<PAGE>
Supplement Dated March 16, 1994
to Prospectus Dated January 28, 1994
____________________
B. F. SAUL
REAL ESTATE INVESTMENT TRUST
QUARTERLY REPORT
FOR QUARTER ENDED
DECEMBER 31, 1993
____________________
<PAGE>
TABLE OF CONTENTS
PAGE
FINANCIAL STATEMENTS
(a) Consolidated Balance Sheets at December 31,1993 and
September 30, 1993. . . . . . . . . . . . . . . . . . 3
(b) Consolidated Statements of Operations and Defi-
cit for the three-month periods ended December
31, 1993 and 1992. . . . . . . . . . . . . . . . . . 4
(c) Consolidated Statements of Cash Flows for the
three-month periods ended December 31, 1993 and
1992 . . . . . . . . . . . . . . . . . . . . . . . . 6
(d) Notes to Consolidated Financial Statements. . . . . . 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(a) Financial Condition
Real Estate. . . . . . . . . . . . . . . . . . . 15
Banking. . . . . . . . . . . . . . . . . . . . . 16
(b) Liquidity and Capital Resources
Real Estate. . . . . . . . . . . . . . . . . . . 42
Banking . . . . . . . . . . . . . . . . . . . . . 45
Liquidity . . . . . . . . . . . . . . . . . 45
Capital . . . . . . . . . . . . . . . . . . 47
(c) Results of Operations
Three Months Ended December 31, 1993
Compared to Three Months Ended December
31, 1992
Real Estate . . . . . . . . . . . . . . . . . . . 51
Banking . . . . . . . . . . . . . . . . . . . . . 55
-2-
<PAGE>
CONSOLIDATED BALANCE SHEETS
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
December 31 September 30
(Dollars in thousands) 1993 1993
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
REAL ESTATE
Income-producing properties
Commercial $ 109,796 $ 109,513
Hotel 110,309 111,484
Other 4,543 3,985
------------ ------------
224,648 224,982
Accumulated depreciation (64,684) (62,626)
------------ ------------
159,964 162,356
Land parcels 38,416 38,411
Cash and cash equivalents 1,668 2,710
Other assets 54,792 17,079
------------ ------------
Total real estate assets 254,840 220,556
- ---------------------------------------------------------------------------------------------------------------------------------
BANKING
Cash and due from banks 162,643 178,508
Interest-bearing deposits 24,056 4,691
Federal funds sold 30,000 --
Investment securities (market value $4,796 and $4,822, respectively) 4,796 4,789
Loans held for sale 211,476 176,027
Loans held for securitization and sale 300,000 300,000
Mortgage-backed securities (market value $1,351,066 and $1,528,060, respectively) 1,351,066 1,501,192
Loans receivable (net of reserve for losses of $66,940 and $68,040, respectively) 2,270,629 1,861,753
Federal Home Loan Bank stock 31,543 31,150
Real estate held for investment or sale (net of reserve for losses of $111,463
and $111,644, respectively) 367,647 388,459
Property and equipment, net 138,836 135,800
Cost in excess of net assets acquired, net 8,593 9,383
Excess servicing assets, net 22,115 27,573
Purchased mortgage servicing rights, net 18,449 20,472
Other assets 188,750 232,974
------------ ------------
Total banking assets 5,130,599 4,872,771
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 5,385,439 $ 5,093,327
- ---------------------------------------------------------------------------------------------------------------------------------
LIABILITIES
REAL ESTATE
Mortgage notes payable $ 264,914 $ 264,776
Notes payable - unsecured 39,887 38,661
Deferred gains - real estate 109,253 109,027
Other liabilities and accrued expenses 38,712 37,689
------------ ------------
Total real estate liabilities 452,766 450,153
- ---------------------------------------------------------------------------------------------------------------------------------
BANKING
Deposit accounts 3,946,272 3,870,023
Securities sold under repurchase agreements and other short-term borrowings 194,189 88,266
Bonds payable 24,320 24,605
Notes payable 7,877 7,925
Federal Home Loan Bank advances 474,500 412,000
Custodial accounts 23,857 25,925
Amounts due to banks 26,262 26,723
Other liabilities and accrued expenses 33,896 40,034
Capital notes -- subordinated 160,000 138,500
------------ ------------
Total banking liabilities 4,891,173 4,634,001
- ---------------------------------------------------------------------------------------------------------------------------------
Minority interest held by affiliates 36,646 34,495
Minority interest -- other 74,307 74,307
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 5,454,892 5,192,956
- ---------------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' DEFICIT
Preferred shares of beneficial interest, $10.50 cumulative, $1 par value, 90 million shares
authorized, 516,000 shares issued and outstanding, liquidation value $51.6 million 516 516
Common shares of beneficial interest, $1 par value, 10 million shares authorized,
6,641,598 shares issued 6,642 6,642
Paid-in surplus 92,943 92,943
Deficit (134,287) (157,882)
Net unrealized holding gains 6,581 --
------------ ------------
(27,605) (57,781)
Less cost of 1,814,688 common shares of beneficial interest in treasury (41,848) (41,848)
------------ ------------
TOTAL SHAREHOLDERS' DEFICIT (69,453) (99,629)
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 5,385,439 $ 5,093,327
- ---------------------------------------------------------------------------------------------------------------------------------
See summary of significant accounting policies and notes to consolidated financial statements.
</TABLE>
-3-
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Three Months
Ended December 31
----------------------------------
(In thousands, except per share amounts) 1993 1992
-------------- --------------
<S> <C> <C>
REAL ESTATE
INCOME
- ------
Commercial properties $ 3,723 $ 12,997
Hotels 10,682 10,781
Other 449 472
-------------- --------------
Total income 14,854 24,250
- -------------------------------------------------------------------------------------------------------------------------------
EXPENSES
- --------
Direct operating expenses:
Commercial properties 1,705 3,651
Hotels 7,905 8,028
Land parcels and other 329 372
Interest expense 9,764 12,835
Amortization of debt expense 479 635
Depreciation 2,075 3,134
Advisory, management and leasing fees - related parties 1,533 1,684
General and administrative 501 334
Write-down of real estate to net realizable value 1,380 --
-------------- --------------
Total expenses 25,671 30,673
- -------------------------------------------------------------------------------------------------------------------------------
Equity in earnings of partnership investments 725 --
- -------------------------------------------------------------------------------------------------------------------------------
Loss on sales of property -- (539)
- -------------------------------------------------------------------------------------------------------------------------------
REAL ESTATE OPERATING LOSS (10,092) (6,962)
- -------------------------------------------------------------------------------------------------------------------------------
BANKING
INTEREST INCOME
- ---------------
Loans 59,164 62,135
Mortgage-backed securities 20,357 25,906
Trading securities 412 --
Investment securities 81 2,789
Other 1,642 1,314
-------------- --------------
Total interest income 81,656 92,144
- -------------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
- ----------------
Deposit accounts 31,383 33,582
Short-term borrowings 3,218 4,769
Long-term borrowings 7,619 6,637
-------------- --------------
Total interest expense 42,220 44,988
-------------- --------------
Net interest income 39,436 47,156
Provision for loan losses (12,095) (27,754)
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 27,341 19,402
- -------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME
- ------------
Credit card fees 7,401 7,461
Loan servicing fees 15,111 12,871
Deposit service fees 4,893 4,636
Gain on sales of trading securities, net 808 --
Loss on real estate held for investment or sale, net (284) (19,601)
Gain on sales of credit card relationships, loans and mortgage-backed securities, net 2,490 12,664
Gain on sales of mortgage servicing rights, net 2,572 1,724
Other 2,338 1,803
-------------- --------------
Total other income 35,329 21,558
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Continued on following page.
-4-
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Three Months
Ended December 31
----------------------------------
(In thousands, except per share amounts) 1993 1992
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BANKING (CONTINUED)
OPERATING EXPENSES
- ------------------
Salaries and employee benefits $ 21,406 $ 16,308
Loan expenses 6,474 2,699
Property and equipment 6,331 5,932
Advertising expenses 7,305 1,369
Computer expenses 6,334 5,708
Deposit insurance premiums 2,958 2,329
Amortization of cost in excess of net assets acquired 516 744
Other 5,351 4,605
-------------- --------------
Total operating expenses 56,675 39,694
- -------------------------------------------------------------------------------------------------------------------------------
BANKING OPERATING INCOME 5,995 1,266
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPANY
Operating loss before income taxes, extraordinary item,
cumulative effect of change in accounting principle and minority interest (4,097) (5,696)
Provision for income taxes (income tax benefit) (708) 232
-------------- --------------
Loss before extraordinary item, cumulative effect of change in accounting principle
and minority interest (3,389) (5,928)
Extraordinary item:
Loss on early extinguishment of debt, net of taxes (6,333) --
-------------- --------------
Loss before cumulative effect of change in accounting principle and minority interest (9,722) (5,928)
Cumulative effect of change in accounting principle 36,260 --
-------------- --------------
Income (loss) before minority interest 26,538 (5,928)
Minority interest held by affiliates (505) (118)
Minority interest -- other (2,438) --
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPANY NET INCOME (LOSS) 23,595 (6,046)
DEFICIT
Beginning of period (157,882) (160,980)
-------------- --------------
End of period $ (134,287) $ (167,026)
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS $ 22,240 $ (7,401)
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) PER COMMON SHARE
Loss before extraordinary item, cumulative effect
of change in accounting principle and minority interest $ (0.98) $ (1.51)
Extraordinary item:
Loss on early extinguishment of debt, net of taxes (1.31) --
-------------- --------------
Loss before cumulative effect of change in accounting
principle and minority interest (2.29) (1.51)
Cumulative effect of change in accounting principle 7.51 --
-------------- --------------
Income (loss) before minority interest 5.22 (1.51)
Minority interest held by affiliates (0.10) (0.02)
Minority interest - other (0.51) --
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) PER COMMON SHARE $ 4.61 $ (1.53)
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See summary of significant accounting policies and notes to consolidated
financial statements.
-5-
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Three Months
Ended December 31
----------------------------------
(In thousands) 1993 1992
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
REAL ESTATE
Net income (loss) $ 21,574 $ (6,520)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation 2,075 3,134
Write-down of real estate to net realizable value 1,380 --
Loss on sales of property -- 539
Increase in accounts receivable and accrued income (858) (24)
Increase in net deferred tax asset (37,186) --
Increase (decrease) in accounts payable and accrued expenses (1,319) 2,238
(Increase) decrease in tax sharing receivable 5,512 (445)
Amortization of debt expense 479 635
Equity in earnings of partnership investments (725) --
Other 3,273 5,152
-------------- --------------
(5,795) 4,709
-------------- --------------
BANKING
Net income 2,021 474
Adjustments to reconcile net income to net cash provided by operating activities:
Accretion of premiums, discounts and deferred loan fees (614) (3,192)
Depreciation and amortization 4,208 3,999
Amortization of cost in excess of net assets acquired, purchased
mortgage servicing rights and excess servicing assets 8,873 4,956
Loss on extinguishment of debt 10,476 --
Provision for loan losses 12,095 27,754
Net fundings of loans held for sale (370,761) (215,665)
Proceeds from sales of trading securities 205,109 --
Proceeds from sales of loans and securities held for sale and/or
securitization 181,650 570,906
Equity (earnings) loss from investments in limited partnerships (461) 15
Gain on real estate held for investment or sale, net (1,848) (702)
Provision for losses on real estate held for investment or sale 3,867 22,694
Gain on sales of trading securities, net (808) --
Gain on sales of credit card relationships, loans and mortgage-backed
securities, net (2,490) (12,664)
Gain on sales of mortgage servicing rights, net (2,572) (1,724)
Minority interest held by affiliates 505 118
Minority interest - other 2,438 --
(Increase) decrease in other assets 40,538 (2,743)
Decrease in other liabilities and accrued expenses (6,599) (2,088)
Increase (decrease) in tax sharing payable (5,512) 445
Other, net (1,618) 2,755
-------------- --------------
78,497 395,338
-------------- --------------
Net cash provided by operating activities 72,702 400,047
- -------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
REAL ESTATE
Capital expenditures - properties (1,037) (3,928)
Property sales -- 386
Equity investment in unconsolidated entities 112 (28)
Other investing activities 6 3
-------------- --------------
(919) (3,567)
-------------- --------------
BANKING
Proceeds from sales of loans -- 4,553
Net proceeds from sales of real estate 22,448 24,191
Net proceeds from sales of mortgage servicing rights 2,572 1,724
Net fundings of loans receivable (302,692) (114,381)
Principal collected on mortgage-backed securities 162,319 128,827
Purchases of mortgage-backed securities (48,636) (40,550)
Purchases of loans receivable (97,505) (76,743)
Purchases of property and equipment (4,297) (1,606)
Purchases of mortgage servicing rights (876) (3,723)
Excess servicing assets capitalized -- (11,841)
Disbursements for real estate held for investment or sale (23,736) (6,673)
Other investing activities, net 708 (5,713)
-------------- --------------
(289,695) (101,935)
-------------- --------------
Net cash used in investing activities (290,614) (105,502)
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Continued on following page.
-6-
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Three Months
Ended December 31
----------------------------------
(In thousands) 1993 1992
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
REAL ESTATE
Proceeds from mortgage financing $ 461 $ 1,900
Principal curtailments of mortgages (323) (249)
Proceeds from sales of unsecured notes 3,005 1,187
Repayments of unsecured notes (1,779) (3,846)
Costs of obtaining financings (277) (576)
-------------- --------------
1,087 (1,584)
-------------- --------------
BANKING
Proceeds from customer deposits and sales of certificates of deposit 2,903,083 2,607,133
Customer withdrawals of deposits and payments for maturing certificates of (2,826,834) (2,668,746)
deposit
Net increase (decrease) in securities sold under repurchase agreements 106,006 (248,370)
Advances from Federal Home Loan Bank 283,000 100,000
Repayments of advances from Federal Home Loan Bank (220,500) (50,000)
Proceeds from other borrowings 18,163 13,205
Repayments of other borrowings (18,579) (14,223)
Cash dividends paid on preferred stock (2,438) --
Repayment of capital notes - subordinated (134,153) --
Net proceeds from sale of capital notes - subordinated 143,603 --
Other financing activities, net (2,068) (50)
-------------- --------------
249,283 (261,051)
-------------- --------------
Net cash provided by (used in) financing activities 250,370 (262,635)
- -------------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 32,458 31,910
Cash and cash equivalents at beginning of period 185,909 121,169
-------------- --------------
Cash and cash equivalents at end of period $ 218,367 $ 153,079
===============================================================================================================================
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (net of amount capitalized) $ 56,625 $ 57,580
Income taxes 220 214
Supplemental schedule of noncash investing and financing activities:
Rollovers of notes payable - unsecured 1,198 656
Loans receivable exchanged for mortgage-backed securities -- 51,956
Loans held for sale exchanged for mortgage-backed securities held for sale 155,475 190,026
Mortgage-backed securities transferred to loans and securities held for sale -- 131,390
Loans made in connection with the sale of real estate 5,993 23,576
Loans receivable transferred to real estate acquired in settlement of loans 1,200 18,113
Loans classified as in-substance foreclosed transferred to loans receivable 15,008 --
Loans held for securitization and sale transferred to loans receivable -- 5,823
Investment securities transferred to investment securities available-for-sale 4,789 --
Mortgage-backed securities transferred to mortgage-backed securities
available-for-sale 1,501,192 --
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See summary of significant accounting policies and notes to consolidated
financial statements.
-7-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. In the opinion of management, the consolidated financial statements
reflect all adjustments necessary for fair presentation of the Trust's
financial position and results of operations. All such adjustments are of a
normal recurring nature. These financial statements and the accompanying
notes should be read in conjunction with the Trust's audited consolidated
financial statements included in its Form 10-K for the fiscal year ended
September 30, 1993. The results of operations for interim periods are not
necessarily indicative of results to be expected for the year.
2. The accompanying financial statements included the accounts of the Trust
and its wholly-owned subsidiaries (the "Real Estate Trust"), which are
involved in the ownership and development of income-producing properties and
operation of hotels. The accounts of the Trust's 80%-owned banking
subsidiary, Chevy Chase Savings Bank, F.S.B., and its subsidiaries (the
"Bank") have also been consolidated. Accordingly, the accompanying financial
statements reflect the assets, liabilities, operating results, and cash flows
for two business segments: Real Estate and Banking. All significant
intercompany balances and transactions have been eliminated.
3. The Real Estate Trust voluntarily terminated its qualification as a real
estate investment trust under the Internal Revenue Code during fiscal 1978.
As a result of the Trust's acquisition of an additional 20% equity interest in
the Bank in June 1990, the Bank became a member of the Trust's affiliated
group filing consolidated federal income tax returns. The current effect of
the Trust's consolidation of the Bank's operations into its federal income tax
return results in the use of the Trust's net operating losses and net
operating loss carryforwards to reduce the federal income taxes the Bank would
otherwise owe. For the three months ended December 31, 1993, the Bank's
taxable income was partially offset by the Real Estate Trust's current
operating loss. In addition, the Bank's taxable income in excess of the Real
Estate Trust's current taxable loss enabled the Trust to utilize operating
loss carryovers. This utilization is reflected on the statement of operations
as an extraordinary item.
In February 1992, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 109 "Accounting for Income
Taxes" ("SFAS 109"). The statement requires the disclosure of the
approximate tax effects of temporary differences and carryforwards, as
well as a valuation allowance if it is more likely than not that the some
portion of the deferred tax asset will not be realized.
On October 1, 1993, the Trust adopted SFAS 109. The
components of the net deferred tax asset are as follows as of
December 31, 1993:
<TABLE>
<CAPTION>
Real
Estate Total
Description Bank Trust Trust
- ----------- ------ ------ -------
<S> <C> <C> <C>
Provision for Losses in Excess
of Deductions $ 60,127 $ - $ 60,127
Property - 5,824 5,824
Net Operating Losses 506 4,548 5,054
Real Estate Mortgage Investment Conduit 4,139 - 4,139
Alternative Minimum Tax Credit - 2,700 2,700
Partnership Investments - 1,219 1,219
Deferred Loan Fees 1,087 - 1,087
Deferred Gains - (8,114) (8,114)
Net Unrealized Holding Gains (10,899) - (10,899)
Depreciation (10,400) 1,658 (8,742)
Other (995) - (995)
Purchase Accounting - (2,804) (2,804)
FHLB Stock Dividends (4,970) - (4,970)
--------- -------- ---------
Total $ 38,595 $ 5,031 $ 43,626
========= ======== =========
*Amounts in Thousands
</TABLE>
The adoption of SFAS 109 on October 1, 1993 had the effect of increasing
the trust's net deferred tax asset by approximately $33.5 million. In the
opinion of management, the net deferred tax asset will be realized through
projected future earnings primarily attributable to the bank and available tax
planning strategies.
-8-
<PAGE>
4. BANKING:
LOANS HELD FOR SALE:
At December 31, 1993 and September 30, 1993, loans held for sale is
composed of single-family residential loans.
LOANS HELD FOR SECURITIZATION AND SALE:
At December 31, 1993 and September 30, 1993, loans held for
securitization and sale are composed of credit card receivables.
SECURITIES:
INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES:
Effective October 1, 1993, the Bank adopted Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" ("SFAS 115"), which was issued in May 1993. SFAS
115 requires institutions to classify and account for debt and equity
securities in one of the three following categories:
1. Debt securities that an institution has the positive intent
and ability to hold to maturity are classified as held-to-maturity and
reported at amortized cost.
2. Debt and equity securities that are purchased and held
principally for the purpose of selling them in the near term and
mortgage-backed securities held for sale in conjunction with mortgage
banking activities are classified as trading securities and reported at fair
value, with unrealized gains and losses included in earnings. See
"Trading Securities."
3. Debt and equity securities not classified as either held-to-maturity or
trading securities are classified as available-for-sale and reported at fair
value, with unrealized gains and losses excluded from earnings and reported in
a separate component of stockholders' equity, net of the related tax effect.
At December 31, 1993, all investment securities and mortgage-backed securities
held by the Bank are classified as available-for-sale and recorded at fair
value. At December 31, 1993, net unrealized holding gains in the amount of
$8,227, net of the related income tax effect, are included in a separate
component of stockholders' equity.
-9-
<PAGE>
Unrealized holding gains and losses in the Bank's investment securities as of
December 31, 1993 are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED AGGREGATE
AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE
--------- ---------- --------- --------
(In thousands)
<S> <C> <C> <C> <C>
December 31, 1993
U.S. Government securities $ 4,690 $ 4 $ - $ 4,694
Other securities 102 - - 102
------- ---- ---- -------
Total $ 4,792 $ 4 $ - $ 4,796
======= ==== ==== =======
</TABLE>
A comparison of amortized cost and fair value for investment securities, along
with the contractual dates of maturity, by category of investments as of
December 31, 1993, is as follows:
<TABLE>
<CAPTION>
AGGREGATE
AMORTIZED FAIR
COST VALUE
---------- ---------
(In thousands)
<S> <C> <C>
December 31, 1993
Investment securities available-for-sale:
U.S. Government securities
Maturing within one year $ 296 $ 296
Maturing after one year, but within five years 4,394 4,398
------- ------
Total U.S. Government securities 4,690 4,694
------- ------
Other securities:
Maturing within one year 102 102
------- -------
Total other securities 102 102
------- -------
Total investment securities available-for-sale $ 4,792 $ 4,796
======= ======
</TABLE>
Gross unrealized holding gains and losses of the Bank's mortgage-backed
securities as of December 31, 1993 are as follows:
-10-
<PAGE>
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED AGGREGATE
AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE
------------ ---------- --------- -----------
(In thousands)
<S> <C> <C> <C> <C>
December 31, 1993
FNMA $ 46,184 $ 311 $ (159) $ 46,336
FHLMC 1,046,148 11,231 (1,726) 1,055,653
Private label, AA-rated 245,128 3,949 - 249,077
----------- -------- --------- -----------
Total $ 1,337,460 $ 15,491 $ (1,885) $ 1,351,066
=========== ======== ========= ===========
</TABLE>
TRADING SECURITIES:
As part of its mortgage banking activities, the Bank exchanges loans held for
sale for mortgage-backed securities and then sells the mortgage-backed
securities to third-party investors in the month of issuance. In accordance
with SFAS 115, these mortgage-backed securities are classified as trading
securities. The Bank realized net gains on the sale of trading securities of
$808 for the three months ended December 31, 1993. There were no unrealized
gains or losses during the three months ended December 31, 1993.
-11-
<PAGE>
LOANS RECEIVABLE:
Loans receivable is composed of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1993 1993
----------- ------------
(In thousands)
<S> <C> <C>
Single-family residential $1,207,232 $1,111,306
Home equity 107,972 60,549
Commercial and multifamily 99,971 95,611
Real estate construction 83,221 69,940
Ground 18,651 19,340
Credit card 653,647 454,520
Automobile 150,899 104,702
Overdraft lines of credit 43,192 42,198
Other 33,642 33,318
---------- ----------
2,398,427 1,991,484
---------- ----------
Less:
Undisbursed portion of loans 65,743 63,620
Unearned discounts 1,275 1,543
Net deferred loan origination
costs (6,512) (3,472)
Reserve for loan losses 66,940 68,040
----------- -----------
127,446 129,731
----------- -----------
Total $2,270,981 $1,861,753
=========== ===========
</TABLE>
IMPAIRED LOANS:
Effective October 1, 1993, the Bank adopted, on a prospective basis, Statement
of Financial Accounting Standards No. 114, "Accounting by Creditors for
Impairment of a Loan" ("SFAS 114"), which was issued in May 1993.
Under SFAS 114, a loan is impaired when, based on all current information
and events, it is probable that a creditor will be unable to collect all amounts
due according to the contractual terms of the agreement, including
all scheduled principal and interest payments. SFAS 114 requires that impaired
loans be measured based on the present value of expected future cash
flows, discounted at the loan's effective interest rate. As a practical
expedient,impairment may be measured based on the loan's observable market
price, or, if the loan is collateral-dependent, the fair value of the
collateral. When the measure of the impaired loan is less than the recorded
investment in the loan, the impairment should be recorded through a valuation
allowance. A change in the fair value of the impaired loan is reported as an
increase in or reduction to the provision for loan losses. In addition,
SFAS 114 requires that impaired loans for which foreclosure is probable be
accounted for as loans. Such loans, with aggregate principal balances of
$15.0 million, have been reclassified from real estate held for sale to loans
receivable during the quarter ended December 31, 1993. The Bank classifies
certain credit card loans in which customers have agreed to modified payment
terms as impaired loans in
-12-
<PAGE>
accordance with SFAS 114. The Bank restructures these loans such
that all principal and interest payments are recovered.
At December 31, 1993, the recorded investment in loans and
related reserves for losses in loans for which impairment has been
recognized in accordance with SFAS 114 is as follows:
<TABLE>
<CAPTION>
IMPAIRED RESERVES FOR
LOANS LOSSES ON LOANS
-------- ---------------
(In thousands)
<S> <C> <C>
Real estate $ 15,008 $ 1,093
Credit card 26,927 2,693
-------- -------
$ 41,935 $ 3,786
======== =======
</TABLE>
REAL ESTATE HELD FOR INVESTMENT OR SALE:
Effective December 31, 1992, Office of Thrift Supervision ("OTS")
regulations required that foreclosed assets be carried at the lower of cost
or fair value. The effect of this regulatory change was to require the Bank to
adopt Statement of Position 92-3, "Accounting for Foreclosed Assets"
("SOP 92-3"), issued by the Accounting Standards Division of the American
Institute of Certified Public Accountants, before the September 30, 1993
deadline for adoption that otherwise would have applied to the Bank. SOP 92-3
requires that foreclosed assets held for sale, including assets classified
as in-substance foreclosed (prior to the implementation of SFAS
114), be carried at the lower of cost or fair value (less estimated selling
costs). Under SOP 92-3, the substantial majority of the Bank's real estate
acquired in settlement of loans is considered to be held for sale. Due to
the early adoption of SOP 92-3, the Bank was required to revise its method
of accounting for real estate held for sale. Based on management's internal
calculations and preliminary information with respect to certain appraisals,
the Bank recorded valuation allowances against its foreclosed assets at
December 31, 1992 of approximately $40.5 million to reduce the book balance of
foreclosed assets to fair value. Because the increase in the Bank's
reserves during the year ended September 30, 1992 was designed in part to
reduce the effects of SOP 92-3, $21.5 million of valuation allowances previously
provided partially offset the valuation allowances required by SOP 92-3.
-13-
<PAGE>
Real estate held for investment or sale is composed of the
following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1993 1993
------------ ------------
(In thousands)
<S> <C> <C>
Land, development, construction
and rental properties $ 69,365 $ 69,313
Investments in limited partnerships (2,577) (1,580)
Investment in real estate ventures 8,898 8,898
----------- -----------
Total real estate held for
investment 75,686 76,631
----------- -----------
Real estate held for sale 414,507 434,616
----------- -----------
Less:
Reserve for losses on real estate
held for investment 10,188 10,182
Reserve for losses on real estate
held for sale 101,275 101,462
Accumulated depreciation and
amortization 11,624 11,144
Total real estate held for ----------- -----------
investment or sale $ 367,106 $ 388,459
=========== ===========
</TABLE>
SUBORDINATED DEBENTURE REFINANCING:
On November 23, 1993, the Bank sold $150.0 million principal
amount of 9 1/4% Subordinated Debentures due 2005 (the "1993 Debentures"). On
December 23, 1993 and December 24, 1993, the Bank redeemed its outstanding 13
1/2% Subordinated Capital Debentures due July 15, 2002 (the "1987
Debentures") and 15% Subordinated Capital Debentures due November 15, 2003 (the
"1988 Debentures"), respectively. The Bank received net proceeds of
$143.6 million from the sale of the 1993 Debentures, of which approximately
$134.2 million was used to redeem the 1987 Debentures and the 1988 Debentures.
The remaining net proceeds were used for general corporate purposes. The Bank
incurred a loss of $6.3 million, after related income taxes, in connection
with the redemption of the 1987 Debentures and the 1988 Debentures. The
OTS has approved the inclusion of the principal amount of the 1993
Debentures in the Bank's supplementary capital for regulatory capital purposes.
-14-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The principal business conducted by the Trust and its
wholly-owned subsidiaries is the ownership and development of income-producing
properties. The Trust owns 80% of the outstanding common stock of Chevy Chase
bank, F.S.B. ("Chevy Chase" or the "Bank"). At December 31, 1993, the Bank's
assets accounted for approximately 96% of the Trust's consolidated
assets.
The Trust has prepared its financial statements and other
disclosures on a fully consolidated basis. The term "Trust" used in the text
and the financial statements included herein refers to the combined
entity, which includes the parent company and its wholly-owned subsidiaries, as
well as Chevy Chase, Chevy Chase subsidiaries and the parent company's
other majority-owned subsidiaries. "Real Estate Trust" refers to the
parent company and its wholly-owned and majority-owned subsidiaries, excluding
Chevy Chase and Chevy Chase's subsidiaries. The business conducted by the
Bank and its subsidiaries is identified by the term "Banking," while the
operations conducted by the Real Estate Trust are designated as "Real
Estate."
The financial data on Banking reflect certain purchase
accounting adjustments made by the Trust in connection with its acquisition
of the Bank and therefore differ in certain respects from the comparable
financial data set forth in the unconsolidated financial statements of the Bank.
FINANCIAL CONDITION
REAL ESTATE
The Real Estate Trust's investment portfolio at December 31, 1993,
which consisted of office properties, hotels and undeveloped land parcels,
was relatively unchanged from September 30, 1993. On August 26, 1993, the
Real Estate Trust transferred its 22 shopping center properties and one of
its office properties, together with the debt associated with such
properties, to Saul Holdings Limited Partnership and a subsidiary limited
partnership in exchange for securities representing a 21.5% limited partnership
interest in Saul Holdings Limited Partnership.
Office space in the Real Estate Trust's office property
portfolio was 80% leased at December 31, 1993, compared to a leasing rate of
77% at September 30, 1993 and 83% at December 31, 1992. The decline in
the leasing percentage from the December 1992 quarter reflected adverse
economic conditions in the metropolitan areas in which the Trust maintains
office properties. At December 31, 1993, the Real Estate Trust's office
property portfolio had a total gross leasable area of 1,365,000 square feet.
Of the gross leasable area at December 31, 1993, 155,000 square feet (11.3%),
432,000 square feet (31.7%) and 194,000 square feet (14.2%) are subject to
leases whose terms expire in the balance of fiscal 1994 and in fiscal 1995
and 1996, respectively. Due to a decline in lease rates for office space in
the markets served by these properties, the terms of certain of the new
leases to be entered into in fiscal 1994 are expected to be less favorable
to the Real Estate Trust than the terms of the expiring leases. The ability
of the Real Estate Trust to re-lease office space subject to leases expiring
in fiscal 1995 and fiscal 1996, and the terms of any such new leases, will
depend on conditions in the markets for the applicable properties during
such periods.
-15-
<PAGE>
For the three months ended December 31, 1993, the nine hotel properties
owned by the Real Estate Trust experienced an average occupancy rate of 57%
and a $53.95 average room rate, compared to an average occupancy rate of 56%
and a $54.78 average room rate in the first three months of fiscal 1992.
Five of the hotels showed improved occupancies over the prior corresponding
period, while occupancy rates at four properties declined from the
December 1992 quarter.
During the first quarter of fiscal 1994, the Trust adopted statement of
Financial Accounting Standards No. 109, "Accounting For Income Taxes" ("SFAS
109").
SFAS 109 changes the manner in which companies record deferred tax
liabilities or assets and requires ongoing adjustments for enacted changes in
tax rates and regulations. The cumulative effect of this change in accounting
principle amounted to an increase in net income of $35.4 million. See Note 3
to the Consolidated Financial Statements in this report.
BANKING
GENERAL. The Bank recorded operating income before income
taxes, extraordinary item and cumulative effect of change in accounting
principle of $6.0 million during the three months ended December 31, 1993,
compared to operating income before income taxes, extraordinary item and
cumulative effect of change in accounting principle of $1.3 million in the prior
corresponding period. The increase in the December 1993 quarter was primarily
attributable to a decrease in the provision for loan losses, a decrease in
losses on real estate held for investment or sale and an increase in loan and
deposit servicing fees. The positive effect of these items was offset by a
decrease in net interest income before the provision for loan losses, and an
increase in operating expenses.
On November 23, 1993, the Bank sold $150.0 million
principal amount of 9 1/4% Subordinated Debentures due 2005 (the "1993
Debentures"). On December 23, 1993 and December 24, 1993, the Bank redeemed
its outstanding 13 1/2% Subordinated Capital Debentures due July 15, 2002 (the
"1987 Debentures") and 15% Subordinated Capital Debentures due November
15, 2003 (the "1988 Debentures"). The Bank received net proceeds of $143.6
million from the sale of the 1993 Debentures, of which approximately $134.2
million was used to redeem the 1987 Debentures and the 1988 Debentures. The
remaining net proceeds were used for general corporate purposes. The Bank
incurred a loss of $6.3 million, after related income taxes, in connection with
the redemption of the 1987 Debentures and the 1988 Debentures. The OTS has
approved the inclusion of the principal amount of the 1993 Debentures in the
Bank's supplementary capital for regulatory capital purposes.
At December 31, 1993, the Bank remained in compliance with
all of its regulatory capital requirements under the Financial Institutions
Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"). The Bank's
tangible, core (or leverage) and risk-based regulatory capital ratios were
4.55%, 5.30% and 11.56%, respectively, compared to the requirements of 1.5%,
3.0% and 8.0%, respectively. Additionally, at December 31, 1993, the Bank's
leverage, tier 1 risk-based and total risk-based capital ratios of 5.30%, 6.88%
and 11.56%, respectively, exceeded the corresponding ratios of 5.0%, 6.0% and
10.0% established under the prompt corrective action regulations for
"well capitalized"
-16-
<PAGE>
institutions. On the basis of its balance sheet at December 31,
1993, the Bank met the FIRREA-mandated fully phased-in capital requirements.
During the first quarter of fiscal 1994, the Bank adopted three new
Statements of Financial Accounting Standards: SFAS 109, Statement of
Financial Accounting Standards No. 114, "Accounting by Creditors for
Impairment of a Loan" ("SFAS 114"), and Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115").
SFAS 109 changes the manner in which companies record
deferred tax liabilities or assets and requires ongoing adjustments for
enacted changes in tax rates and regulations. The cumulative effect of this
accounting change in accounting principle amounted to an increase in the Bank's
net income and deferred tax asset of $5.1 million. See Note 4 to the
Consolidated Financial Statements in this report.
Effective October 1, 1993, the Bank adopted, on a
prospective basis, SFAS 114, which was issued in May 1993. SFAS 114 requires
that impaired loans be measured based on the present value of expected future
cash flows, discounted at the loan's effective interest rate. As a practical
expedient, impairment may be measured based on the loan's observable market
price, or the fair value of the collateral, if the loan is
collateral-dependent. When the measure of the impaired loan is less than the
recorded investment in the loan, the impairment should be recorded through a
valuation allowance. A change in the fair value of the impaired loan is
reported as an increase in or reduction to the provision for loan losses.
In addition, SFAS 114 requires that impaired loans for which foreclosure is
probable be accounted for as loans. Such loans, with aggregate principal
balances of $15.0 million have been reclassified from real estate held for
sale to loans receivable during the quarter ended December 31, 1993. No
additional reserves were required by adoption of this pronouncement. Impaired
loans that are also nonperforming are included in nonperforming assets. See
Note 4 to the Consolidated Financial Statements in this report.
SFAS 115 requires companies to classify certain equity
securities and all debt securities into one of three categories on the date of
acquisition and the date of all subsequent financial statements. Under SFAS
115, securities are categorized as either "held-to-maturity,"
"available-for-sale" or "trading." As a result of implementing SFAS 115, the
Bank determined that both the investment security and mortgage-backed security
portfolios should be classified as available-for-sale. The Bank implemented
SFAS 115 effective October 1, 1993 and recorded $16.3 million of net unrealized
holding gains, net of related income taxes, as a separate component of
stockholders' equity as of that date. At December 31, 1993, net unrealized
holding gains of $8.2 million are reported as a separate component of
stockholders' equity. This net unrealized holding gain, which will fluctuate
based on market interest rates and the composition of the Bank's investment
securities and mortgage-backed securities portfolios, is fully includable in
tier 1 capital for
-17-
<PAGE>
regulatory capital purposes pursuant to interim guidance issued
by the OTS. The OTS has announced its intention to issue a proposed rule on
this subject and has stated that any final rule may differ from the interim
guidance based on consideration of any comments received on the proposal and
consultations with the other federal bank regulatory agencies. See Note 4 to
the Consolidated Financial Statements in this report.
ASSET QUALITY. The Bank's asset quality has improved in
recent periods as a result of a number of significant actions taken by
management to resolve problem real estate assets and enhance risk management
efforts. The Bank has committed substantial resources to problem asset
resolution and has reorganized its staff in order to facilitate the resolution
and workout of problem real estate assets.
NON-PERFORMING ASSETS. The following table sets forth
information concerning the Bank's non-performing assets at the dates
indicated. The figures shown are after charge-offs and, in the case of real
estate acquired in settlement of loans ("real estate held for sale" or "REO"),
all valuation allowances.
-18-
<PAGE>
NON-PERFORMING ASSETS
---------------------
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31, September 30, December 31,
1993 1993 1992
-------------- -------------- --------------
<S> <C> <C> <C>
Non-performing assets:
Non-accrual loans:
Residential $ 8,830 $ 9,108 $ 12,262
Commercial and multifamily 3,066 -- --
Residential construction and ground -- -- 571
Commercial construction and ground 11,942 -- --
-------------- -------------- --------------
Total non-accrual real estate loans 23,838 9,108 12,833
Credit card 21,657 20,557 25,262
Consumer and other 258 314 1,107
-------------- -------------- --------------
Total non-accrual loans (1) 45,753 29,979 39,202
-------------- -------------- --------------
Non-accrual real estate held for investment (1) 8,898 8,898 8,892
-------------- -------------- --------------
Real estate acquired in settlement of loans 414,507 434,616 514,404
Reserve for losses on real estate acquired in settlement
of loans (101,275) (101,462) (109,017)
-------------- -------------- --------------
Real estate acquired in settlement of loans, net 313,232 333,154 405,387
-------------- -------------- --------------
Total non-performing assets $ 367,883 $ 372,031 $ 453,481
-------------- -------------- --------------
-------------- -------------- --------------
Reserve for losses on loans $ 66,940 $ 68,040 $ 80,637
Reserve for losses on real estate held for investment 10,188 10,182 12,188
Reserve for losses on real estate acquired in settlement
of loans 101,275 101,462 109,017
-------------- -------------- --------------
Total reserves for losses $ 178,403 $ 179,684 $ 201,842
-------------- -------------- --------------
-------------- -------------- --------------
Ratios:
Non-performing assets to total assets (3) 7.18% 7.63% 9.57%
Reserve for losses on real estate loans to non-accrual
real estate loans (1) 80.29% 219.29% 123.20%
Reserve for losses on credit card loans to non-accrual
credit card loans (1) 216.49% 228.08% 247.36%
Reserve for losses on consumer and other loans to
non-accrual consumer and other loans (1) 354.65% 376.11% 211.29%
Reserve for losses on loans to non-accrual loans (1) 146.31% 226.96% 205.70%
Reserve for losses on real estate held for investment
to non-accrual real estate held for investment (1) 114.50% 114.43% 137.07%
Reserve for losses on real estate held for investment
or sale to non-performing real estate held for
investment or sale (1) 26.33% 25.17% 21.19%
Reserve for losses on loans to total loans receivable (2) 2.35% 2.83% 3.93%
Reserve for losses on real estate held for investment to
real estate held for investment (1) 15.90% 15.55% 13.67%
- -----------------------------------------------------------------------------------------------------------
<FN>
(1) Before deduction of reserves for losses.
(2) Includes loans receivable and loans held for sale and/or securitization,
before deduction of reserve for losses.
(3) Non-performing assets is after valuation allowances on real estate acquired
in settlement of loans but before reserves for losses on non-accrual loans
and non-accrual real estate held for investment.
</TABLE>
-19-
<PAGE>
Non-performing assets include non-accrual loans (loans
contractually past due 90 days or more or with respect to which other factors
indicate that full payment of principal and interest is unlikely), non-accrual
real estate held for investment ("non-accrual REI"), and real estate acquired
in settlement of loans, either pursuant to in-substance foreclosure
(prior to the adoption of SFAS 114 in the December 1993 quarter) or through
foreclosure or deed-in-lieu of foreclosure.
Non-performing assets totaled $367.9 million, after
valuation allowances on REO of $101.3 million, or 7.2% of total assets at
December 31, 1993, compared to $372.0 million, after valuation allowances on
REO of $101.5 million, or 7.6% of total assets at September 30, 1993. In
addition to the valuation allowances on REO, the Bank maintained $5.8 million
and $4.5 million of valuation allowances on its non-accrual loans and
non-accrual real estate held for investment at December 31, 1993 and
September 30, 1993, respectively. The decrease in non-performing assets
was primarily attributable to the sale of one REO property with a book balance
of $5.5 million. As a result of implementation of SFAS 114, the Bank
transferred $15.0 million of non-performing assets from REO to non-accrual
loans. See Note 4 to the Consolidated Financial Statements in
this report.
The Bank's non-performing real estate assets, which include
non-accrual real estate loans, non-accrual real estate held for investment
and REO, totaled $346.0 million at December 31, 1993 or 94.0% of total
non-performing assets at that date. As shown in the following table, the
Bank's non-performing real estate assets, after valuation allowances on
such assets, have declined from their peak of $567.6 million in February 1992
to $342.5 million at December 31, 1993, reflecting both additional
write-downs on non-performing assets during that period and, in more recent
periods, asset sales.
<TABLE>
<CAPTION>
DECLINE IN NON-PERFORMING
REAL ESTATE ASSETS
Total
Valuation
Total Allowances on Total Cumulative
Non-Performing Non-Accrual Real Non-Performing Decline from
Real Estate Estate Loans and Real Estate FEBRUARY 29, 1992
ASSETS (1) NON-ACCRUAL REI(2) ASSETS, NET AMOUNT PERCENT
----------- ------------------ ----------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
December 31, 1991 .. $559,665 $ 6,692 $552,973 - -
February 29, 1992 .. 574,321 6,712 567,609 - -
March 31, 1992 ..... 551,960 5,490 546,470 ($21,139) -3.7%
June 30, 1992 ...... 512,729 10,224 502,505 (65,104) -11.5%
September 30, 1992 . 487,287 7,147 480,140 (87,469) -15.4%
December 31, 1992 .. 427,113 2,332 424,781 (142,828) -25.2%
March 31, 1993 ..... 394,672 2,635 392,037 (175,572) -30.9%
</TABLE>
-20-
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C>
June 30, 1993 ...... 382,657 2,634 380,023 (187,586) -33.1%
September 30, 1993 . 351,160 2,427 348,733 (218,876) -38.6%
December 31, 1993 .. 345,968 3,493 342,475 (225,134) -39.7%
<FN>
_____________________
(1) Represents total non-accrual real estate loans and
non-accrual REI before deduction of valuation allowances and REO, after
deduction of valuation allowances.
(2) Represents valuation allowances on non-accrual real estate
loans and non-accrual REI. At December 31, 1993, valuation
allowances on non-accrual real estate loans and non-accrual REI were
$1.5 million and $2.0 million, respectively.
</TABLE>
A larger portion of the affected properties financed by the
Bank involves residential rather than commercial properties. In
general, the residential real estate market has been less significantly
affected by the downturn in recent years than the commercial real estate market.
At December 31, 1993, $298.0 million or 86.1% of the Bank's total
non-performing real estate assets related to residential real estate properties.
NON-ACCRUAL LOANS. The Bank's non-accrual loans totaled
$45.8 million at December 31, 1993, an increase of $15.8 million from $30.0
million at September 30, 1993. At December 31, 1993, non-accrual loans
consisted primarily of $23.8 million of non-accrual real estate loans and
$21.7 million of non-accrual credit card loans. Non-accrual loans increased
primarily because of the reclassification from REO to non-accrual real
estate loans of two loans with aggregate principal balances of $15.0 million
as a result of the implementation of SFAS 114. See Note 4 to the
Consolidated Financial Statements in this report. A slight increase in
non-accrual credit card loans of $1.1 million was partially offset by net
principal repayments and reductions of non-accrual residential loans and other
consumer loans of $0.2 million and $0.1 million, respectively.
At December 31, 1993, the Bank had $21.7 million of credit
card loans which were classified for regulatory purposes as substandard and
disclosed as non-performing assets because they were 90 days or more past due.
At that date, the Bank also had $8.7 million of credit card loans
classified for regulatory purposes as substandard and $115.4 million of credit
card loans classified for regulatory purposes as special mention which were
not disclosed as either non-performing assets (i.e., credit card loans which
are 90 days or more past due) or potential problem assets. The amount
classified as substandard but not disclosed as non-performing assets ($8.7
million) primarily related to accounts for which the customers have agreed
to modified payment terms, but which were 60-89 days past due. Of the $8.7
million, $1.0 million was current, $0.3 million was 30-59 days past due and
$7.4 million was 60-89 days past due at December 31, 1993. The amount
classified as special mention ($115.4 million) primarily related to accounts
which have had purchasing privileges suspended, including accounts for which
the customers have agreed to modified payment terms and which were less than 60
days past due. Of the
-21-
<PAGE>
$115.4 million reported as special mention, $90.1 million was
current, $15.5 million was 30-59 days past due and $9.8 million was 60-89 days
past due at December 31, 1993. All delinquent amounts are included in the
table of delinquent loans. See "Delinquent Loans."
NON-ACCRUAL REAL ESTATE HELD FOR INVESTMENT. At December
31, 1993 and September 30, 1993, a participating loan to a developer with a
balance of $8.9 million, before valuation allowances of $2.0 million, was
non-performing.
REO. In the past, the Bank was an active lender on
residential real estate development projects and, to a lesser extent, commercial
buildings and land. The majority of the amount of loans originated were to
developers for the acquisition and development of residential planned unit
developments. The majority of the loans contained provisions that entitled the
Bank to a portion of the profits generated by the underlying properties.
Beginning in mid-1990 and extending through 1992, as a result of the slowdown
in the Washington, D.C. area economy, the Bank took active control, either
through foreclosure or deed-in-lieu of foreclosure, of most of the properties
securing these loans. The Bank decided that completing the infrastructure of
the properties, implementing an aggressive marketing program, and then selling
building lots to home builders represented the most effective method of
recovering the Bank's investment in these properties.
At December 31, 1993, the Bank's REO totaled $313.2
million, after valuation allowances on such assets of $101.3 million. The
principal component of REO is five planned unit developments
("Communities") with an aggregate book value of $243.2 million at that date.
Four of the Communities are under active development.
During the three months ended December 31, 1993, REO
decreased $19.9 million primarily due to the sale of one commercial construction
property with a book value of $5.5 million after valuation allowances, and the
reclassification from REO to non-accrual real estate loans of two
loans with an aggregate book value of $13.9 after valuation allowances, as a
result of implementing SFAS 114. See Note 4 to the Consolidated
Financial Statements in this report.
The Bank capitalizes costs relating to development and
improvement of REO. Interest costs are capitalized on real estate properties
under development. See "Disposition of REO." The Bank capitalized
interest in the amount of $2.3 million during the three months ended December
31, 1993, all of which related to the Bank's four active Communities.
DISPOSITION OF REO. During the three months ended December
31, 1993, the Bank received proceeds of approximately $28.2 million upon
the disposition of REO consisting of one industrial building ($5.7 million), 225
residential lots or units in the Communities and other smaller residential
properties ($19.5 million), various single-family residential properties
($1.4 million) and 2.5 acres of land in two of its Communities ($1.6 million).
-22-
<PAGE>
The Bank's objective with respect to its REO is to sell
such properties as expeditiously as possible and in an orderly manner which will
best preserve the value of the Bank's assets. The Bank's ability to achieve
this objective will depend on a number of factors, some of which are beyond its
control, including continued improvement in general economic conditions in
the Washington, D.C. metropolitan area and increased availability of
financing for the potential purchasers of these properties. In addition, under
its written agreement with OTS, the Bank is required to make every effort to
reduce its exposure in certain of its real estate development properties,
including the four active Communities. In accordance with this requirement,
management of the Bank is pursuing several strategies. First, the Bank has
focused its efforts on marketing building lots directly to home builders.
The Bank is proceeding with lot finishing to meet the requirements of
existing and new contracts with builders and is accelerating the record plat
process so that individual lots can be sold at the earliest possible time.
Second, the Bank continues to seek and negotiate with potential purchasers of
retail and commercial ground in the Communities. Finally, the Bank
continues to engage in discussions with potential investors concerning the
possibility of larger scale or bulk purchases of ground at the Communities.
The following table sets forth the Bank's REO at December
31, 1993.
<TABLE>
<CAPTION>
BALANCE BALANCE
BEFORE ALL AFTER
VALUATION VALUATION VALUATION
ALLOWANCES ALLOWANCES ALLOWANCES
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Communities................... $318,054 $ 74,828 $243,226
Residential ground and
construction................ 62,669 19,334 43,335
Retail centers................ 2,765 608 2,157
Commercial land............... 21,161 4,948 16,213
Office buildings.............. 7,161 1,424 5,737
Single-family residential
properties.................. 2,697 133 2,564
-------- -------- --------
Total REO................... $414,507 $101,275 $313,232
======== ======== ========
</TABLE>
-23-
<PAGE>
Approximately $243.2 million (or 77.7%), after valuation allowances, of
the Bank's aggregate book value of REO at December 31, 1993 was attributable
to the five Communities. At December 31, 1993, the Bank's remaining 22.3% of
REO consisted of various types of properties, including residential ground and
construction (13.8%), retail centers (0.7%), commercial land (5.2%), office
buildings (1.8%) and single-family residential properties (0.8%). These
properties had an aggregate book value of $70.0 million, after valuation
allowances, at December 31, 1993. At December 31, 1993, the Bank had executed
contracts to sell seven of these properties at their aggregate book value of
$16.9 million at that date.
The four active Communities consist primarily of 13,425 residential lots
or units and 172.5 acres of land designated for retail use. At December 31,
1993, 8,493 residential units (63.3%) had been sold to builders, consisting of
6,077 units (45.3%) which had been settled and 2,416 units (18.0%) which were
under contract and pending settlement, and approximately 89.0 acres (51.6%) of
retail land had been sold to developers, including 21.1 acres (12.2%) which
were under contract and pending settlement. In addition, at December 31,
1993, the Bank was engaged in discussions with potential purchasers regarding
the sale of additional residential units and retail land.
The rate of home sales at the Bank's four active Communities has
increased in recent periods. Home sales at these Communities increased
slightly from 308 units during the three months ended December 31, 1992 to 318
units during the three months ended December 31, 1993. In addition, home
sales increased from 1,061 units during fiscal 1992 to 1,522 units during
fiscal 1993, which represented a 43.5% increase. Management believes that the
positive trend in home sales activity indicates that the demand for the Bank's
lots will increase, because builders generally will not purchase a lot from
the Bank until the home is under contract with the home purchaser and because
inventories of lots previously purchased by builders are being depleted.
There can be no assurance, however, that home sales will remain at these
levels in future periods.
The Bank in some cases has made financing available in an attempt to
facilitate sales of lots in the four Communities under active development.
The following table presents, at the periods indicated, the outstanding
balances of loans provided by the Bank (subsequent to its acquisition of title
to the properties) to facilitate sales of lots in such Communities.
-24-
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1993 1993 1992
------------ -------- --------
(In thousands)
<S> <C> <C> <C>
Residential construction loans......... $ 9,344 $10,386 $ 3,138
Single-family permanent loans (1)...... 68,916 79,104 93,856
------- ------- -------
Total................................ $78,260 $89,490 $96,994
======= ======= =======
<FN>
_____________________
(1) Includes $9.6 million, $8.8 million and $13.3 million of loans
classified as held for sale at December 31, 1993 and September 30, 1993
and 1992, respectively, in the Consolidated Financial Statements in this
report.
</TABLE>
The Bank anticipates that it will provide construction financing for
approximately 20% of the remaining unsold lot inventory in the Communities.
The Bank also anticipates that it will provide permanent financing for
approximately 25% of the homes to be sold in the Communities. The Bank
retains in its portfolio certain single-family permanent loans for which the
date of initial application is prior to October 1, 1991. The Bank's policy is
to sell all such loans for which the date of initial application is subsequent
to September 30, 1991. At December 31, 1993, the Bank had originated $128.0
million and sold $118.4 million of such loans with application dates
subsequent to September 30, 1991. The remaining $9.6 million of such loans
are classified as held for sale and generally are expected to be sold in the
second quarter of fiscal 1994. The total pre-tax cost to the Bank of granting
more favorable terms to the borrowers was approximately $1.9 million, or 1.5%
of the $128.0 million principal amount of the loans made. The estimated cost
is generally recognized by the Bank as a cost of sale at the time that the
Bank sells building lots to developers.
In furtherance of its objective of facilitating sales, the Bank in the
past has elected to use its own funds to continue development of some of the
Communities to the extent proceeds generated by sales of lots or housing units
at the Communities have been insufficient to fund development costs, and may
do so again in the future. The following table presents net funds provided or
used by the Bank to continue development at the four active Communities for
the years indicated.
-25-
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
DECEMBER 31, YEAR ENDED
SEPTEMBER 30,
1993 1993 1992
------------ ------- ------
(In thousands)
<S> <C> <C> <C>
Sales proceeds................. $ 13,978 $ 66,291 $ 39,594
Development costs ............. 15,976 51,649 35,803
Net funds (used for) --------- -------- ---------
provided by development...... $( 1,998) $ 14,642 $ 3,791
========= ======== ========
</TABLE>
Sales proceeds were insufficient to fund development costs for the three
months ended December 31, 1993 as a result of the seasonal slowdown in lot
sales during the quarter. The Bank currently anticipates that sales proceeds
will exceed development costs in future periods. In the event development
costs exceed sales proceeds in future periods, the Bank believes that adequate
funds will be available from its primary liquidity sources to fund such costs.
See "Liquidity."
In addition to the four active Communities, REO includes a fifth
Community, consisting of approximately 2,900 acres in Loudoun County,
Virginia, which is in the pre-development stage. At December 31, 1993, this
property had a book value of $36.1 million, after valuation allowances. The
Bank continues to assess various strategies for the ultimate disposition of
the property.
Under its written agreement with the OTS, the Bank may not increase its
investments in certain of its large REO properties beyond levels existing at
September 30, 1991 without OTS approval. The Bank had submitted to the OTS
budgets for additional investments in these properties, and the OTS did not
object to the implementation of those budgets through September 30, 1993. The
Bank has submitted to the OTS project budgets for fiscal 1994.
The Bank will continue to monitor closely its major non-performing and
potential problem assets in light of current and anticipated market
conditions. The Bank's asset workout group focuses its efforts in resolving
these problem assets as expeditiously as possible. While the Bank does not
anticipate any significant increases in non-performing and potential problem
assets, additional charge-offs or reserves could be required absent a
continued recovery of the local real estate markets.
POTENTIAL PROBLEM ASSETS. Although not considered non-performing
assets, primarily because the loans are not 90 or more days past due and the
borrowers have not abandoned control of the properties, potential problem
assets are experiencing problems sufficient to cause management to have
serious doubts as to the ability of the borrowers to comply with present
repayment terms. The majority of the Bank's potential problem assets involve
borrowers
-26-
<PAGE>
or properties experiencing cash flow problems due primarily to the downturn in
recent years of the real estate markets in which the properties are located.
At December 31, 1993, potential problem assets totaled $72.8 million
before valuation allowances of $14.5 million, as compared to $73.6 million,
before valuation allowances of $15.4 million at September 30, 1993.
DELINQUENT LOANS. At December 31, 1993, delinquent loans totaled
$62.9 million or 2.2% of gross loans compared to $49.1 million or 2.0% of
gross loans at September 30, 1993. The following table sets forth information
regarding the Bank's delinquent loans at December 31, 1993.
<TABLE>
<CAPTION>
TOTAL AS A
PRINCIPAL BALANCE PERCENTAGE
MORTGAGE NON-MORTGAGE OF GROSS
LOANS LOANS TOTAL LOANS (1)
------ --------- -------- ----------
(Dollars in thousands)
Loans delinquent for:
<S> <C> <C> <C> <C>
30-59 days .......... $ 7,133 $27,825 $34,958 1.2%
60-89 days .......... 11,803 16,166 27,969 1.0%
------- ------- ------- -----
Total ............. $18,936 $43,991 $62,927 2.2%
======= ======= ======= =====
<FN>
_____________
(1) Includes loans held for sale and/or securitization, before deduction of
reserves.
</TABLE>
Mortgage loans classified as delinquent 60-89 days includes one
residential construction loan with a balance at December 31, 1993 of $9.7
million, which is included in total troubled debt restructurings. The 30-59
day delinquency category and the balance of the 60-89 day delinquency category
consists of single-family permanent residential mortgage loans and home equity
credit line loans. Total delinquent mortgage loans increased to $18.9 million
at December 31, 1993 from $8.9 million at September 30, 1993. The $10.0
million increase was primarily attributable to the decline in the financial
condition of one residential construction loan with a principal balance of
$9.7 million which became 60-89 days delinquent during the quarter.
Subsequent to December 31, 1993, this loan became current in accordance with
the restructured payment terms negotiated with the borrower.
Non-mortgage loans (principally credit card loans) delinquent 30-89 days
increased slightly to $44.0 million at December 31, 1993 from $40.2 million at
September 30, 1993, but decreased as a percentage of total non-mortgage loans
outstanding to 3.8% at December 31, 1993 from 4.5% at September 30, 1993, as a
result of an increase in the balance of the Bank's portfolio of non-mortgage
loans during the period.
-27-
<PAGE>
TROUBLED DEBT RESTRUCTURINGS. A troubled debt restructuring occurs
when the Bank agrees to modify significant terms of a loan in favor of the
borrower, when the borrower is experiencing financial difficulties. The
following table sets forth loans accounted for as troubled debt restructurings,
before deduction of valuation allowances, at the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
1993 1993 1992
------------ ------------- ------------
(In thousands)
<S> <C> <C> <C>
Troubled debt
restructurings..... $36,238 $36,729 $39,685
======= ======= =======
</TABLE>
At December 31, 1993, loans accounted for as troubled debt restructurings
included three commercial permanent loans with principal balances totaling
$17.2 million, two residential construction loans with principal balances
totaling $9.8 million and a residential ground loan with a principal balance
of $9.2 million. One residential construction loan with a principal balance
of $9.7 million became delinquent 60-89 days during the quarter. Subsequent
to December 31, 1993, this loan became current in accordance with its present
repayment terms. Since becoming restructured, the remaining loans are paying
principal and interest in accordance with their present repayment terms. Loans
accounted for as troubled debt restructurings with principal balances totaling
$36.0 million were classified as potential problem assets at December 31, 1993;
the remaining $0.2 million represents the principal balance of one residential
construction loan which, other than an extension of its maturity date, was
performing in accordance with its original terms. At December 31, 1993, the
Bank had commitments to lend $3.5 million of additional funds on loans that have
been restructured.
REAL ESTATE HELD FOR INVESTMENT. At December 31, 1993,
real estate held for investment consisted of seven properties with an
aggregate book value of $54.4 million, net of accumulated depreciation of $11.6
million and valuation allowances of $10.2 million. This category includes
one office building (which was approximately 89% leased at such date) and
two apartment buildings (which were approximately 98% and 99% leased at such
date and are financed with bonds issued by a local housing finance agency).
These properties are owned and operated by subsidiaries of the Bank.
Also included is a loan to a developer with a book value of $8.9 million at
December 31, 1993, before valuation allowances of $2.0 million, which has a
profit participation feature. The loan, which is secured by commercial
land, is included in non-performing assets. The Bank has discussions from
time to time with potential investors concerning the possible sale of certain
of its real estate.
RESERVES FOR LOSSES. The following tables show loss
experience by asset type and the components of the reserve for losses on loans
and the reserve for losses on real estate held for investment or sale.
These tables reflect charge-offs taken against assets during the periods
indicated and may include
-28-
<PAGE>
charge-offs taken against assets which the Bank disposed of
during such periods.
-29-
<PAGE>
ANALYSIS OF RESERVE BALANCES ON AND CHARGE-OFFS OF LOANS
--------------------------------------------------------
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended Year Ended
December 31, September 30,
--------------------- -------------
1993 1992 1993
-------- -------- ---------
<S> <C> <C> <C>
Balance at beginning of year $ 68,040 $ 78,818 $ 78,818
-------- -------- ---------
Provision for loan losses 12,095 27,754 62,513
-------- -------- ---------
Charge-offs:
Residential 660 -- 45
Commercial and multifamily -- 766 766
Ground -- 3,703 4,274
Credit card 15,806 22,507 78,445
Consumer and other 134 2,304 3,664
-------- -------- --------
Total charge-offs 16,600 29,280 87,194
-------- -------- --------
Recoveries:
Residential 8 -- --
Credit card 3,324 3,264 13,601
Consumer and other 73 81 302
-------- -------- --------
Total recoveries 3,405 3,345 13,903
-------- -------- --------
Charge-offs, net of recoveries 13,195 25,935 73,291
-------- -------- --------
Balance at end of year $ 66,940 $ 80,637 $ 68,040
-------- -------- --------
-------- -------- --------
Provision for loan losses to average loans (1) (2) 1.95% 5.26% 2.93%
Net loan charge-offs to average loans (1) (2) 2.13% 4.91% 3.43%
Ending reserve for losses on loans to total
loans (2) (3) 2.35% 3.93% 2.83%
<FN>
- ----------------------------------------------------------------------------------------
(1) Annualized
(2) Includes loans held for sale and/or securitization.
(3) Before deduction of reserves.
</TABLE>
-30-
<PAGE>
COMPONENTS OF RESERVE FOR LOSSES ON LOANS BY TYPE
-------------------------------------------------
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
December 31, September 30,
------------------------------------------------- -----------------------
1993 1992 1993
----------------------- ----------------------- -----------------------
Percent of Percent of Percent of
Loans to Loans to Loans to
Amount Total Loans Amount Total Loans Amount Total Loans
------- ----------- ------- ----------- ------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at end of period allocated to:
Residential permanent $ 2,874 49.9 % $ 2,817 41.8 % $ 4,235 53.6 %
Home equity 377 3.8 431 3.4 250 2.5
Commercial and multifamily 9,812 3.5 6,758 3.6 9,606 3.9
Residential construction 3,452 1.2 3,038 2.0 4,125 1.5
Commercial construction 1,178 0.8 977 0.5 345 0.4
Ground 1,446 0.6 1,789 0.6 1,412 0.7
Credit card 46,886 33.5 62,488 44.6 46,886 31.4
Consumer and other 915 6.7 2,339 3.5 1,181 6.0
-------- -------- --------
Total $66,940 $80,637 $68,040
-------- -------- --------
-------- -------- --------
</TABLE>
-31-
<PAGE>
ANALYSIS OF RESERVE BALANCES ON AND CHARGE-OFFS
-----------------------------------------------
OF REAL ESTATE HELD FOR INVESTMENT OR SALE
------------------------------------------
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
Three Months Ended Year Ended
December 31, September 30,
------------------------- -------------
1993 1992 1993
---------- ---------- ------------
<S> <C> <C> <C>
Balance at beginning of period
Real estate held for investment $ 10,182 $ 14,919 $ 14,919
Real estate held for sale 101,462 94,125 94,125
----------- ----------- ------------
Total 111,644 109,044 109,044
----------- ----------- ------------
Provision for real estate losses:
Real estate held for investment 6 (2,731) 1,470
Real estate held for sale 3,861 25,425 28,945
----------- ----------- ------------
Total 3,867 22,694 30,415
----------- ----------- ------------
Charge-offs:
Real estate held for investment:
Commercial construction -- -- 6,207
----------- ----------- ------------
Total -- -- 6,207
----------- ----------- ------------
Real estate held for sale:
Residential construction -- -- 79
Residential ground -- -- 259
Commercial ground -- 73 1,353
Commercial permanent 4,048 -- 761
Commercial construction -- 10,460 19,156
----------- ----------- ------------
Total 4,048 10,533 21,608
----------- ----------- ------------
Total charge-offs on real
estate held for investment
or sale 4,048 10,533 27,815
----------- ----------- ------------
Balance at end of period
Real estate held for investment 10,188 12,188 10,182
Real estate held for sale 101,275 109,017 101,462
----------- ----------- ------------
Total $ 111,463 $ 121,205 $ 111,644
----------- ----------- ------------
----------- ----------- ------------
- ----------------------------------------------------------------------------
</TABLE>
-32-
<PAGE>
COMPONENTS OF RESERVE FOR LOSSES
--------------------------------
ON REAL ESTATE HELD FOR INVESTMENT OR SALE
------------------------------------------
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31, September 30,
------------------------- -------------
1993 1992 1993
---------- ---------- -------------
<S> <C> <C> <C>
Reserve for losses on real estate
held for investment:
Commercial and multifamily $ 7,945 $ 5,500 $ 7,945
Commercial construction -- 4,543 --
Ground 1,972 1,689 1,972
Other 271 456 265
---------- ---------- -----------
Total 10,188 12,188 10,182
---------- ---------- -----------
Reserve for losses on real estate
held for sale:
Residential 81 257 102
Home equity 52 11 53
Commercial and multifamily 1,424 3,143 4,678
Commercial construction 608 10,388 1,387
Residential construction 3,002 2,317 2,924
Ground 96,108 92,901 92,318
---------- ---------- -----------
Total 101,275 109,017 101,462
---------- ---------- -----------
Total reserve for losses on real
estate held for investment
or sale $ 111,463 $ 121,205 $ 111,644
---------- ---------- -----------
---------- ---------- -----------
</TABLE>
-33-
<PAGE>
The Bank maintains reserves for estimated losses on loans and real
estate. The Bank's total reserves for losses on loans and real estate held
for investment or sale decreased by $1.3 million from the level at September
30, 1993 to $178.4 million at December 31, 1993. The $1.3 million decrease
was primarily attributable to decreased reserves on real estate assets.
During the three months ended December 31, 1993, the Bank recorded net
charge-offs of $4.7 million on loans secured by real estate and real estate
held for investment or sale and provided an additional $3.7 million in
valuation allowances on these assets.
The following table shows reserves for losses on performing and
non-performing assets at the dates indicated.
-34-
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, 1993
PERFORMING NON-PERFORMING TOTAL
---------- -------------- -----
(In thousands)
Reserves for losses on:
<S> <C> <C> <C>
Loans:
Real estate.............. $17,618 $ 1,521 $ 19,139
Credit card.............. 44,720 2,166 46,886
Consumer and other....... 787 128 915
-------- --------- ---------
Total reserve for
losses on loans........ 63,125 3,815 66,940
-------- --------- ---------
Real estate held for
investment............... 8,216 1,972 10,188
Real estate held for sale. - 101,275 101,275
-------- --------- ---------
Total reserve for losses on
real estate held for
investment or sale...... 8,216 103,247 111,463
------- -------- --------
Total reserves for losses.. $71,341 $107,062 $178,403
======= ======== ========
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1993
PERFORMING NON-PERFORMING TOTAL
---------- -------------- -----
(In thousands)
Reserves for losses on:
<S> <C> <C> <C>
Loans:
Real estate.............. $19,518 $ 455 $ 19,973
Credit card.............. 44,830 2,056 46,886
Consumer and other....... 1,125 56 1,181
-------- --------- ---------
Total reserve for
losses on loans........ 65,473 2,567 68,040
-------- --------- ---------
Real estate held for
investment............... 8,210 1,972 10,182
Real estate held for sale. - 101,462 101,462
-------- --------- ---------
Total reserve for losses on
real estate held for
investment or sale...... 8,210 103,434 111,644
------- -------- --------
Total reserves for losses. $73,683 $106,001 $179,684
======= ======== ========
</TABLE>
-35-
<PAGE>
Reserves for losses on loans secured by real estate and
real estate held for investment or sale totaled $130.6 million at December 31,
1993, which constituted 29.2% of total non-performing real estate assets,
before valuation allowances. This amount represented a $1.0 million decrease
from the September 30, 1993 level of $131.6 million, or 29.1% of total
non-performing real estate assets, before valuation allowances, at that date.
When real estate collateral securing an extension of credit
is initially recorded as REO, it is written down to fair value on the basis of
an appraisal. Such initial write-downs represent management's best
estimate of exposure to the Bank at the time that the collateral becomes REO
and in effect substitutes for reserves that would otherwise be recorded if the
collateral had not become REO. As circumstances change, it may be necessary
to provide additional reserves based on new information. Depending on the
nature of the information, these new reserves may be valuation allowances,
which reflect additional impairment with respect to a specific asset, or may be
unallocated reserves, which provide protection against changes in
management's perception of overall economic factors. Accordingly, the Bank
believes that relatively lower levels of reserves are initially required for
REO because of the Bank's policy of adjusting the book basis of its REO to
reflect the fair value of the collateral. Reserves for losses on real estate
held for sale at December 31, 1993 are net of approximately $62.2 million
of cumulative charge-offs against assets remaining in the Bank's portfolio at
December 31, 1993.
The Bank from time to time obtains updated appraisals on
its real estate acquired in settlement of loans. As a result of such updated
appraisals, the Bank could be required to increase its reserves.
Net charge-offs of credit card loans for the three months
ended December 31, 1993 were $12.5 million, compared to $19.2 million for the
three months ended December 31, 1992. The decrease in net charge-offs
resulted primarily from a decline in payment defaults. The allowance at any
balance sheet date relates only to receivable balances that exist as of that
date. Because of the nature of a revolving credit card account, however, the
cardholder may enter into transactions (such as retail purchases and cash
advances) subsequent to a balance sheet date, which increases the
outstanding balance of the account. Accordingly, charge-offs in any fiscal
period relate both to balances that existed at the beginning of the period and
to balances created during the period and may therefore exceed the levels of
reserves established at the beginning of the fiscal period.
The reserve for losses on credit card loans remained constant at
$46.9 million from September 30, 1993 to December 31, 1993. The ratios of
the reserve for such losses to non-performing credit card loans and to
outstanding credit card loans decreased to 216.5% and 4.9%, respectively, at
December 31, 1993 from 228.1% and 6.2%, respectively, at September 30, 1993.
-36-
<PAGE>
The reserve for losses on consumer and other loans decreased to $0.9
million at December 31, 1993 from $1.2 million at September 30, 1993.
The ratios of the reserves for losses on consumer and other loans to
non-performing consumer and other loans and to outstanding
consumer and other loans declined to 354.7% and 0.5%, respectively, at
December 31, 1993 from 376.1% and 0.8%, respectively, at September 30, 1993.
In November 1990, the Securities and Exchange Commission
initiated an informal investigation concerning the Bank's reserves for losses
and related matters and has requested documents from the Bank covering the
period since October 1, 1988. Based upon the information available to it at
this time, management believes that the matter should be resolved in a
manner that will not result in a material adverse financial impact on the Bank.
-37-
<PAGE>
ASSET AND LIABILITY MANAGEMENT. A key element of banking is
the monitoring and management of liquidity risk and interest-rate
risk. The process of planning and controlling asset and liability mixes,
volumes and maturities to stabilize the net interest spread is referred to as
asset and liability management. The objective of asset and liability
management is to maximize the net interest yield within the constraints imposed
by prudent lending and investing practices, liquidity needs and capital
planning.
The Bank is pursuing an asset-liability management strategy
to control its risk from changes in market interest rates principally by
originating interest-sensitive loans for its portfolio. In furtherance of
this strategy, the Bank emphasizes origination and retention of ARMs,
adjustable-rate home equity credit line loans and credit card loans, which
generally have shorter terms and higher yields than mortgage loans. At
December 31, 1993, ARMs and home equity credit line loans with rates
adjustable in one year or less accounted for 16.0% of total loans,
and credit card loans accounted for 33.5% of total loans.
In recent periods, the Bank's policy has generally been to
sell all of its long-term fixed-rate mortgage production, thereby avoiding
the exposure to market interest rate fluctuations typically associated with
long-term fixed-rate lending. The Bank retains in its portfolio the
majority of its variable-rate mortgage production.
Also in furtherance of asset and liability management
objectives, the Bank has engaged, and may continue to engage in the future, in
securitization transactions with respect to credit card and home equity credit
line receivables depending on its need for additional funds, market
conditions and related factors. At December 31, 1993, the Bank was considering
the securitization and sale of approximately $300.0 million of credit
card receivables during the second and third quarters of fiscal 1994.
A traditional measure of interest-rate risk within the
savings industry is the interest sensitivity "gap," which is the sum of all
interest-earning assets minus all interest-bearing liabilities to be repriced
within the same period. A negative gap like that shown below for the Bank
implies that, if market interest rates rise, the Bank's average cost of funds
will increase more rapidly than the concurrent increase in the average yield on
interest-earning assets. In a period of rising market interest
rates, the differential effect on the average yield on interest-earning
assets and the average cost of interest-bearing liabilities will decrease the
Bank's net interest spread and thereby adversely affect the Bank's operating
results. Conversely, in a period of declining interest rates, a negative
gap would result in an increase in the Bank's net interest spread.
The Bank views control over interest rate sensitivity as a
key element in its financial planning process and monitors its interest rate
sensitivity through its forecasting system. The Bank manages its interest
rate exposure and will narrow or widen its gap, depending on its perception of
interest rate movements and the composition of its balance sheet. For the
reasons discussed
-38-
<PAGE>
above, the Bank might take action to narrow its gap if it
believes that market interest rates will experience a significant prolonged
increase, and might widen its gap if it believes that market interest rates
will decline or remain relatively stable. A number of asset and liability
management strategies are available to the Bank in structuring its balance
sheet. These include selling or retaining certain portions of the Bank's
current residential mortgage loan production; altering the Bank's pricing on
certain deposit products to emphasize or de-emphasize particular maturity
categories; altering the type and maturity of securities acquired for the
Bank's investment portfolio when replacing securities following normal
portfolio maturation and turnover; lengthening or shortening the maturity
or repricing terms for any current period asset securitizations; and
altering the maturity or interest rate reset profile of borrowed funds,
if any, including funds borrowed from the FHLB of Atlanta.
The following table presents the contractual maturities of
the Bank's interest-earning assets and interest-bearing liabilities at
December 31, 1993, as adjusted for estimated prepayments and amortization and
provisions for adjustable interest rates. Adjustable and floating rate loans
are included in the period in which their interest rates are next scheduled to
adjust, and the prepayment rates assumed in each period for the Bank's loans are
those rates published most recently by the FHLB of Atlanta. Statement
savings and passbook accounts with balances under $20,000 are classified
based upon management's assumed attrition rate of 17.5%, and those with
balances of $20,000 or more, as well as all NOW accounts, are assumed to be
subject to repricing within six months or less.
-39-
<PAGE>
INTEREST RATE SENSITIVITY TABLE (GAP)
-------------------------------------
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
More than More than More than
Six Months One Year Three Years
Six Months through through through More than
or Less One Year Three Years Five Years Five Years Total
------------- ------------- ------------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1993
Mortgage loans:
Adjustable-rate $ 386,224 $ 162,898 $ 290,410 $ 301,396 $ 36,278 $1,177,206
Fixed-rate 16,934 16,369 60,761 52,410 54,916 201,390
Loans held for sale 211,476 -- -- -- -- 211,476
Home equity credit lines and second mortgages 113,645 62 -- -- -- 113,707
Credit card and other 694,073 21,324 76,528 50,365 3,328 845,618
Loans held for securitization and sale 300,000 -- -- -- -- 300,000
Mortgage-backed securities 305,464 275,611 421,683 348,308 -- 1,351,066
Other investments 129,461 -- 4,394 102 -- 133,957
------------- ------------- ----------- ----------- ----------- ----------
Total interest-earning assets 2,157,277 476,264 853,776 752,581 94,522 4,334,420
Total non-interest earning assets -- -- -- -- 796,179 796,179
------------- ------------- ----------- ----------- ----------- ----------
Total assets $ 2,157,277 $ 476,264 $ 853,776 $ 752,581 $ 890,701 $5,130,599
------------- ------------- ----------- ----------- ----------- ----------
------------- ------------- ----------- ----------- ----------- ----------
Deposits:
Fixed maturity deposits $ 386,386 $ 149,414 $ 164,420 $ 73,072 $ -- $ 773,292
NOW, statement and passbook accounts 1,494,957 37,692 125,539 85,445 182,093 1,925,726
Money market deposit accounts 1,164,091 -- -- -- -- 1,164,091
Borrowings:
Capital notes - subordinated 10,000 -- -- -- 150,000 160,000
Other 594,079 75,409 24,178 622 6,598 700,886
------------- ------------- ----------- ----------- ----------- ----------
Total interest-bearing liabilities 3,649,513 262,515 314,137 159,139 338,691 4,723,995
Total non-interest bearing liabilities -- -- -- -- 167,178 167,178
Stockholders' equity -- -- -- -- 239,426 239,426
------------- ------------- ----------- ----------- ----------- ----------
Total liabilities & stockholders' equity $ 3,649,513 $ 262,515 $ 314,137 $ 159,139 $ 745,295 $5,130,599
------------- ------------- ----------- ----------- ----------- ----------
------------- ------------- ----------- ----------- ----------- ----------
Gap ($1,492,236) $213,749 $539,639 $593,442 ($244,169)
Cumulative gap ($1,492,236) ($1,278,487) ($738,848) ($145,406) ($389,575)
Cumulative gap as a percentage
of total assets (29.1)% (24.9)% (14.4)% (2.8)% (7.6)%
</TABLE>
-40-
<PAGE>
The one-year gap, as a percentage of total assets, was a
negative 24.9% at December 31, 1993, compared to a negative 26.3% at September
30, 1993. As noted above, the Bank's negative one-year gap would adversely
affect the Bank's net interest spread and earnings if interest rates rise
and the Bank is unable to take steps to reduce its gap.
In addition to gap measurements, the Bank measures and
manages interest-rate risk with the extensive use of computer simulation.
This simulation includes calculations of Market Value of Portfolio
Equity and Net Interest Margin as promulgated by the OTS's Thrift Bulletin 13.
Effective January 1, 1994, the OTS's risk-based capital
requirements were amended to incorporate interest-rate risk measures to
complement those already established for credit risk. Under the amendments, an
institution that would experience a change in "portfolio equity" in an amount
in excess of 2.0% of the market value of the institution's assets as a result
of an increase or decrease in the general level of interest rates of as
much as 200 basis points is required to maintain additional amounts of
risk-based capital. Additional capital will have to be maintained by affected
institutions beginning July 1, 1994 based on interest rate exposure as of
December 31, 1993. Although the analysis of the Bank's interest rate exposure
at December 31, 1993 is not yet available, based upon an OTS analysis of the
Bank's exposure at September 30, 1993, management believes that the Bank
would not experience a change in "portfolio equity" in an amount in excess
of 2.0% of its assets under this test and therefore believes that the Bank
will not be required to maintain additional amounts of risk-based capital
beginning July 1, 1994.
DEFERRED TAX ASSET. At December 31, 1993, the Bank's net
deferred tax asset was $38.6 million, which generally represents the
cumulative temporary differences between financial reporting basis and tax
basis of the Bank's assets and liabilities. This net deferred tax asset is
reported on the Bank's financial statements in accordance with SFAS 109.
In January 1993, the OTS issued Thrift Bulletin 56 ("TB
56") setting forth additional guidance regarding the treatment of net deferred
tax assets for regulatory reporting and capital purposes. For purposes of
the Reports of Condition and Income and the Thrift Financial Reports and other
regulatory reporting, TB 56 provides that thrift institutions are required
to report their net deferred tax assets in accordance with SFAS 109.
For regulatory capital purposes, TB 56 generally sets forth
a limitation on the amount of a thrift's net deferred tax asset reported under
SFAS 109 that can be included in a thrift's regulatory capital. TB 56
provides that deferred tax assets which "can be realized from taxes paid in
prior carryback years are generally not limited." To the extent realization of
deferred tax assets depends on an institution's future taxable income, such
deferred tax assets are limited for regulatory capital purposes to the lesser
of (i) the amount that can be realized within one year of the quarter-end
report date or (ii) 10% of core capital. For regulatory purposes, the amount
of the Bank's deferred tax asset is not affected by the above limitations of TB
56.
-41-
<PAGE>
TAX SHARING PAYMENTS. Under the terms of the Bank's written agreement
with the OTS, the Bank has agreed not to make any payments to the Real Estate
Trust pursuant to the Tax Sharing Agreement between the Bank and the Trust
unless such payments are approved by the OTS. The OTS has further conditioned
the approval of any such payments on a pledge by the Real Estate Trust of
certain assets to secure certain of the Trust's obligations under the Tax
Sharing Agreement. Following execution of such a pledge, during the first
quarter of fiscal 1994, after receiving OTS approval, the Bank made
$4.6 million in tax sharing payments to the Real Estate Trust. Subsequent to
December 31, 1993, the OTS approved, and the Bank made, an additional tax
sharing payment of $5.0 million to the Real Estate Trust.
LIQUIDITY AND CAPITAL RESOURCES
REAL ESTATE
GENERAL. The Real Estate Trust's primary cash requirements
fall into four categories: operating expenses (exclusive of interest on
outstanding debt), capital improvements, interest on outstanding debt and
repayment of outstanding debt.
Historically, the Real Estate Trust's total cash
requirements have exceeded the cash generated by its operations. As described
below, this condition is currently the case and is expected to continue to be
so for the foreseeable future. The Real Estate Trust's internal sources of
funds, primarily cash flow generated by its income-producing properties,
generally have been sufficient to meet its cash needs other than the
repayment of principal on outstanding debt, including outstanding unsecured
notes ("Notes") sold to the public, and the payment of capital improvement
costs. In the past, the Real Estate Trust has funded such shortfalls through a
combination of external funding sources, primarily new financings (including
the sale of Notes), refinancings of maturing mortgage debt, asset sales and
tax sharing payments from the Bank.
The Real Estate Trust's liquidity position was constrained
in the last three fiscal years, primarily because of the persistence of
recessionary conditions in the Real Estate Trust's major real estate markets.
Those conditions have significantly curtailed the availability of
long-term fixed-rate mortgage financing on satisfactory terms. The Real
Estate Trust refinanced $350.0 million of mortgage debt in the first quarter
of fiscal 1992.
The Real Estate Trust's current program of public Note sales was
initiated in the 1970's as a vehicle for supplementing other external funding
sources. Note sales were suspended in June 1990, but resumed in
November 1992. During the period from the date of resumption of Note
sales through January 31, 1994, the Real Estate Trust sold $18.4 million of
Notes. The table under "Recent Liquidity Trends" below provides information
at December 31, 1993 with respect to the maturities of Notes outstanding at
such date.
-42-
<PAGE>
The Real Estate Trust has actively pursued a number of
strategies to improve its ability to meet its cash requirements.
RECENT LIQUIDITY TRENDS. The Real Estate Trust's liquidity
position was positively affected by two developments in fiscal 1993.
Short-term liquidity constraints were eased as a result of OTS approval of
the resumption of tax sharing payments by the Bank to the Real Estate Trust
following a significant improvement in the Bank's regulatory capital ratios
and overall financial condition. The Real Estate Trust's long-term liquidity
prospects improved as a result of the transfer to Saul Holdings Limited
Partnership and a subsidiary limited partnership of the mortgage debt
encumbering the 22 shopping centers and one office property transferred by the
Real Estate Trust to such partnerships in August 1993. A substantial portion
of such mortgage debt was scheduled to mature in fiscal years 1993 to 1997.
The maturity schedule for Real Estate Trust's outstanding
mortgage and Note debt at December 31, 1993 for the periods indicated is set
forth in the following table:
<TABLE>
<CAPTION>
FISCAL NOTES PAYABLE -
YEAR MORTGAGE NOTES UNSECURED TOTAL
- ------ -------------- --------------- --------
(In thousands)
<S> <C> <C> <C>
1994 (1) $ 9,194 $ 11,077 $ 20,271
1995 9,643 7,034 16,677
1996 7,011 5,553 12,564
1997 179,692 (2)(3) 2,904 182,596 (2)(3)
1998 16,024 7,990 24,014
Thereafter 43,350 5,329 48,679
---------- --------- ----------
$ 264,914 $ 39,887 $ 304,801
---------- --------- ----------
---------- --------- ----------
<FN>
(1) January 1, 1994 to September 30, 1994.
(2) The Real Estate Trust has five one-year options to extend
$146 million of this amount upon payment of $9 million in reduction of
principal in fiscal 1997 and $8 million in reduction of principal each
year thereafter.
(3) Balance does not include deferred interest, which amounted to
approximately $16.8 million at December 31, 1993 and is payable at
maturity.
</TABLE>
Of the $264.9 million of mortgage debt outstanding at
December 31, 1993, $161.9 million was nonrecourse to the Real Estate Trust.
The Real Estate Trust believes that its capital improvements costs
in the next several fiscal years will be in the range for $2 to $3 million
per year.
-43-
<PAGE>
In order to meet its debt amortization and capital improvement costs
in fiscal 1993 and in future years, the Real Estate Trust will be
required to raise substantial amounts of cash primarily from a combination of
mortgage loan refinancing, sales of Notes, and tax sharing payments and
cash dividends from the Bank.
The Real Estate Trust is currently selling Notes principally to pay
outstanding Notes as they mature. In paying maturing Notes with
proceeds of Note sales, the Real Estate Trust effectively is refinancing its
outstanding Notes with similar new unsecured debt at the lower interest rates
currently prevailing in today's market. To the degree that the Real Estate
Trust does not sell new Notes in an amount sufficient to finance completely
the scheduled repayment of outstanding Notes as they mature, which was the case
in fiscal 1993, it will finance such repayments from other sources of
funds.
In April 1993, the Bank received net proceeds of $71.9 million from
its sale of a preferred stock issue, which significantly strengthened
the Bank's regulatory capital ratios. This capital infusion, together with
the Bank's improved operating results, should enhance the Real Estate
Trust's prospects to receive tax sharing payments and dividends from the Bank.
In June 1993, after receiving approval of the OTS, the Bank made a $5.0 million
payment to the Real Estate Trust pursuant to the Tax Sharing Agreement
between the Bank and the Trust. OTS approval of this payment was further
conditioned on a pledge by the Real Estate Trust of certain assets to secure
certain of the Trust's obligations under the Tax Sharing Agreement. Following
execution of the pledge, the OTS approved, and the Bank made subsequent to
September 30,1993, additional tax sharing payments of $9.6 million to the Real
Estate Trust. Under the terms of the Bank's written agreement with the
OTS, any additional tax sharing payments by the Bank must be approved by
the OTS.
The Real Estate Trust to date has not relied on cash dividends from
Chevy Chase to meet its cash needs. In October 1993, the Bank's
written agreement with the OTS was amended to eliminate the requirement
that the Bank obtain the written approval of the OTS prior to declaring or
paying dividends on its common stock. However, the OTS retains general
discretion to prohibit any otherwise permitted capital distributions on
general safety and soundness grounds and must be given 30 days advance notice
of all capital distributions. OTS regulations tie Chevy Chase's ability to
pay dividends to specific levels of regulatory capital and earnings.
As the owner, directly and through a wholly-owned
subsidiary, of a 21.5% limited partnership interest in Saul Holdings Limited
Partnership, the Real Estate Trust will share in cash distributions from
operations and from capital transactions involving the sale or refinancing
of the properties of Saul Holdings Limited Partnership. The partnership
agreement of Saul Holdings Limited Partnership provides for quarterly
distributions to the partners out of net cash flow. In October 1993, the Real
Estate Trust received its first cash distribution, which was for a partial
period, in the amount of $524,000, from the Partnership. In
February 1994, the Real Estate Trust received its second cash distribution,
in the amount of $1,363,000.
-44-
<PAGE>
BANKING
LIQUIDITY. The standard measure of liquidity in the savings
industry is the ratio of cash and short-term U.S. Government and other
specified securities to net withdrawable accounts and borrowings payable in
one year or less.
The OTS has established a minimum liquidity requirement,
which may vary from time to time depending upon economic conditions and deposit
flows. The required liquidity level is currently 5.0%. The Bank's liquidity
ratio at December 31, 1993 was 24.1%, compared to 24.3% at September 30,
1993.
The Bank's primary sources of funds historically have
consisted of (i) principal and interest payments on loans and mortgage-backed
securities, (ii) savings deposits, (iii) sales of loans, mortgage-backed
securities and investments and (iv) borrowed funds. The Bank's holdings of
readily marketable securities constitute another important source of
liquidity. At December 31, 1993, the Bank's portfolio included mortgage loans,
U.S. Government securities and mortgage-backed securities with
outstanding principal balances of $676.5 million, $4.7 million and $1.3
billion, respectively, which could be used as collateral for borrowings
from the FHLB of Atlanta and various securities brokers. The amount which the
Bank could have borrowed against its unpledged mortgage loans, U.S.
Government securities and mortgage-backed securities totaled $1.0 billion
at December 31, 1993, after market-value and broker adjustments of the
collateral.
In recent periods, the proceeds from sales of credit card
relationships and other assets and securitization and sale of credit card, home
equity credit line and automobile loan receivables have been significant
sources of liquidity for the Bank. At December 31, 1993, the Bank was
considering the securitization and sale of approximately $300.0 million of
credit card receivables during the second and third quarters of fiscal 1994.
As part of its operating strategy, the Bank will continue to explore
opportunities to sell assets and to securitize and sell credit card and home
equity credit line receivables to meet liquidity and other balance sheet
objectives.
The ability of the Bank to securitize and sell assets in
the future will depend on a number of factors, including conditions in
the market for asset-backed securities and competitive pressures in the credit
card industry. The Bank does not currently anticipate relying upon
securitizations of receivables other than credit card and home equity credit
line receivables. The Bank's currently projected levels of securitization of
credit card and home equity credit line receivables reflect in part a reduction
in the pool of receivables eligible for such securitizations. The reduction in
the amount of eligible receivables has resulted from prior securitization and
sales activities. Management believes that to support future
securitization activity, a sufficient pool of eligible receivables will be
provided by the existing portfolio of receivables, the amortization of existing
credit card and home equity credit line trusts, increased usage of existing
accounts and originations of new accounts.
-45-
<PAGE>
The Bank uses its liquidity primarily to meet its commitments to fund
maturing savings certificates and deposit withdrawals, fund existing and
continuing loan commitments, repay borrowings and meet operating expenses.
For the three months ended December 31, 1993, the Bank used the
cash provided by operating, investing and financing activities primarily to
meet its commitments to fund maturing savings certificates and deposit
withdrawals of $2.8 billion, repay borrowings of $1.5 billion, fund existing
and continuing loan commitments (including real estate held for investment or
sale) of $766.5 million, purchase investments and loans of $146.1 million and
meet operating expenses, before depreciation and amortization, of $43.2
million. These commitments were funded primarily through proceeds from customer
deposits and sales of certificates of deposit of $2.9 billion, proceeds from
borrowings of $1.7 billion, proceeds from sales of loans, securities and real
estate of $409.2 million, and principal and interest collected on
investments, loans and mortgage-backed securities of $335.3 million.
The Bank is obligated under various recourse provisions
related to the securitization and sale of credit card, home equity credit line
and automobile loan receivables. Of the $1.2 billion of outstanding trust
certificate balances at December 31, 1993, the primary recourse to the Bank
was approximately $77.0 million.
The Bank also is obligated under various recourse provisions
related to the swap of single-family residential loans for participation
certificates and mortgage-backed securities issued to the Bank by FHLMC and
FNMA. At December 31, 1993, recourse to the Bank under these arrangements
was approximately $6.0 million.
The Bank's commitments at December 31, 1993 are set forth
in the following table:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
Commitments to originate loans $ 54,440
Loans in process (collateralized loans):
Home equity ................................. 524,174
Real estate construction..................... 25,626
Commercial and multifamily ................... 1,406
Residential ground........................... 2,679
-------
553,885
-------
Loans in process (unsecured loans):
Credit cards................................. 2,980,576
Overdraft lines.............................. 36,012
Commercial................................... 20
---------
3,016,608
---------
Total commitments to extend credit....... 3,624,933
</TABLE>
-46-
<PAGE>
<TABLE>
<S> <C>
Letters of credit ............................. 74,387
Recourse arrangements on asset-backed
securitizations ............................. 77,019
Recourse arrangements on mortgage-backed
securities .................................. 5,991
----------
Total commitments ....................... $3,782,330
==========
</TABLE>
Based on historical experience, the Bank expects to fund
substantially less than the total amount of its outstanding credit card and
home equity credit line commitments, which together accounted for 92.7% of
commitments at December 31, 1993.
At December 31, 1993, repayments of borrowed money
scheduled to occur during the next 12 months were $564.5 million.
Certificates of deposit maturing during the next 12 months amounted to
$535.8 million, of which a substantial portion is expected to remain with
the Bank.
There were no material commitments for capital expenditures
at December 31, 1993.
The Bank's liquidity requirements in fiscal 1994 and for
years subsequent to fiscal 1994 will continue to be affected both by
the asset size of the Bank, the growth of which will be constrained by capital
and other regulatory requirements, and the composition of the asset
portfolio. Management believes that the Bank's primary sources of funds,
described above, will be sufficient to meet the Bank's foreseeable long-term
liquidity needs. The mix of funding sources utilized from time to time will be
determined by a number of factors, including capital planning objectives,
lending and investment strategies and market conditions.
CAPITAL. At December 31, 1993, the Bank was in compliance
with all of its regulatory capital requirements under FIRREA, including
FIRREA-mandated fully phased-in capital requirements, and its capital ratios
exceeded the ratios established for well-capitalized institutions under OTS
prompt corrective action regulations. The following table shows the
Bank's regulatory capital levels at December 31, 1993, in relation to
the regulatory requirements in effect at that date. The information below is
based upon the Bank's understanding of the regulations and interpretations
currently in effect and may be subject to change.
-47-
<PAGE>
REGULATORY CAPITAL
(Dollars in thousands)
<TABLE>
<CAPTION>
Actual Capital Required
---------------------- ------------------------
As a % As a % Excess
Amount of Assets Amount of Assets Capital
--------- ----------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Capital per financial statements......... $ 292,982
Adjustments for tangible and core
capital:
Intangible assets...................... (54,234)
Non-includable subsidiaries (1)........ (6,412)
---------
Total tangible capital............... 232,336 4.55% $ 76,651 1.50% $155,685
-------- --------- ----- --------
-------- ------ ----- --------
Supervisory goodwill................... 38,325
---------
Total core capital(2)(3)............. 270,661 5.30% $ 153,301 3.00% $117,360
--------- ----- ------- ----- --------
----- ------- ----- --------
Total tier 1 risk-based capital
(2)................................. 270,661 6.88% N/A N/A N/A
---------- ----------- ----------- ----------- -------
----------- ----------- ----------- -------
Adjustments for risk-based capital:
Subordinated capital debentures........ 154,300
Reserve for general loan losses........ 59,068
---------
Total supplementary capital.......... 213,368
Excess loan loss reserves.............. (9,782)
---------
Adjusted supplementary capital......... 203,586
---------
Total available capital.............. 474,247
Equity investments (1)................. (19,584)
---------
Total risk-based capital (2)........ $ 454,663 11.56% $314,651 8.00% $140,012
--------- ----------- ----------- ----------- --------
--------- ----------- ----------- ----------- --------
- -------------------
<FN>
(1) Reflects an aggregate offset of $6.3 million representing the amount of
general reserves maintained against the Bank's equity investments
and non-includable subsidiaries which, pursuant to OTS guidelines, is
available as a "credit" against the deductions from capital otherwise required for
such investments.
(2) Under the OTS prompt corrective action regulations, the standards for
classification as "well capitalized" are a leverage (or "core capital") ratio
of a least 5.0%, a tier 1 risk-based capital ratio of at least 6.0% and a
total risk-based capital ratio of a least 10.0%
(3) Effective January 1, 1994, the amount of supervisory goodwill includable
as core capital under OTS regulations decreased from 0.75% to 0.375% of
tangible assets. If the 0.375% limit had been in effect on December 31,
1993, the Bank's core capital ratio would have been 4.92% or $98.2 million
above the regulatory requirement.
</TABLE>
-48-
<PAGE>
REGULATORY ACTION AND REQUIREMENTS. The Bank is subject to
a written agreement, dated September 30, 1991 as amended in October 1993,
with the OTS which imposes certain restrictions on the Bank's operations and
requires certain affirmative actions by the Bank. Primarily because of
its level of non-performing assets, the Bank is also subject to restrictions
on asset growth. Under the applicable OTS requirements, the Bank may not
increase its total assets during any calendar quarter in excess of an amount
equal to net interest credited on deposit liabilities during the quarter
without prior written approval from OTS. In September 1993, the Bank received
OTS approval, subject to certain conditions, to increase incrementally its
total assets during the period from July 1, 1993 through June 30, 1994 by an
amount up to $500 million. The Bank is also subject to a requirement to
obtain OTS approval for changes in directors and senior executive officers
and the imposition of increased OTS assessments and FDIC insurance
premiums. In January 1994, the OTS approved the appointment of three
additional directors to the Bank's Board of Directors. The OTS has approved the
payment of dividends on the Preferred Stock provided certain conditions are
met. In the future, if the Bank is unable to maintain capital compliance, the
Bank could be subject to additional regulatory sanctions.
CAPITAL MAINTENANCE STRATEGIES. The regulatory capital
requirements applicable to the Bank will continue to increase over time as a
result of the gradual phase-out of various assets from regulatory capital. On
the basis of its balance sheet at December 31, 1993, the Bank met the
FIRREA-mandated fully phased-in capital requirements. On a fully phased-in
basis, at December 31, 1993 the Bank's tangible, core (or leverage), and total
risk-based capital ratios were 4.14%, 4.14% and 9.81%, respectively, compared
with the requirements of 1.5%, 3.0% and 8.0%, respectively. At December
31, 1993, the Bank had $30.4 million, after subsequent valuation allowances, of
investments in subsidiaries engaged in activities impermissible for national
banks ("non-includable subsidiaries") which are currently subject to a
25% phase-out from all three FIRREA capital requirements. This phase-out will
gradually increase to 100% on July 1, 1996, in accordance with a delayed
phase-in period approved by the OTS pursuant to legislation enacted in October
1992. At December 31, 1993, the Bank also had one equity investment with a
balance, after subsequent valuation allowances, of $41.2 million which is
currently subject to a 60% phase-out from total capital for risk-based
capital purposes. This phase-out will increase to 100% on July 1, 1994.
Pursuant to OTS guidelines, $6.3 million of general reserves maintained against
the Bank's non-includable subsidiaries and equity investments is available
as a "credit" against the deduction from capital otherwise required for such
investments. The OTS adopted a rule, effective April 19, 1993, eliminating the
capital deduction for equity investments that are permissible for
national banks.
The Bank will continue to attempt to reduce the level of
its investments in non-includable subsidiaries and its level of equity
investments. The level of the Bank's investments in non-includable
subsidiaries is a key factor in the capital calculation because,
under the fully phased-in capital requirements, those investments represent
dollar-for-dollar reductions in core capital, which in turn reduce the amount
of supplementary capital which may be
-49-
<PAGE>
included for risk-based capital purposes. The Bank does not
anticipate entering into any new transactions that would result in an
increase in its investments in non-includable subsidiaries, and is attempting to
reduce the existing level of those investments over the next several years.
OTS capital regulations provide a five-year holding period
(or such longer period as may be approved by the OTS) for REO to qualify
for an exception from treatment as an equity investment. If an REO
property is considered an equity investment, its then-current book value is
deducted from total risk-based capital. Accordingly, if the Bank is unable to
dispose of any of its REO property (through bulk sales or otherwise) prior
to the end of its applicable five-year holding period and is unable to obtain
an extension of such five-year holding period from the OTS, the Bank would be
required to deduct the then-current book value of such REO property from
risk-based capital. The following table sets forth the Bank's REO at
December 31, 1993, after valuation allowances of $101.3 million, by the fiscal
year in which the property was acquired through foreclosure.
<TABLE>
<CAPTION>
FISCAL YEAR (IN THOUSANDS)
----------- --------------
<S> <C>
1990 (1) $145,141
1991 125,547
1992 21,255
1993 14,451
1994 6,838
---------
Total REO $313,232
=========
<FN>
____________________
(1) Includes one property with a net book value of $36.1
million, which the Bank agreed in fiscal 1991 to treat as an equity
investment for regulatory capital purposes.
</TABLE>
At December 31, 1993, the Bank had $51.3 million in
supervisory goodwill, of which $38.3 million was includable in core capital
pursuant to statutory provisions limiting the includable amount of
supervisory goodwill to an amount not to exceed 0.75% of tangible assets
beginning January 1, 1993, 0.375% beginning January 1, 1994 and 0% beginning
January 1, 1995.
The Bank's ability to maintain capital compliance will be
subject to general economic conditions, particularly in the Bank's local
markets. Continued softness in general economic conditions or a renewed
downturn in local real estate markets could require further additions to the
Bank's reserves for losses and further charge-offs. Any such
developments would adversely affect the Bank's earnings and thus its ability to
maintain capital compliance. The failure of the Bank to maintain capital
compliance could result in further regulatory sanctions.
-50-
<PAGE>
PROMPT CORRECTIVE ACTION. Under the OTS prompt corrective
action regulations which became effective on December 19, 1992, an
institution is categorized as "well capitalized" if it has a leverage (or core
capital) ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least
6.0% and a total risk-based capital ratio of at least 10.0%. At December
31, 1993, the Bank's leverage, tier 1 risk-based and total risk-based capital
ratios were 5.30%, 6.88% and 11.56%, respectively, which exceeded the ratios
established for "well capitalized" institutions. The OTS has the discretion
to reclassify an institution from one category to the next lower category, for
example from "well capitalized" to "adequately capitalized," if, after notice
and an opportunity for a hearing, the OTS determines that the
institution is in an unsafe or unsound condition or has received and
has not corrected a less than satisfactory examination rating for asset
quality, management, earnings or liquidity. The Bank's levels of
non-performing assets may result in reductions in capital to the extent losses
are recognized as a result of deteriorating collateral value or economic
conditions. Further, under the OTS's regulatory capital requirements, the
Bank is required to phase out from regulatory capital supervisory goodwill
and certain investments in subsidiaries and equity investments. Accordingly,
there can be no assurance that the Bank will be able to maintain levels of
capital sufficient to continue to meet the standards for classification as
"well capitalized."
RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31,1993 COMPARED TO THREE
MONTHS ENDED DECEMBER 31,1992.
REAL ESTATE
The following tables set forth, for the three-month periods ended
December 31, 1993 and 1992, respectively, direct operating results for the
Real Estate Trust's commercial properties portfolio, which includes shopping
centers and office properties, and the Real Estate Trust's hotel properties.
-51-
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
December 31,
--------------------
1993(1) 1992
--------------------
SHOPPING CENTERS (In thousands)
<S> <C> <C>
Revenue
Base rent - $ 5,502
Expense recoveries - 1,286
Percentage rent - 828
Other - 204
--------------------
Total revenues - 7,820
--------------------
Direct operating expenses
Real estate taxes - 527
Repairs and maintenance - 245
Utilities - 252
Payroll - 257
Insurance - 90
Ground rent - 139
Other - 250
--------------------
Total direct operating expenses - 1,760
--------------------
Income after direct operating expenses - $ 6,060
--------------------
--------------------
OFFICE PROPERTIES
Revenue
Base rent $3,478 $ 4,658
Expense recoveries 151 417
Other 94 102
--------------------
Total revenues 3,723 5,177
--------------------
Direct operating expenses
Real estate taxes 375 483
Repairs and maintenance 385 411
Utilities 578 569
Payroll 137 143
Insurance 65 76
Other 165 209
--------------------
Total direct operating expenses 1,705 1,891
--------------------
Income after direct operating expenses $2,018 $ 3,286
--------------------
--------------------
COMMERCIAL PROPERTIES
(SHOPPING CENTERS AND OFFICE PROPERTIES)
Revenue
Base rent $3,478 $10,160
Expense recoveries 151 1,703
Percentage rent 0 828
Other 94 306
--------------------
Total revenues 3,723 12,997
--------------------
Direct operating expenses
Real estate taxes 375 1,010
Repairs and maintenance 385 656
Utilities 578 821
Payroll 137 400
Insurance 65 166
Ground rent 0 139
Other 165 459
--------------------
Total direct operating expenses 1,705 3,651
--------------------
Income after direct operating expenses $2,018 $ 9,346
--------------------
--------------------
<FN>
- ---------------------
(1) Reflects the Real Estate Trust's transfer, in August 1993, of 22 shopping
center properties and one office property to Saul Holdings Limited
Partnership and a subsidiary limited partnership of Saul Holdings
Limited Partnership.
</TABLE>
-52-
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended December 31,
-------------------------------
1993 1992
-------------------------------
HOTELS (In thousands)
<S> <C> <C>
Revenue
Room sales $ 6,794 $ 6,715
Food sales 2,254 2,385
Beverage sales 766 898
Other 868 783
-------------------------
Total revenues 10,682 10,781
-------------------------
Direct operating expenses
Payroll 3,555 3,556
Cost of sales 1,069 1,222
Utilities 677 689
Repairs and maintenance 564 550
Advertising and promotion 532 593
Property taxes 230 289
Insurance 140 139
Other 1,138 990
--------------------------
Total direct operating expenses 7,905 8,028
--------------------------
Income after direct operating expenses $ 2,777 $ 2,753
--------------------------
--------------------------
</TABLE>
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<PAGE>
The Real Estate Trust recorded an operating loss of $10.1 million for
the three-month period ended December 31, 1993, compared to a $7.0 million
operating loss for the corresponding period in fiscal 1993. The current
period's loss reflected a $1.4 million writedown of real estate to net
realizable value, while the results of the December 1992 quarter included a
$539,000 loss on the sale of property.
On August 26, 1993, the Real Estate Trust transferred its 22 shopping
centers and one of its office properties to Saul Holdings Limited Partnership
and a subsidiary limited partnership in exchange for securities representing a
21.5% limited partnership interest in Saul Holdings Limited Partnership (the
"Saul Centers Transaction"). As a result of this transaction, the operating
results of commercial properties for the current quarter are not entirely
comparable to the prior period's results, which included the operations of the
transferred properties.
Income after direct operating expenses from commercial properties, which
includes only office properties, decreased $7.3 million (78.4%) from the three
months ended December 31, 1992, which includes income from both shopping
center and office properties. Because of the Saul Centers Transaction, the
Real Estate Trust received no income from shopping centers in the current
period. Income after direct operating expenses from commercial properties
held during both periods declined $825,000 (29.0%). The performance of the
office portfolio was adversely affected by a reduction in the leasing rate,
to 80% at December 31, 1993 from 83% at December 31, 1992. The lower leasing
rate generally reflected recessionary economic conditions in the markets in
which these properties are located, including the effects of the termination
on March 31, 1993 of a lease for 134,000 square feet of space in one of the
Trust's office buildings located in Atlanta.
Income after direct operating expenses from hotel properties increased
$24,000 (0.9%) in the December 1993 quarter. Room sales increased by $79,000
(1.2%), while food and beverage sales declined by $263,000 (8.0%). The net
decline in total revenues of $99,000 (0.9%) was more than offset by reductions
of $123,000 (1.5%) in operating costs.
Interest expense decreased by $3.1 million (23.9%) in the current period
primarily as a result of the transfer of the mortgage debt associated with the
properties conveyed in the Saul Centers Transaction. Average balances of the
Real Estate Trust's outstanding borrowings declined to $304.0 million in the
three months ended December 31, 1993 from $477.9 million in the prior
corresponding period.
Depreciation declined $1.1 million (33.8%) primarily as a result of the
transfer of properties in the Saul Centers Transaction.
Advisory, management and leasing fees-related parties declined $151,000
(9.0%) from the level in the three months ended December 31, 1992. The
monthly advisory fee in the December 1993 quarter was $250,000, compared to
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<PAGE>
$97,000 in the prior period. The effect of this increase was offset by
decreases in management and leasing fees, primarily because of the transfer of
properties in the Saul Centers Transaction and, to a lesser extent, reductions
in rental and sales income on which these fees are based.
Higher legal and accounting expense in the current quarter contributed
to an increase of $167,000 (50.0%) in general and administrative expenses.
Writedown of real estate to net realizable value reflects a $1.4 million
reduction in the carrying value of a hotel property. Although this hotel has
produced satisfactory operating results in the past, the Real Estate Trust
reduced the carrying value of the asset based on management's evaluation of
the hotel's location, recent operating history and unlikely prospects for a
near-term recovery.
BANKING
GENERAL. The Bank recorded operating income before income taxes,
extraordinary item and cumulative effect of change in accounting principle of
$6.0 million during the three months ended December 31, 1993, compared to
operating income before income taxes, extraordinary item and cumulative effect
of change in accounting principle of $1.3 million for the corresponding period
in fiscal 1993. The increase in the December 1993 quarter was attributable to
a $15.7 million decrease in the provision for loan losses and a $13.8 million
increase in other (non-interest) income. The positive effect of these items
was offset in part by a $7.7 million decrease in net interest income before
provision for loan losses and by a $17.0 million increase in operating
expenses.
The Bank's net income in the current quarter reflected a $6.3 million
extraordinary loss resulting from the Bank's redemption of its 1987 Debentures
and 1988 Debentures in December 1993. See "Financial Condition - General."
The Bank adopted SFAS 109 effective October 1, 1993. The cumulative
effect of this change in accounting principle of $5.1 million was recognized
as a benefit in the operating results for the December 1993 quarter. See Note
4 to the Consolidated Financial Statements in this report.
NET INTEREST INCOME. Net interest income, before the provision for
loan losses, decreased $7.7 million (or 16.4%) in the three months ended
December 31, 1993, as the average yield on interest-earning assets decreased
at a rate greater than the decrease in the average rate on interest-bearing
liabilities. See "Financial Condition - Asset and Liability Management."
The Bank would have recorded interest income of $3.2 million for the
three months ended December 31, 1993 if non-accrual assets and restructured
loans had been current in accordance with their original terms. Interest
income of $0.6 million was actually recorded on non-accrual assets and
restructured loans for the three months ended December 31, 1993. The Bank's
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<PAGE>
net interest income in future periods will continue to be adversely affected
by the Bank's non-performing assets.
The following table sets forth, for the periods indicated, information
regarding the total amount of income from interest-earning assets and the
resulting yields, the interest expense associated with interest-bearing
liabilities, expressed in dollars and rates, and the net interest spread and
net yield on interest-earning assets.
-56-
<PAGE>
NET INTEREST MARGIN ANALYSIS
----------------------------
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended December 31,
------------------------------------------------------------------
1993 1992
------------------------------- -----------------------------
Average Yield/ Average Yield/
Balances Interest Rate Balances Interest Rate
---------- -------- ------- ---------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans receivable, net (1) $2,483,114 $59,164 9.53 % $2,113,138 $62,135 11.76 %
Mortgage-backed securities (2) 1,457,544 20,769 5.70 1,590,149 25,906 6.52
Federal funds sold 17,487 131 3.00 18,533 138 2.98
Investment securities 4,688 81 6.91 173,333 2,789 6.44
Other interest-earning assets 208,643 1,511 2.90 162,334 1,176 2.90
---------- ------- ----------- -------
Total 4,171,476 81,656 7.83 4,057,487 92,144 9.08
------- ------- ------- ------
Non-interest earning assets:
Cash 113,301 101,089
Real estate held for investment or sale 391,983 524,555
Property and equipment, net 136,011 144,788
Cost in excess of net assets acquired, net 9,333 12,225
Other assets 163,340 158,757
---------- ----------
Total assets $4,985,444 $4,998,901
========== ==========
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits $ 800,230 5,376 2.69 $ 719,725 4,377 2.43
Savings deposits 1,053,995 8,710 3.31 770,053 6,311 3.28
Time deposits 804,299 8,041 4.00 1,077,711 12,530 4.65
Money market deposits 1,181,021 9,256 3.13 1,287,366 10,364 3.22
---------- ------- ---------- -------
Total deposits 3,839,545 31,383 3.27 3,854,855 33,582 3.48
Borrowings 792,038 10,837 5.47 919,306 11,406 4.96
---------- ------- ---------- -------
Total liabilities 4,631,583 42,220 3.65 4,774,161 44,988 3.77
Non interest-bearing items: ------- ------- ------- -------
Non-interest bearing deposits 55,742 34,374
Other liabilities 37,186 38,335
Stockholders' equity 260,933 152,031
---------- ----------
Total liabilities and stockholders' equity $4,985,444 $4,998,901
---------- ----------
---------- ----------
Net interest income $39,436 $47,156
------- -------
------- -------
Net interest spread (3) 4.18 % 5.31 %
------- -------
------- -------
Net yield on interest-earning assets (4) 3.78 % 4.65 %
------- -------
------- -------
Interest-earning assets to interest-bearing liabilities 90.07 % 84.99 %
------- -------
------- -------
<FN>
- --------------------------------------------------------------------------------------------------------------------------
(1) Includes loans held for sale and/or securitization. Interest on
non-accruing loans has been included only to the extent reflected in the
income statement; however, the loan balance is included in the average
amount outstanding until transferred to real estate acquired in
settlement of loans.
(2) Includes mortgage-backed securities held for sale for the three months
ended December 31, 1992.
(3) Equals weighted average yield on total interest-earning assets less
weighted average rate on total interest-bearing liabilities.
(4) Equals net interest income divided by the average balances of total
interest-earning assets.
</TABLE>
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<PAGE>
The following table presents certain information regarding changes in
interest income and interest expense of the Bank during the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to changes in volume (change
in volume multiplied by old rate); changes in rate (change in rate multiplied
by old volume); and changes in rate and volume.
-58-
<PAGE>
VOLUME AND RATE CHANGES IN NET INTEREST INCOME
----------------------------------------------
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended December 31, 1993
Compared to
Three Months Ended December 31, 1992
Increase (Decrease)
Due to Change in (1)
------------------------------------------
Total
Volume Rate Change
------------ ------------ ------------
<S> <C> <C> <C>
Interest income:
Loans (2) $ 43,811 $ (46,782) $ (2,971)
Mortgage-backed securities (3) (2,048) (3,089) (5,137)
Federal funds sold (13) 6 (7)
Investment securities (4,035) 1,327 (2,708)
Other interest-earning assets 335 0 335
---------- ------------ ------------
Total interest income 38,050 (48,538) (10,488)
----------- ------------ ------------
Interest expense:
Deposit accounts (136) (2,063) (2,199)
Borrowings (5,707) 5,138 (569)
------------ ------------ ------------
Total interest expense (5,843) 3,075 (2,768)
------------ ------------ ------------
Increase (decrease) in
net interest income $ 43,893 $ (51,613) $ (7,720)
------------ ------------ ------------
------------ ------------ ------------
<FN>
- --------------------------------------------------------------------------------------------------------------------------
(1) The net change attributable to the combined impact of volume and rate has
been allocated in proportion to the absolute value of the change due to
volume and the change due to rate.
(2) Includes loans held for sale and/or securitization.
(3) Includes mortgage-backed securities held for sale for the three months
ended December 31, 1992.
</TABLE>
-59-
<PAGE>
Interest income for the three months ended December 31, 1993 decreased
$10.5 million from the level in the prior corresponding period, primarily as a
result of lower average yields earned by the Bank on the principal categories
of its interest-earning assets. The effect of the lower average yields on
interest income was offset in part by higher average balances of certain
interest-earning assets, principally loans receivable and, to a lesser extent,
interest-bearing deposits.
Interest income on loans, the largest category of interest-earning
assets, declined by $3.0 million (or 4.8%) from the December 1992 quarter.
The decline in interest income was attributable to lower average yields on the
loan portfolio, which reflected a decline in market interest rates. The
average yield on the portfolio in the current quarter decreased by 223 basis
points (to 9.53% from 11.76%) from the average yield in the three months ended
December 31, 1992. Special introductory and promotional interest rates to new
and existing credit card holders contributed to a decline in the average yield
on credit card loans to 15.1% from 18.2% and a decline of $7.8 million in
interest income on these loans. The average yield on single-family
residential loans declined to 6.83% from 7.72%, while the average yield on
home equity credit line loans decreased to 6.59% from 7.25%. Both of these
loan types generally bear interest at variable rates that adjust based on
specified market interest rates, which declined significantly from levels
prevailing in the three months ended December 31, 1992. The effect of these
lower yields was offset in part by an increase in the average yield on
construction and ground loans of 165 basis points (from 6.02% to 7.67%).
An increase in average loan balances partially offset the effects of
lower average yields. Average balances of single-family residential permanent
loans increased $407.5 million as a result of increased origination of such
loans during the December 1993 quarter. Interest income on these loans
increased $4.9 million from the prior period. An increase of $1.8 million (or
107.8%) in interest income on consumer loans (other than credit card loans)
was attributable to increased originations of automobile loans. Average
balances of commercial permanent loans increased $33.1 million (or 55.8%)
primarily as a result of an increase in loans made to purchasers of certain of
the Bank's REO in connection with the sales of such REO. Average balances of
credit card and home equity credit line loans declined during the current
quarter, largely as a result of the Bank's loan securitization and sale
activity. The securitization and sale of $150.0 million and $200.0 million of
credit card
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<PAGE>
receivables in March 1993 and August 1993, respectively, were reflected in a
decrease of $30.2 million (or 3.5%) in average balances of this loan type.
This decrease was partially mitigated by an increase in new account
originations in connection with the Bank's resumption of active national
solicitation of new credit card accounts. A decline of $134.6 million (or
61.3%) in average balances of home equity credit line receivables contributed
to a $2.6 million decline in interest income. Average loan balances in the
construction and ground loan categories decreased $19.9 million (or 24.4%)
from the level in the prior corresponding period primarily as a result of loan
principal repayments and the acquisition of the underlying collateral through
foreclosure.
Interest income on mortgage-backed securities decreased $5.1 million
primarily because of lower average balances resulting from the sale of $127.8
million of mortgage-backed securities in March 1993. Interest income in the
December 1993 quarter also was adversely affected by a decline in average
rates to 5.70% from 6.52%. The Bank's mortgage-backed securities principally
bear interest at variable rates that adjust based on market interest rates.
Interest income on investment securities decreased $2.7 million as the
result of lower average balances of U.S. Government securities.
Interest expense decreased $2.8 million (or 6.2%) for the three months
ended December 31, 1993 primarily because of a decline of $2.2 million in
interest expense on deposits, the largest category of interest-bearing
liabilities. Interest expense on deposits decreased principally as a result
of a decrease in average rates (to 3.27% from 3.48%), which reflected a
decline in market interest rates, and, to a lesser extent, a decrease of $15.3
million in average deposit balances.
Interest on borrowings decreased $0.6 million in the December 1993
quarter primarily because of a decrease in interest expense on repurchase
transactions. The decrease was offset in part by increased interest expense on
FHLB advances and on the Bank's subordinated indebtedness. The Bank paid
interest on the 1987 Debentures and 1988 Debentures through December 23, 1993
and December 24, 1993, respectively, when it redeemed those securities with
the proceeds of the 1993 Debentures, which were issued on November 23, 1993.
See "Financial Condition - Banking - General."
PROVISION FOR LOAN LOSSES. The Bank's provision for loan losses
decreased to $12.1 million in the December 1993 quarter from $27.8 million in
the prior period. The provision for credit card loans decreased $11.7 million
primarily as a result of a decline in net charge-offs of credit card loans in
fiscal 1993. The provision for real estate loans also decreased $3.9 million
as a result of the Bank's implementation of SOP 92-3 in the December 1992
quarter. See "Financial Condition - Reserve for Losses" and Note 4 to the
Consolidated Financial Statements in this report.
OTHER INCOME. The increase in other income (to $35.3 million in the
December 1993 quarter from $21.6 million in the December 1992 quarter) was
primarily attributable to an increase in earnings on real estate held for
investment or sale and an increase in loan and deposit servicing fees. These
increases were partially offset by decreased gains on sales of credit card
relationships, loans and mortgage-backed securities.
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<PAGE>
The $19.3 million increase in earnings on real estate held for
investment or sale was primarily attributable to a decrease of $18.8 million
in the provision for losses as a result of the Bank's implementation of SOP
92-3 in the three months ended December 31, 1992. See "Financial Condition -
Reserves for Losses." The decreased provision was partially offset by a $1.1
million decrease in the operating income generated by the Bank's REO
properties.
An increase of $4.2 million in excess servicing fees earned by the Bank
in servicing its portfolios of securitized credit card loans contributed to an
increase of $2.5 million (or 14.3%) in loan and deposit servicing fees.
Excess servicing fees represent the contractual interest and fees paid by
credit card holders less certificate interest paid to holders of certificates
in the trusts and administrative fees paid to providers of services to the
trusts. The $4.2 million increase is excess servicing fees earned from
servicing the credit card portfolios, have increased as a result of more
securitization activity by the Bank in recent periods. The higher
level of securitized credit card receivables also resulted in increased credit
card servicing fees of $0.7 million. As the Bank securitizes and sells
assets, purchases mortgage servicing rights, or sell mortgage loans and
retains the servicing rights on those loans, servicing fee income levels
increase. The level of servicing fee income declines upon repayment of assets
previously securitized and sold and upon prepayment of mortgage loans serviced
for others. The positive effect of these items on loan and deposit servicing
fees was offset in part by a $1.6 million increase in rebate expense on credit
card retail purchases, which the Bank incurred in connection with promotional
activities undertaken beginning in 1993. The amortization of the excess
servicing asset related to home equity credit line securitizations increased
$2.2 million during the three months ended December 31, 1993. The increase
was primarily attributable to the securitization and sale of $194.2 million
and $146.2 million of home equity credit line receivables in December 1992 and
September 1993, respectively.
Gain on sales of credit card relationships, loans and mortgage-backed
securities decreased $10.2 million in the three months ended December 31, 1993
from the prior corresponding period. The prior period's results were affected
by the sale of $194.2 million of home equity credit line receivables in the
December 1992 quarter, which resulted in a gain of $10.4 million.
OPERATING EXPENSES. Operating expenses in the quarter ended December
31, 1993 increased $17.0 million primarily as a result of increases in
advertising expenses, salaries and employee benefits and loan expenses. The
$5.9 million increase in advertising expenses was primarily attributable to
increased solicitation by the Bank of its credit card products and services in
connection with the resumption of active national solicitation of new credit
card accounts. The $5.1 million increase in salaries and employee benefits
resulted primarily from staffing increases and a discretionary bonus paid to
substantially all employees in December 1993. The $3.8 million increase in
loan expenses is primarily attributable to the accelerated amortization of
purchased mortgage servicing rights, which resulted from increased prepayments
of the underlying loans.
In order to take advantage of additional opportunities to enhance
profitability, the Bank may be required to incur increased expenditures for
salaries and employee benefits, loan expenses and advertising expenses, which
will contribute to higher operating expenses in future periods.
-62-
