,
1997 and 1996 are as follows:
December 31, 1997
-------------------------------
Carrying Fair
Amount Value
-------------- --------------
Financial assets:
Cash and interest-bearing deposits $ 3,894,269 $ 3,894,269
Residential mortgage loans
receivable, net 290,382,131 291,310,000
Other financial assets 11,937,369 11,937,369
Financial liabilities 6,908,167 6,908,167
December 31, 1996
-------------------------------
Carrying Fair
Amount Value
-------------- --------------
Financial assets:
Cash and interest-bearing deposits $ 365,175 $ 365,175
Residential mortgage loans
receivable, net 294,504,138 294,504,138
Other financial assets 7,448,975 7,448,975
Financial liabilities 2,324,803 2,324,803
The following methods and assumptions were used to estimate the fair value
amounts at December 31, 1997 and 1996.
Cash and interest-bearing deposits: Carrying amount approximates fair value.
Residential mortgage loans: Fair value of the residential mortgage loans is
estimated using discounted cash flow analyses based on contractual repayment and
anticipated prepayment schedules. The discount rates used in these analyses are
based on either the interest rates paid on U.S. Treasury securities of
comparable maturities adjusted for credit risk and non-interest operating costs,
or the interest rates currently offered for loans with similar terms to
borrowers of similar credit quality.
F-14
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
NOTE 8 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued):
Other financial assets: The carrying amounts of accounts receivable from parent
and accrued interest receivable approximate fair value.
Financial liabilities: The carrying amounts of accounts payable to parent,
accounts payable - others, dividends payable to parent and dividends payable -
others approximate fair value.
F-15
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors and Executive Officers
The Company's Board of Directors currently consists of six members, two of whom
are not officers or employees of the Company and are not directors, officers or
employees of the Bank or any of its affiliates (the "Independent Directors").
Each director was elected to serve for a term of one year and until his
successor shall have been duly elected and qualified. The Board of Directors met
four times during the year ended 1997 and all of its members attended at least
75% of the meetings. The Company currently has eight officers. The Company has
no other employees and does not anticipate that it will require additional
employees.
The following persons are the Company's current directors and/or executive
officers, each of whom has served since 1996.
Name Age Position and Offices Held
- -------------------------- --- -----------------------------------------
B. Francis Saul II........ 65 Chairman of the Board, President
and Chief Executive Officer
Alexander R. M. Boyle..... 59 Director
Stephen R. Halpin, Jr..... 42 Executive Vice President, Chief Financial
Officer, Treasurer and Director
N. Alexander MacColl, Jr.. 63 Director
Leslie A. Nicholson....... 57 Executive Vice President, General
Counsel and Director
John J. O'Connor III...... 67 Director
17
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
The following is a summary of the experience of the executive officers and
directors of the Company:
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 the B. F.
Saul Company since 1969. Mr. Saul has also served as the Chairman of the 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 December 31, 1997, 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 serves as Chairman of the Board and Chief Executive Officer of Saul
Centers, Inc., a public real estate investment trust. He 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 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 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 is also a
Trustee of the B. F. Saul Employees Profit Sharing Retirement Trust. Mr. Boyle
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 the 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 public accounting firm.
N. ALEXANDER MACCOLL, JR. was a 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.
LESLIE A. NICHOLSON joined the Bank as Executive Vice President and General
Counsel on June 1, 1996. Prior to joining the Bank, Mr. Nicholson had been a
partner for twenty four years in the firm of Shaw, Pittman, Potts & Trowbridge
in Washington, D.C., where he was a member of its Management Committee and
Chairman of its Litigation Department. Mr. Nicholson is a member of the American
College of Real Estate Lawyers and the American College of Construction Lawyers,
where he served as a National Governor for three years, and a member of the
Board of Directors of the Frederick M. Abramson Foundation.
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.
18
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
Audit Committee
The Company's audit committee reviews the engagement of independent accountants
and reviews their independence. The audit committee also reviews the adequacy of
the Company's internal accounting controls. The audit committee is comprised of
John J. O'Connor III and N. Alexander MacColl, Jr. The audit committee did not
meet in 1997.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), requires the Company's officers, directors and persons who own more than
ten percent of either the Common Stock or the Series A Preferred Shares to file
reports of ownership on Form 3 and changes in ownership on Form 4 or 5 with the
Securities and Exchange Commission (the "SEC") and the New York Stock Exchange.
Such officers, directors and ten percent shareholders are also required by SEC
rules to furnish the Company with copies of all Section 16(a) forms that they
file.
Based solely on its review of copies of such reports received or representations
from certain reporting persons, the Company believes that, during the year ended
December 31, 1997, all of its officers, directors and ten percent shareholders
complied with all Section 16(a) filing requirements applicable to them with
respect to transactions during fiscal 1997, except as follows. Mr. Boyle filed a
Form 4 late reporting a disposition of Series A Preferred Shares.
ITEM 11. EXECUTIVE COMPENSATION
Since the Company's inception on November 5, 1996, no compensation has been
awarded to, earned by or paid to any of the Company's directors (other than its
Independent Directors), officers or employees. The Company does not intend to
pay any compensation to any of its directors (other than its Independent
Directors), officers or employees. The Company intends to pay the Independent
Directors 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. In 1997, each
of the Independent Directors earned the $3,000 fee for attending four Board of
Directors meetings.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of March 15, 1998, the number and percentage
of outstanding shares of Common Stock and Series A Preferred Shares beneficially
owned by (i) all persons known by the Company to own more than five percent of
such shares; (ii) each director of the Company; (iii) each executive officer of
the Company; and (iv) all executive officers and directors of the Company as a
group. The persons or entities named in the table have sole voting and sole
investment power with respect to each of the shares beneficially owned by such
person or entity. The calculations were based on a total of 100 shares of Common
Stock and 3,000,000 Series A Preferred Shares outstanding as of March 15, 1998.
19
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
Names and Address of Amount of Beneficial Percent of Class of
Beneficial Owner (1) Ownership Outstanding Shares
- ------------------------------- --------------------- ---------------------
Chevy Chase Bank, F.S.B. 100 Common - 100%
B. Francis Saul II (2)(3) 0 0%
Alexander R. M. Boyle (2) 0 0%
Stephen R. Halpin, Jr. (2)(3) 1,000 Preferred - 0.033%
N. Alexander MacColl, Jr. (2) 0 0%
Leslie A. Nicholson (2)(3) 0 0%
John J. O'Connor III (2) 0 0%
All directors and executive 1,000 Preferred - 0.033%
officers as a group (6 persons)
(1) The address of each beneficial owner is 8401 Connecticut Avenue,
Chevy Chase, Maryland 20815.
(2) Indicates a director of the Company.
(3) Indicates an executive officer of the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Set forth below are certain transactions between the Company and its directors
and affiliates. 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 administers the day-to-day operations of the Company and is entitled to
receive fees in connection with the Advisory Agreement. Advisory fees paid to
the Bank for the year ended December 31, 1997 totaled $200,000. See "Business -
The Advisor."
The Bank services the Residential Mortgage Loans included in the Company's
portfolio and is entitled to receive fees in connection with the Servicing
Agreement. Loan servicing fees paid to the Bank for the year ended December 31,
1997 totaled $1,137,487. See "Business - Servicing."
The Company had cash balances of $3,894,269 as of December 31, 1997 held in
various deposit accounts with the Bank. Interest earned on these accounts was
$140,238 for the year ended December 31, 1997.
20
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The following financial statements of the Company are included
in Item 8 of this report:
Report of Independent Public Accountants
Statements of Financial Condition at
December 31, 1997 and 1996
Statements of Operations for the Year Ended
December 31, 1997 and the Period Ended December 31, 1996
Statements of Stockholders' Equity for the Year Ended
December 31, 1997 and the Period Ended December 31, 1996
Statements of Cash Flows for the Year Ended
December 31, 1997 and the Period Ended December 31, 1996
Notes to Financial Statements
(a)(2) All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission
are not required under the related instruction or are
inapplicable and therefore have been omitted.
(a)(3) Exhibits:
3.1 Articles of Incorporation of the Company, as amended
(incorporated herein by reference to Exhibit 3.1 of the Company's
1996 Annual Report on Form 10-K).
3.2 Bylaws of the Company (incorporated herein by reference to
Exhibit 3(b) of Form S-11 (file number 333-10495) filed by the
Company).
4.1 Articles Supplementary of 103/8% Noncumulative Exchangeable
Preferred Stock, Series A. (incorporated herein by reference to
Exhibit 4.1 of the Company's 1996 Annual Report on Form 10-K).
10.1 Residential Mortgage Loan Purchase Agreement between the Company
and the Bank (incorporated herein by reference to Exhibit 10.1 of
the Company's 1996 Annual Report on Form 10-K).
10.2 Mortgage Loan Servicing Agreement between the Company and the
Bank (incorporated herein by reference to Exhibit 10.2 of the
Company's 1996 Annual Report on Form 10-K).
10.3 Advisory Agreement between the Company and the Bank (incorporated
herein by reference to Exhibit 10.3 of the Company's 1996 Annual
Report on Form 10-K).
* 12.1 Computation of ratio of earnings to fixed charges and Preferred
Stock dividend requirements.
* 27 Financial Data Schedule.
(b) No reports on Form 8-K were issued during the three months ended
December 31, 1997
- ------------------
* Filed herewith.
21
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
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
March 17, 1998.
CHEVY CHASE PREFERRED CAPITAL CORPORATION
(Registrant)
By: /s/ B. Francis Saul II
-----------------------
B. Francis Saul II
Chairman of the Board of Directors
and President 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 officers and directors of the Registrant
and in the capacities and on the dates indicated.
March 17, 1998 By: /s/ Alexander R. M. Boyle
-------------------------
Alexander R. M. Boyle
Director
March 17, 1998 By: /s/ Joel A. Friedman
--------------------
Joel A. Friedman
Senior Vice President and
Controller
(Principal Accounting Officer)
March 17, 1998 By: /s/ Stephen R. Halpin, Jr.
--------------------------
Stephen R. Halpin, Jr.
Director,
Executive Vice President, Treasurer and
Chief Financial Officer
(Principal Financial Officer)
22
<PAGE>
CHEVY CHASE PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 1997 and 1996
March 17, 1998 By: /s/ N. Alexander MacColl, Jr.
-----------------------------
N. Alexander MacColl, Jr.
Director
March 17, 1998 By: /s/ Leslie A. Nicholson
-----------------------
Leslie A. Nicholson
Director,
Executive Vice President and
General Counsel
March 17, 1998 By: /s/ John J. O'Connor III
------------------------
John J. O'Connor III
Director
March 17, 1998 By: /s/ B. Francis Saul II
----------------------
B. Francis Saul II
Chairman of the Board,
President and Chief Executive Officer
(Principal Executive Officer)
23
<PAGE>
EXHIBIT 12.1
CHEVY CHASE PREFERRED CAPITAL CORPORATION
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
AND PREFERRED STOCK DIVIDEND REQUIREMENTS
(in thousands. except ratio)
Year Ended Period Ended
December 31, December 31,
1997 1996 1
------------- -------------
Net income $ 21,628 $ 1,832
Fixed charges - -
Earnings before fixed charges $ 21,628 $ 1,832
Fixed charges, as above $ - $ -
Preferred stock dividend requirements 15,563 1,254
Fixed charges including preferred stock
dividends $ 15,563 $ 1,254
Ratio of earnings to fixed charges and
preferred stock dividend requirements 1.39 1.46
- --------
1 For the period from inception (November 5, 1996) through December 31, 1996.
<PAGE>
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<ARTICLE> 5
<S> <C>
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