<PAGE>
Registration No. 33-34930
Rule 424(b)(3)
Supplement Dated August 15, 1997
to Prospectus Dated January 30, 1997
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B. F. SAUL
REAL ESTATE INVESTMENT TRUST
QUARTERLY REPORT
FOR QUARTER ENDED
JUNE 30, 1997
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<PAGE>
TABLE OF CONTENTS
FINANCIAL INFORMATION
Financial Statements:
(a) Consolidated Balance Sheets at June 30, 1997 and
September 30, 1996
(b) Consolidated Statements of Operations for the
three-month and nine-month periods ended
June 30, 1997 and 1996
(c) Consolidated Statements of Cash Flows for the
nine-month periods ended June 30, 1997 and 1996
(d) Notes to Consolidated Financial Statements
Management's Discussion and Analysis of Financial Condition
and Results of Operations:
(a) Financial Condition
Real Estate
Banking
(b) Liquidity and Capital Resources
Real Estate
Banking
(c) Results of Operations
Three months ended June 30, 1997 compared to
three months ended June 30, 1996
Nine months ended June 30, 1997 compared to
nine months ended June 30, 1996
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<TABLE>
Consolidated Balance Sheets
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
===================================================================================================================================
June 30 September 30
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(In thousands) 1997 1996
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<S> <C> <C>
ASSETS
Real Estate
Income-producing properties
Hotel $ 128,692 $ 121,417
Office and industrial 108,890 106,496
Other 4,252 4,715
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241,834 232,628
Accumulated depreciation (84,389) (76,513)
-------------- --------------
157,445 156,115
Land parcels 41,580 41,580
Cash and cash equivalents 10,450 15,516
Other assets 82,357 81,292
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Total real estate assets 291,832 294,503
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Banking
Cash and due from banks 235,123 213,394
Interest-bearing deposits 106,276 53,031
Federal funds sold and securities purchased under agreements to resell 415,000 --
Loans held for sale 71,239 76,064
Loans held for securitization and sale 211,000 450,000
Investment securities (market value $5,009 and $9,820, respectively) 4,998 9,818
Mortgage-backed securities (market value $1,064,621 and $1,307,838, respectively) 1,063,990 1,306,417
Loans receivable (net of allowance for losses of $97,726 and $95,523, respectively) 3,134,714 2,772,967
Federal Home Loan Bank stock 33,170 31,940
Real estate held for investment or sale (net of allowance for losses of $142,370
and $126,710, respectively) 108,244 123,489
Property and equipment, net 261,792 225,135
Cost in excess of net assets acquired, net 1,342 2,399
Excess spread assets, net 88,684 --
Mortgage servicing rights, net 35,388 --
Other assets 364,216 428,420
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Total banking assets 6,135,176 5,693,074
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TOTAL ASSETS $ 6,427,008 $ 5,987,577
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LIABILITIES
Real Estate
Mortgage notes payable $ 180,911 $ 173,345
Notes payable - secured 175,000 177,500
Notes payable - unsecured 45,391 42,367
Deferred gains - real estate 112,883 112,883
Accrued dividends payable - preferred shares of beneficial interest 34,876 31,563
Other liabilities and accrued expenses 34,041 40,434
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Total real estate liabilities 583,102 578,092
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Banking
Deposit accounts 4,836,822 4,164,037
Borrowings 81,843 644,418
Federal Home Loan Bank advances 375,422 269,065
Other liabilities and accrued expenses 134,410 150,924
Capital notes -- subordinated 250,000 160,000
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Total banking liabilities 5,678,497 5,388,444
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Commitments and contingencies
Minority interest held by affiliates 47,674 46,065
Minority interest -- other 218,307 74,307
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TOTAL LIABILITIES 6,527,580 6,086,908
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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 (158,179) (156,084)
Net unrealized holding loss (646) (1,500)
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(58,724) (57,483)
Less cost of 1,814,688 common shares of beneficial interest in treasury (41,848) (41,848)
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TOTAL SHAREHOLDERS' DEFICIT (100,572) (99,331)
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TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 6,427,008 $ 5,987,577
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The Notes to Consolidated Financial Statements are an integral part of these
statements.
</TABLE>
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<TABLE>
Consolidated Statements of Operations
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
===================================================================================================================================
For the Three Months Ended For the Nine Months Ended
June 30 June 30
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(In thousands, except per share amounts) 1997 1996 1997 1996
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<S> <C> <C> <C> <C>
REAL ESTATE
Income
Hotels $ 17,366 $ 15,540 $ 43,717 $ 40,178
Office and industrial properties 5,442 4,164 15,496 12,828
Other 640 992 1,908 3,055
-------------- -------------- -------------- --------------
Total income 23,448 20,696 61,121 56,061
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Expenses
Direct operating expenses:
Hotels 10,142 9,291 28,410 26,733
Office and industrial properties 1,944 1,715 5,579 5,184
Land parcels and other 395 408 1,305 1,187
Interest expense 10,056 9,921 30,098 29,923
Amortization of debt expense 189 154 525 479
Depreciation 2,571 2,432 7,876 7,277
Advisory, management and leasing fees - related parties 2,107 1,956 5,932 5,523
General and administrative 175 238 920 955
-------------- -------------- -------------- --------------
Total expenses 27,579 26,115 80,645 77,261
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Equity in earnings of unconsolidated entities 1,240 854 2,779 2,230
Gain (loss) on sale of property 724 1 724 (56)
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REAL ESTATE OPERATING LOSS $ (2,167) $ (4,564) $ (16,021) $ (19,026)
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BANKING
Interest income
Loans $ 99,753 $ 82,679 $ 292,877 $ 231,515
Mortgage-backed securities 16,573 11,481 55,206 36,966
Trading securities 284 281 902 640
Investment securities 118 74 404 171
Other 4,020 4,739 9,916 14,781
-------------- -------------- -------------- --------------
Total interest income 120,748 99,254 359,305 284,073
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Interest expense
Deposit accounts 43,674 39,929 120,700 123,333
Borrowings 17,572 5,472 60,001 17,137
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Total interest expense 61,246 45,401 180,701 140,470
-------------- -------------- -------------- --------------
Net interest income 59,502 53,853 178,604 143,603
Provision for loan losses (36,129) (30,062) (89,891) (70,825)
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Net interest income after provision for loan losses 23,373 23,791 88,713 72,778
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Other income
Credit card fees 14,930 7,964 42,498 18,682
Loan and deposit servicing fees 52,150 77,805 167,990 220,903
Gain on sales of trading securities, net 487 401 976 1,061
Loss on real estate held for investment or sale, net (4,460) (5,875) (13,854) (19,376)
Gain on sales of loans, net 21,488 11,850 50,693 17,092
Other 5,563 4,790 17,562 14,109
-------------- -------------- -------------- --------------
Total other income 90,158 96,935 265,865 252,471
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Continued on following page.
</TABLE>
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<TABLE>
Consolidated Statements of Operations (Continued)
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
===================================================================================================================================
For the Three Months Ended For the Nine Months Ended
June 30 June 30
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(In thousands, except per share amounts) 1997 1996 1997 1996
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<S> <C> <C> <C> <C>
BANKING (Continued)
Operating expenses
Salaries and employee benefits $ 41,717 $ 32,670 $ 117,301 $ 93,354
Loan 7,258 7,012 18,519 19,758
Property and equipment 10,306 8,629 29,372 24,729
Marketing 16,463 14,473 55,211 35,568
Data processing 15,175 12,504 45,756 37,081
Deposit insurance premiums 988 2,712 4,024 8,046
Amortization of cost in excess of net assets acquired 320 444 1,056 1,407
Other 10,632 10,665 32,583 36,364
-------------- -------------- -------------- --------------
Total operating expenses 102,859 89,109 303,822 256,307
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BANKING OPERATING INCOME $ 10,672 $ 31,617 $ 50,756 $ 68,942
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TOTAL COMPANY
Operating income $ 8,505 $ 27,053 $ 34,735 $ 49,916
Income tax provision 5,061 11,432 13,223 21,254
-------------- -------------- -------------- --------------
Income before minority interest 3,444 15,621 21,512 28,662
Minority interest held by affiliates (194) (3,129) (3,197) (6,776)
Minority interest -- other (6,329) (2,438) (16,348) (7,313)
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TOTAL COMPANY NET INCOME (LOSS) (3,079) 10,054 1,967 14,573
DEFICIT
Beginning of period (153,746) (119,424) (156,084) (123,943)
Additions to dividends payable
Preferred shares of beneficial interest 1,354 500 4,062 500
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End of period $ (158,179) $ (109,870) $ (158,179) $ (109,870)
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NET INCOME (LOSS) AVAILABLE TO COMMON
SHAREHOLDERS $ (4,433) $ 8,699 $ (2,095) $ 10,508
NET INCOME (LOSS) PER COMMON SHARE
Income before minority interest $ 0.44 $ 2.96 $ 3.62 $ 5.10
Minority interest held by affiliates (0.04) (0.65) (0.66) (1.40)
Minority interest -- other (1.31) (0.51) (3.39) (1.52)
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NET INCOME (LOSS) PER COMMON SHARE $ (0.91) $ 1.80 $ (0.43) $ 2.18
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The Notes to Consolidated Financial Statements are an integral part of these
statements.
</TABLE>
<PAGE>
<TABLE>
Consolidated Statements of Cash Flows
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
===================================================================================================================================
For the Nine Months Ended
June 30
------------------------------
(In thousands) 1997 1996
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Real Estate
Net loss $ (10,819) $ (12,529)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation 7,876 7,277
(Gain) loss on sale of property (724) 56
(Increase) decrease in accounts receivable and accrued income 818 (4,534)
Increase in deferred tax asset (5,417) (6,821)
Decrease in accounts payable and accrued expenses (4,474) (6,434)
Decrease in tax sharing receivable 3,167 20,000
Amortization of debt expense 525 479
Equity in earnings of unconsolidated entities (2,779) (2,230)
Other 7,893 3,236
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(3,934) (1,500)
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Banking
Net income 12,784 27,102
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Amortization (accretion) of premiums, discounts and net deferred loan fees (1,470) 2,798
Depreciation and amortization 21,062 18,112
Amortization of cost in excess of net assets acquired and mortgage
servicing rights 7,434 6,956
Capitalized interest on real estate held for investment or sale (1,670) --
Originations of mortgage servicing rights (6,340) --
Provision for loan losses 89,891 70,825
Net fundings of loans held for sale and/or securitization (523,645) (530,783)
Proceeds from sales of trading securities 348,519 257,257
Proceeds from sales of loans held for sale and/or securitization 2,119,153 1,585,916
Provision for losses on real estate held for investment or sale 15,660 20,152
Earnings on real estate (1,996) (1,597)
Gain on sales of trading securities, net (976) (1,061)
Gain on sales of loans, net (50,693) (17,092)
Minority interest held by affiliates 3,197 6,776
Minority interest - other 7,313 7,313
Increase in interest-only strips receivable (46,082) (19,383)
Increase in other assets (4,323) (19,650)
Increase (decrease) in other liabilities and accrued expenses (22,736) 3,184
Decrease in tax sharing payable (3,167) (20,000)
Other operating activities, net 9,080 (9,622)
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1,970,995 1,387,203
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Net cash provided by operating activities 1,968,045 1,385,703
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CASH FLOWS FROM INVESTING ACTIVITIES
Real Estate
Capital expenditures - properties (4,998) (3,606)
Property sales 1,245 1,812
Property acquisition (4,709) --
Equity investment in unconsolidated entities, net 254 1,018
Other investing activities, net 43 1
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(8,165) (775)
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Banking
Net proceeds from redemption of Federal Home Loan Bank stock 9,482 --
Net proceeds from maturities of investment securities 5,000 4,410
Net proceeds from sales of real estate 19,784 46,046
Net proceeds from sales of mortgage servicing rights -- 966
Net fundings of loans receivable (1,561,452) (1,088,856)
Principal collected on mortgage-backed securities 552,591 166,790
Purchases of Federal Home Loan Bank Stock (10,712) --
Purchases of investment securities -- (10,000)
Purchases of mortgage-backed securities (311,554) (135,125)
Purchases of loans receivable (547,717) (209,480)
Purchases of property and equipment (58,008) (47,635)
Purchases of mortgage servicing rights -- (9,902)
Disbursements for real estate held for investment or sale (15,672) (15,359)
Other investing activities, net 650 (5,527)
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(1,917,608) (1,303,672)
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Net cash used in investing activities (1,926,757) (1,304,447)
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Continued on following page.
</TABLE>
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<TABLE>
Consolidated Statements of Cash Flows (Continued)
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
===================================================================================================================================
For the Nine Months Ended
June 30
------------------------------
(In thousands) 1997 1996
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<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Real Estate
Proceeds from mortgage financing $ 25,000 $ --
Principal curtailments and repayments of mortgages (17,272) (6,837)
Proceeds from secured note financing -- --
Repayments of secured notes (2,500) (500)
Proceeds from sales of unsecured notes 4,417 2,617
Repayments of unsecured notes (1,393) (2,186)
Dividends paid - preferred shares of beneficial interest (750) (500)
Other financing activities, net (469) (179)
-------------- --------------
7,033 (7,585)
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Banking
Proceeds from customer deposits and sales of certificates of deposit 13,941,389 11,255,134
Customer withdrawals of deposits and payments for maturing certificates of deposit (13,268,604) (11,189,276)
Net decrease in securities sold under repurchase agreements (574,253) (1,055)
Advances from the Federal Home Loan Bank 863,767 11,904
Repayments of advances from the Federal Home Loan Bank (757,410) (50,207)
Proceeds from other borrowings 4,160,549 1,399,981
Repayments of other borrowings (4,148,871) (1,392,414)
Cash dividends paid on preferred stock (7,313) (7,313)
Cash dividends paid on common stock (9,000) (5,000)
Repayment of capital notes - subordinated (10,000) --
Net proceeds from issuance of capital notes - subordinated 96,112 --
Net proceeds from issuance of preferred stock of subsidiary 144,000 --
Other financing activities, net 6,221 6,848
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436,587 28,602
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Net cash provided by financing activities 443,620 21,017
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Net increase in cash and cash equivalents 484,908 102,273
Cash and cash equivalents at beginning of period 281,941 376,637
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Cash and cash equivalents at end of period $ 766,849 $ 478,910
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Supplemental disclosures of cash flow information: Cash paid during the year
for:
Interest (net of amount capitalized) $ 202,588 $ 189,504
Income taxes 1,134 8,075
Supplemental disclosures of noncash activities:
Rollovers of notes payable - unsecured 3,600 2,991
Loans held for sale exchanged for trading securities 347,887 256,770
Loans receivable transferred to loans held for sale and/or securitization 1,645,177 1,142,802
Loans made in connection with the sale of real estate 1,775 42,441
Loans receivable transferred to real estate acquired in settlement of loans 3,091 4,891
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The Notes to Consolidated Financial Statements are an integral part of these
statements.
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. In the opinion of management, the consolidated financial statements reflect
all adjustments necessary for a 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,
1996. The results of operations for interim periods are not necessarily
indicative of results to be expected for the year.
2. The accompanying financial statements include the accounts of B.F.Saul Real
Estate Investment Trust and its wholly owned subsidiaries (the "Real Estate
Trust"), which are involved in the ownership and development of income-producing
properties. The accounts of the Trust's 80%-owned banking subsidiary, Chevy
Chase Bank, F.S.B., and its subsidiaries ("Chevy Chase" or 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.
4. In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 129, "Disclosure of Information
about Capital Structure," which established standards for disclosing information
about an entity's capital structure. In June 1997, FASB issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income," which
establishes standards for reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. These
standards are required to be adopted for fiscal years beginning after December
15, 1997. In the opinion of management, these standards will not have a material
impact on the Trust's results of operations and financial position.
<PAGE>
5. BANKING:
LOANS HELD FOR SALE:
At June 30, 1997 and September 30, 1996, loans held for sale is composed of
single-family residential loans.
LOANS HELD FOR SECURITIZATION AND SALE:
Loans held for securitization and sale are composed of the following:
June 30, September 30,
1997 1996
-------- --------
(In thousands)
Credit card receivables ...................... $115,000 $225,000
Automobile loan receivables .................. 75,000 225,000
Home loan receivables ........................ 21,000 --
-------- --------
Total ...................................... $211,000 $450,000
======== ========
LOANS RECEIVABLE:
June 30, September 30,
1997 1996
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(In thousands)
Single-family residential .................... $ 1,799,387 $ 1,525,322
Home equity .................................. 50,590 32,052
Commercial real estate and multifamily ....... 78,965 78,951
Real estate construction ..................... 49,758 41,561
Ground ....................................... 35,253 44,723
Commercial ................................... 154,185 85,372
Credit card .................................. 946,525 893,271
Automobile ................................... 105,938 72,560
Overdraft lines of credit .................... 22,122 21,296
Home improvement and
other consumer ............................. 45,273 94,316
Other consumer ............................... 14,714 16,658
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3,302,710 2,906,082
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Less:
Undisbursed portion of loans ............... 88,263 50,811
Unearned discounts ......................... 647 836
Net deferred loan origination
costs .................................... (18,640) (14,055)
Allowance for loan losses .................. 97,726 95,523
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167,996 133,115
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Total ...................................... $ 3,134,714 $ 2,772,967
=========== ===========
<PAGE>
REAL ESTATE HELD FOR INVESTMENT OR SALE:
The Bank's real estate held for investment is carried at the lower of aggregate
cost or net realizable value. The Bank's real estate acquired in settlement of
loans is considered to be held for sale and is carried at the lower of cost or
fair value (less estimated selling costs).
Real estate held for investment or sale is composed of the following:
June 30, September 30,
1997 1996
-------- --------
(In thousands)
Real estate held for investment .................. $ 3,819 $ 3,819
-------- --------
Real estate held for sale ........................ 246,795 246,380
-------- --------
Less:
Allowance for losses on real estate
held for investment ............................ 195 191
Allowance for losses on real estate
held for sale .................................. 142,175 126,519
-------- --------
142,370 126,710
-------- --------
Total real estate held for
investment or sale ............................ $108,244 $123,489
======== ========
MINORITY INTEREST:
On December 3, 1996, a new real estate investment trust subsidiary of the Bank
(the "REIT Subsidiary") sold $150.0 million of its Noncumulative Exchangeable
Perpetual Preferred Stock, Series A (the "REIT Preferred Stock") and received
net cash proceeds of $144.0 million. Cash dividends on the REIT Preferred Stock
are payable quarterly in arrears at an annual rate of 103/8%. The REIT Preferred
Stock is automatically exchangeable for a new series of preferred stock of the
Bank upon the occurrence of certain events. The Bank has received OTS approval
to include the proceeds received from the sale of the REIT Preferred Stock in
the core capital of the Bank for regulatory capital purposes in an amount up to
25% of the Bank's core capital. The REIT Preferred Stock is not redeemable prior
to January 15, 2007, and is redeemable thereafter at the option of the REIT
Subsidiary. The net cash proceeds from the sale of the REIT Preferred Stock is
reflected as "Minority Interest" in the Consolidated Balance Sheets. Dividends
on the REIT Preferred Stock are presented as a reduction of net income in the
Consolidated Statements of Operations.
<PAGE>
ADOPTION OF RECENTLY ISSUED ACCOUNTING STANDARDS:
Effective January 1, 1997, the Bank adopted Statement of Financial Accounting
Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" ("SFAS 125"). Among other things, SFAS 125
requires that, upon the transfer of assets, an entity recognize the financial
and servicing assets it controls and the liabilities it has incurred,
derecognize financial assets when control has been surrendered, and derecognize
liabilities when extinguished. As a result of the adoption of SFAS 125, the Bank
began to recognize gains upon the securitization and sale of credit card
receivables based upon the net present value of the expected cash flows to be
generated by the underlying receivables. Except for the effects on the Bank's
credit card securitization program, the impacts of SFAS 125 are not material to
the Bank's other lending and servicing activities.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The principal business conducted by the B.F. Saul Real Estate Investment Trust
(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 June 30,
1997, the Bank's assets accounted for approximately 95% of the Trust's
consolidated assets. The Trust recorded net income of $2.0 million for the
nine-month period ended June 30, 1997 compared to net income of $14.6 million
for the nine-month period ended June 30, 1996. The reduction in net income was
the result of a decline in Bank operating income due to higher operating
expenses and a decrease in other income.
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 B.F.
Saul Real Estate Investment Trust and its subsidiaries, including Chevy Chase
and Chevy Chase's subsidiaries. "Real Estate Trust" refers to B.F. Saul Real
Estate Investment Trust and its subsidiaries, excluding Chevy Chase and Chevy
Chase's subsidiaries. The operations conducted by the Real Estate Trust are
designated as "Real Estate," while the business conducted by the Bank and its
subsidiaries is identified by the term "Banking."
FINANCIAL CONDITION
REAL ESTATE
The number of properties in the Real Estate Trust's investment portfolio at June
30, 1997, which consisted primarily of hotels, office and industrial projects
and land parcels, was increased by one property from the number at September 30,
1996. In the first quarter of fiscal 1997, the Real Estate Trust purchased a
115-room Holiday Inn Express in Herndon, Virginia.
Overall, the hotel portfolio experienced an average occupancy rate of 69%, and
average room rate of $71.43 during the nine-month period ended June 30, 1997.
For the nine hotel properties owned by the Real Estate Trust throughout the
nine-month periods of fiscal 1997 and fiscal 1996, the average occupancy rates
were 69% and 67%, respectively, and the average room rates were $71.82 and
$68.16, respectively. Five of these hotels registered improved occupancies and
seven registered higher average room rates in the current period. On October 30,
1996, the Real Estate Trust purchased a 115-room Holiday Inn Express hotel in
Herndon, Virginia, which is located approximately three miles from the
Washington Dulles International Airport. The purchase price was $4.7 million.
The Real Estate Trust obtained five year floating-rate financing on the project
in the amount of $3.3 million.
The Real Estate Trust's office and industrial property portfolio was 99% leased
at June 30, 1997, compared to leasing rates of 93% and 91% at September 30, 1996
and at June 30, 1996, respectively. At June 30, 1997, the Real Estate Trust's
office and industrial property portfolio had a total gross leasable area of 1.3
million square feet, of which 57,000 square feet(4.4%) and 283,000 square
feet(21.7%), are subject to leases whose terms expire in the balance of fiscal
1997 and in fiscal 1998, respectively.
<PAGE>
BANKING:
General. The Bank recorded operating income of $10.7 million during the June
1997 quarter, compared to operating income of $31.6 million in the prior
corresponding period. The $20.9 million decrease in operating income for the
current quarter was primarily a result of a $13.8 million increase in operating
expenses and a $6.1 million increase in the provision for loan losses. Also
contributing to the decline in income was a $6.8 million decrease in the Bank's
other (non-interest) income, which was primarily due to a decline in loan and
deposit servicing fees. Partially offsetting these decreases were increases in
net interest income before provision for loan losses and gain on sales of loans.
Gains on sales of loans continued to be a large component of the Bank's
non-interest income during the current quarter (an increase of 81.3% over the
prior corresponding period), resulting from the Bank's securitization activity.
In the June 1997 quarter, the Bank securitized and sold $210.0 million of credit
card receivables, $214.1 million of automobile loan receivables, and $216.3
million of mortgage loan receivables, consisting of $146.6 million of home
equity receivables and $69.7 million of home loan receivables, and recognized
gains of $2.3 million, $6.6 million and $11.2 million, respectively, in
connection with these sales. During the June 1997 quarter, the Bank also
securitized and sold $144.2 million of amounts on deposit in certain spread
accounts established in connection with certain of the Bank's outstanding credit
card securitizations. See "Capital." See Note 8 to the Consolidated
Financial Statements. See "Liquidity."
At June 30, 1997, the Bank's tangible, core, tier 1 risk-based and total
risk-based regulatory capital ratios were 6.19%, 6.19%, 6.87% and 12.87%,
respectively. The Bank's capital ratios exceeded the requirements under the
Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA")
as well as the standards established for "well-capitalized" institutions under
the prompt corrective action regulations issued pursuant to the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"). See "Capital."
During the quarter, the Bank declared and paid, out of the retained earnings of
the Bank, a cash dividend on its Common Stock in the amount of $300 per share.
On June 25, 1997 the Bank signed a definitive agreement to acquire ASB Capital
Management, Inc. ("ASB"), a wholly-owned subsidiary of NationsBank Corporation
and one of the largest SEC-registered investment managers headquartered in the
Washington, D.C. metropolitan area. ASB provides a variety of investment
products, including equity and fixed income securities, money market
investments, and real estate investments, to a primarily institutional client
base and is expected to have approximately $4.3 billion of assets under
management upon closing of the transaction. Consummation of the transaction is
subject to regulatory approvals, including approval from the OTS for the Bank to
obtain trust powers through a new operating subsidiary which will acquire ASB.
Although the acquisition will generate additional goodwill which will reduce the
Bank's regulatory
<PAGE>
capital levels, the Bank anticipates that its capital levels will remain above
the levels established for well-capitalized institutions and that the
acquisition will provide the Bank with an additional source of fee-based
revenues.
The Bank's assets are subject to review and classification by the OTS and the
FDIC upon examination. The OTS concluded its most recent annual examination of
the Bank in June 1997.
Asset Quality. 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, after all valuation allowances.
<PAGE>
<TABLE>
Non-Performing Assets
(Dollars in thousands)
June 30, March 31, September 30,
1997 1997 1996
----------------- ------------------ ---------------------
<S> <C> <C> <C>
Non-performing assets:
Non-accrual loans:
Residential $ 10,735 $ 9,533 $ 8,200
Credit card (1) - 28,947 25,350
Other consumer 3,290 2,505 1,239
----------------- ------------------ ---------------------
Total non-accrual loans (2) 14,025 40,985 34,789
----------------- ------------------ ---------------------
Real estate acquired in settlement of loans 246,795 247,465 246,380
Allowance for losses on real estate acquired in
settlement of loans (142,175) (136,785) (126,519)
----------------- ------------------ ---------------------
Real estate acquired in settlement of loans, net 104,620 110,680 119,861
----------------- ------------------ ---------------------
Total non-performing assets $ 118,645 $ 151,665 $ 154,650
================= ================== =====================
Allowance for losses on loans $ 97,726 $ 91,254 $ 95,523
Allowance for losses on real estate held for investment 195 193 191
Allowance for losses on real estate acquired in settlement
of loans 142,175 136,785 126,519
----------------- ------------------ ---------------------
Total allowances for losses $ 240,096 $ 228,232 $ 222,233
================= ================== =====================
Ratios:
Non-performing assets, net to total assets (1) (3) 0.34% 0.98% 1.03%
Allowance for losses on real estate loans to non-accrual
real estate loans (2) 97.69% 114.06% 134.44%
Allowance for losses on other consumer loans to
non-accrual other consumer loans (2) 171.73% 183.63% 370.86%
Allowance for losses on loans to non-accrual loans (1) (2) 696.80% 222.65% 274.58%
Allowance for losses on loans to total loans receivable (4) 2.78% 2.51% 2.81%
(1) Non-performing assets and related ratios do not include loans more than 90
days past due and still accruing.
(2) Before deduction of allowances for losses.
(3) Non-performing assets is presented after all allowances for losses on loans
and real estate held for investment or sale.
(4) Includes loans receivable and loans held for sale and/or securitization,
before deduction of allowance for losses.
</TABLE>
<PAGE>
Non-performing assets include non-accrual loans (loans contractually past due 90
days or more or with respect to which other factors indicate that full payment
of principal and interest is unlikely) and real estate acquired in settlement of
loans, either through foreclosure or deed-in-lieu of foreclosure.
During the quarter ended June 30, 1997, the Bank conformed its reporting
practices for credit card loans to that of most credit card issuers and has
excluded credit card loans from non-performing assets. Credit card loans are not
placed on non-accrual status, but continue to accrue interest until the loan is
either paid or charged-off.
Non-performing assets totaled $118.6 million, after valuation allowances on real
estate held for sale or real estate owned ("REO") of $142.2 million, at June 30,
1997, compared to $151.7 million, after valuation allowances on REO of $136.8
million, at March 31, 1997. In addition to the valuation allowances on REO, the
Bank maintained $0.7 million of valuation allowances on its non-accrual loans at
June 30, 1997. The $33.1 million decrease in non-performing assets for the
current quarter was comprised of a net decrease in REO of $6.1 million and a
decrease in non-accrual loans of $27.0 million. See "Non-accrual Loans" and
"REO."
Non-accrual Loans. The Bank's non-accrual loans totaled $14.0 million at June
30, 1997, as compared to $41.0 million at March 31, 1997. At June 30, 1997,
non-accrual loans consisted of $10.7 million of non-accrual real estate loans
and $3.3 million of non-accrual other consumer loans. The $27.0 million decrease
in non-accrual loans was primarily due to a change in reporting practices for
credit card loans as discussed above. At March 31, 1997 total non-accrual loans
of $41.0 million consisted of $28.9 million of credit card loans.
REO. At June 30, 1997, the Bank's REO totaled $104.6 million, after valuation
allowances on such assets of $142.2 million as set forth in the following table.
The principal component of REO consists of five planned unit developments (the
"Communities"), four of which are under active development. Only commercial
ground remains in two of the four active Communities. The fifth Community,
consisting of approximately 2,400 acres in Loudoun County, Virginia, is in the
pre-development stage.
Balance Balance
Before All After
Number of Valuation Valuation Valuation Percent
Properties Allowances Allowances Allowances of Total
---------- ---------- ------------ ------------ --------
(Dollars in thousands)
Communities .......... 5 $209,485 $129,181 $ 80,304 76.8%
Residential ground ... 4 13,657 6,329 7,328 7.0%
Commercial ground .... 7 20,837 6,665 14,172 13.5%
Single-family
residential
properties .......... 17 2,816 -- 2,816 2.7%
-------- -------- -------- -------- -----
Total REO ......... 33 $246,795 $142,175 $104,620 100.0%
======== ======== ======== ======== =====
During the three months ended June 30, 1997, REO decreased $6.1 million, which
was primarily attributable to additional valuation allowances of $5.4 million
and sales in the Communities and other residential properties, partially offset
by additional capitalized costs.
<PAGE>
During the three months ended June 30, 1997, the Bank received revenues of $7.9
million from the disposition of REO, which consisted of 82 residential lots or
units in the Communities ($5.2 million), 6.0 acres of commercial land in one of
the Communities ($1.5 million) and various single-family residential properties
($1.2 million).
At June 30, 1997, the Bank had executed contracts to sell two residential ground
properties and one commercial ground property at their aggregate book value of
$5.0 million at that date.
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. At June
30, 1997, none of the Bank's assets were deemed by management to be potential
problem assets. At March 31, 1997, potential problem assets totaled $2.3
million, before valuation allowances of $0.4 million. The decline in potential
problem assets was primarily attributable to the reclassification of one
residential construction loan with a principal balance of $2.3 million as recent
lot sales in the property have resulted in the reduction in the principal
balance of the loan.
Delinquent Loans. At June 30, 1997, delinquent loans totaled $80.4 million (or
2.3% of loans) compared to $62.9 million (or 1.7% of loans) at March 31, 1997.
The following table sets forth information regarding the Bank's delinquent loans
at June 30, 1997.
Principal Balance
--------------------------------- Total as a
Mortgage Non-Mortgage Percentage
Loans Loans Total of Loans (1)
------- ------- ------- ------------
(Dollars in thousands)
Loans delinquent for:
30-59 days ....................$ 8,351 $27,858 $36,209 1.1%
60-89 days .................... 1,469 17,281 18,750 0.5%
90 days or more and
still accruing .............. -- 25,469 25,469 0.7%
------- ------- ------- ---
Total ........................$ 9,820 $70,608 $80,428 2.3%
======= ======= ======= ===
- ----------------
(1) Includes loans held for sale and/or securitization, before deduction of
reserves.
Mortgage loans classified as delinquent 30-89 days consists entirely of
single-family permanent residential mortgage loans and home equity credit line
loans. Total delinquent mortgage loans decreased from $15.5 million at March 31,
1997 to $9.8 million at June 30, 1997. The decrease in delinquent mortgage loans
is primarily related to the correction of certain processing delays in the March
1997 quarter which resulted from the transfer to the Bank of servicing
responsibilities associated with a home equity credit line loan portfolio
purchased by the Bank in the December 1996 quarter.
Non-mortgage loans (principally credit card loans) delinquent 30-89 days
decreased to $45.1 million at June 30, 1997 from $47.4 million at March 31,
1997. The decrease in such non-mortgage loans was primarily due to a decline in
delinquent credit card loans due to increased collection efforts by the Bank.
<PAGE>
Non-mortgage loans delinquent 90 days or more and still accruing consists
entirely of credit card loans. During the quarter ended June 30, 1997, the Bank
conformed its reporting practices for credit card loans to that of most credit
card issuers and continues to accrue interest until the loan is either paid or
charged-off.
Troubled Debt Restructurings. At June 30, 1997 loans, accounted for as troubled
debt restructurings totaled $11.8 million, and included one commercial permanent
loan with a principal balance of $11.7 million and one commercial collateralized
loan with a principal balance of $0.1 million. The $0.2 million decrease, from
$12.0 million at March 31, 1997, was a result of net principal reductions. At
June 30, 1997, the Bank had commitments to lend $0.1 million of additional funds
on loans that have been restructured.
Real Estate Held for Investment. At June 30, 1997 and September 30, 1996, real
estate held for investment consisted of two properties with an aggregate book
value of $3.6 million, net of valuation allowances of $0.2 million.
Allowances for Losses. The following tables show loss experience by asset type
and the components of the allowance for losses on loans and the allowance for
losses on real estate held for investment or sale. These tables reflect
charge-offs taken against assets during the periods indicated and may include
charge-offs taken against assets which the Bank disposed of during such periods.
<PAGE>
<TABLE>
Analysis of Allowance for and Charge-offs of Loans
(Dollars in thousands)
Three Months
Nine Months Ended Ended
June 30, June 30,
-----------------------------------
1997 1996 1997
-------------- --------------- ---------------------
<S> <C> <C> <C>
Balance at beginning of period $ 95,523 $ 60,496 $ 91,254
-------------- --------------- ---------------------
Provision for loan losses 89,891 70,825 36,129
-------------- --------------- ---------------------
Increase due to acquisition of loans 118 - -
-------------- --------------- ---------------------
Charge-offs:
Residential 658 655 214
Credit card 88,860 62,804 30,127
Other 6,499 4,790 2,404
-------------- --------------- ---------------------
Total charge-offs 96,017 68,249 32,745
-------------- --------------- ---------------------
Recoveries:
Residential 31 16 4
Credit card 7,380 8,172 2,774
Other 800 359 310
-------------- --------------- ---------------------
Total recoveries 8,211 8,547 3,088
-------------- --------------- ---------------------
Charge-offs, net of recoveries 87,806 59,702 29,657
-------------- --------------- ---------------------
Balance at end of period $ 97,726 $ 71,619 $ 97,726
============== =============== =====================
Provision for loan losses to average loans (1) (2) 3.33% 3.28% 3.93%
Net loan charge-offs to average loans (1) (2) 3.25% 2.77% 3.22%
Ending allowance for losses on loans to total
loans (2) (3) 2.78% 2.43% 2.78%
(1) Annualized.
(2) Includes loans held for sale and/or securitization.
(3) Before deduction of allowances.
</TABLE>
<PAGE>
<TABLE>
Components of Allowance for Losses on Loans by Type
(Dollars in thousands)
June 30, March 31, September 30,
1997 1997 1996
------------------------------ -------------------------- -----------------------------
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:
Single-family residential $ 1,128 53.4% $ 1,076 49.6% $ 925 47.4%
Home equity 494 1.4 583 5.1 446 0.9
Commercial real estate and multifamily 7,958 2.3 7,943 2.1 8,398 2.3
Real estate construction 238 0.7 630 0.8 838 0.7
Ground 322 0.9 354 1.0 417 1.2
Commercial 347 2.7 287 2.2 223 1.7
Credit card 81,589 (1) 30.4 75,781 30.4 79,681 33.1
Automobile 2,100 5.2 1,600 4.8 1,858 8.8
Home improvement, overdraft lines of
credit and other consumer 3,550 3.0 3,000 4.0 2,737 3.9
------------- ------------ -------------
Total $ 97,726 $ 91,254 $ 95,523
============= ============ =============
(1) The increase in the credit card allowance for losses is the result of
the reclassification of reserves for delinquent interest that were
previously presented net of the credit card loan balance in the
accompanying Consolidated Balance Sheets, substantially all of which
relates to prior periods.
</TABLE>
<PAGE>
<TABLE>
Analysis of Allowance for and Charge-offs of
Real Estate Held for Investment or Sale
(In thousands)
Three Months
Nine Months Ended Ended
June 30, June 30,
---------------------------------------------
1997 1996 1997
------------------- -------------------- -------------------
<S> <C> <C> <C>
Balance at beginning of period:
Real estate held for investment $ 191 $ 193 $ 193
Real estate held for sale 126,519 135,043 136,785
------------------- -------------------- -------------------
Total 126,710 135,236 136,978
------------------- -------------------- -------------------
Provision for real estate losses:
Real estate held for investment 4 (5) 2
Real estate held for sale 15,656 20,157 5,390
------------------- -------------------- -------------------
Total 15,660 20,152 5,392
------------------- -------------------- -------------------
Charge-offs:
Real estate held for sale:
Residential ground - 27,430 -
------------------- -------------------- -------------------
Total charge-offs on real estate
held for investment or sale - 27,430 -
------------------- -------------------- -------------------
Balance at end of period:
Real estate held for investment 195 188 195
Real estate held for sale 142,175 127,770 142,175
------------------- -------------------- -------------------
Total $ 142,370 $ 127,958 $ 142,370
=================== ==================== ===================
</TABLE>
<PAGE>
<TABLE>
Components of Allowance for Losses
on Real Estate Held for Investment or Sale
(In thousands)
June 30, March 31, September 30,
1997 1997 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
Allowance for losses on real estate
held for investment $ 195 $ 193 $ 191
----------------- ----------------- -----------------
Allowance for losses on real estate
held for sale:
Residential permanent - 136 112
Home equity - 3 8
Ground 142,175 136,646 126,399
----------------- ----------------- -----------------
Total 142,175 136,785 126,519
----------------- ----------------- -----------------
Total allowance for losses on real
estate held for investment or sale $ 142,370 $ 136,978 $ 126,710
================= ================= =================
</TABLE>
<PAGE>
The Bank maintains valuation allowances for estimated losses on loans and real
estate. The Bank's total valuation allowances for losses on loans and real
estate held for investment or sale increased by $11.9 million from the level at
March 31, 1997 to $240.1 million at June 30, 1997. The $11.9 million increase
was primarily attributable to increased valuation allowances on credit card
loans and the Communities.
The allowance for losses on loans secured by real estate and real estate held
for investment or sale totaled $152.5 million at June 30, 1997, which
constituted 59.2% of total non-performing real estate assets, before valuation
allowances. This amount represented a $4.9 million increase from the March 31,
1997 level of $147.6 million, or 57.4% of total non-performing real estate
assets, before valuation allowances at that date.
During the nine months ended June 30, 1997, the Bank provided an additional
$15.4 million of valuation allowances on loans secured by real estate and real
estate held for investment or sale and recorded net charge-offs of $0.6 million
on these assets. The allowance for losses on real estate held for sale at June
30, 1997 is in addition to approximately $50.7 million of cumulative charge-offs
previously taken against assets remaining in the Bank's portfolio at June 30,
1997.
During the nine months ended June 30, 1997, the Bank provided an additional $2.9
million of general valuation allowances against the Communities pursuant to its
policy of providing additional general valuation allowances equal to, or in
excess of, the amount of the net earnings generated by the development and sale
of land in the Communities.
Net charge-offs of credit card loans for the nine months ended June 30, 1997
were $81.5 million, compared to $54.6 million for the nine months ended June 30,
1996. The increase in net charge-offs over the prior nine-month period is
consistent with management's expectations and generally reflects the trends that
are affecting the credit card industry as a whole. However, management expects
that the Bank will experience a decline in such losses in future periods,
resulting from more effective underwriting and other lending policies which the
Bank has implemented in recent periods. The allowance for losses on credit card
loans was $81.6 million at June 30, 1997 compared to $75.8 million at March 31,
1997. The increase in the credit card allowance is a result of a
reclassification of reserves for delinquent interest that were previously
presented net of the credit card loan balance in the accompanying Consolidated
Balance Sheets, substantially all of which related to prior periods. The ratio
of the allowance for such losses to outstanding credit card loans was 7.7% at
June 30, 1997 compared to 6.9% at March 31, 1997.
The combined allowance for losses on consumer and other loans (automobile, home
improvement, overdraft lines of credit and other consumer loans) increased to
$5.7 million at June 30, 1997 from $4.6 million at March 31, 1997. The ratios of
the allowances for losses on consumer and other loans to non-performing consumer
and other loans and to outstanding consumer and other loans were 171.7% and
2.0%, respectively, at June 30, 1997 compared to 183.6% and 1.1%, respectively,
at March 31, 1997.
<PAGE>
Asset and Liability Management. A key element of banking is the monitoring and
management of liquidity risk and interest-rate risk. The process of planning and
controlling asset and liability mixes, volumes and maturities to stabilize the
net interest spread is referred to as asset and liability management. The
objective of asset and liability management is to maximize the net interest
yield within the constraints imposed by prudent lending and investing practices,
liquidity needs and capital planning.
The following table presents the interest rate sensitivity of the Bank's
interest-earning assets and interest-bearing liabilities at June 30, 1997, which
reflects management's estimate of mortgage loan prepayments and amortization and
provisions for adjustable interest rates. Adjustable and floating rate loans are
included in the period in which their interest rates are next scheduled to
adjust, and prepay ment rates are assumed for the Bank's loans based on recent
actual experience. Statement savings and passbook accounts with balances under
$20,000 are classified based upon management's assumed attrition rate of 17.5%,
and those with balances of $20,000 or more, as well as all NOW accounts, are
assumed to be subject to repricing within six months or less.
<PAGE>
<TABLE>
Interest Rate Sensitivity Table (Gap)
(Dollars in thousands)
More than More than More than
Six Months One Year Three Years
Six Months through through through More than
or Less One Year Three Years Five Years Five Years Total
------------- ------------- ------------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1997
Mortgage loans:
Adjustable-rate $ 321,951 $ 211,078 $ 498,011 $ 243,767 $ 502,696 $ 1,777,503
Fixed-rate 12,334 7,714 42,961 69,979 22,805 155,793
Loans held for sale 71,239 - - - - 71,239
Home equity credit lines and
second mortgages 65,690 497 1,725 1,371 4,982 74,265
Credit card and other 1,048,200 29,996 74,806 47,684 24,193 1,224,879
Loans held for securitization
and sale 211,000 - - - - 211,000
Mortgage-backed securities 632,086 363,675 26,366 15,178 26,685 1,063,990
Other investments 651,653 - 4,998 - - 656,651
------------- ------------- ------------- ------------- ------------ ------------
Total interest-earning assets 3,014,153 612,960 648,867 377,979 581,361 5,235,320
Total non-interest earning assets - - - - 899,856 899,856
------------- ------------- ------------- ------------- ------------ ------------
Total assets $ 3,014,153 $ 612,960 $ 648,867 $ 377,979 $1,481,217 $ 6,135,176
============= ============= ============= ============= ============ ============
Deposits:
Fixed maturity deposits $ 852,841 $ 557,499 $ 261,903 $ 48,250 $ - $ 1,720,493
NOW, statement and passbook
accounts 1,400,604 42,732 142,324 96,869 206,439 1,888,968
Money market deposit accounts 986,988 - - - - 986,988
Borrowings:
Capital notes - subordinated - - - - 250,000 250,000
Other 425,694 1,942 5,569 10,114 13,946 457,265
------------- ------------- ------------- ------------- ------------ ------------
Total interest-bearing
liabilities 3,666,127 602,173 409,796 155,233 470,385 5,303,714
Total non-interest bearing
liabilities - - - - 518,783 518,783
Stockholders' equity - - - - 312,679 312,679
------------- ------------- ------------- ------------- ------------ ------------
Total liabilities & stockholders'
equity $ 3,666,127 $ 602,173 $ 409,796 $ 155,233 $1,301,847 $ 6,135,176
============= ============= ============= ============= ============ ============
Gap $ (651,974) $ 10,787 $ 239,071 $ 222,746 $ 110,976
Cumulative gap $ (651,974) $ (641,187) $ (402,116) $ (179,370) $ (68,394)
Adjustment for interest rate caps(1)$ 325,000 $ 225,000 $ 100,000 $ - $ -
Adjusted cumulative gap $ (326,974) $ (416,187) $ (302,116) $ (179,370) $ (68,394)
Adjusted cumulative gap as a
percentage of total assets (5.3%) (6.8%) (4.9%) (2.9%) (1.1%)
- ------------------------------------------------------------------------------------------------------------------------------
(1) At June 30, 1997, the Bank had $350,000 notional amount of interest rate caps. The adjustments reflect the average
notional amount outstanding for each period until the last cap expires June 30, 1999.
</TABLE>
<PAGE>
The interest sensitivity "gap" shown in the table represents the sum of all
interest-earning assets minus all interest-bearing liabilities subject to
repricing within the same period. The one-year gap, adjusted for the effect of
the Bank's interest rate caps, as a percentage of total assets, was a negative
6.8% at June 30, 1997. A negative gap like that shown for the Bank implies that,
if market rates rise, the Bank's average cost of funds will increase more
rapidly than the concurrent increase in the average yield on interest-earning
assets.
Capital. At June 30, 1997, the Bank was in compliance with all of its regulatory
capital requirements under FIRREA, and its capital ratios exceeded the ratios
established for "well- capitalized" institutions under OTS prompt corrective
action regulations.
The following table shows the Bank's regulatory capital levels at June 30, 1997
in relation to the regulatory requirements in effect at that date. The
information below is based upon the Bank's under standing of the regulations and
interpretations currently in effect and may be subject to change.
<PAGE>
<TABLE>
Regulatory Capital
(Dollars in thousands)
Minimum Excess
Actual Capital Requirement Capital
--------------------------- ------------------------ --------------------------
As a % As a % As a %
Amount of Assets Amount of Assets Amount of Assets
------------ ----------- ------------ ---------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Stockholders' equity per Bank's financial
statements $ 345,485
Minority interest in REIT Subsidiary (1) 144,000
Net unrealized holding losses (2) 810
------------
490,295
Adjustments for tangible and core capital:
Intangible assets (44,658)
Non-allowable minority interest in
REIT Subsidiary (1) (44,704)
Non-includable subsidiaries (3) (3,700)
Non-qualifying servicing assets (49)
------------
Total tangible capital 397,184 6.48% $ 91,896 1.50% $ 305,288 4.98%
------------ =========== ============ ========== ============ ===========
Total core capital (4) 397,184 6.48% $ 245,055 4.00% $ 152,129 2.48%
------------ =========== ============ ========== ============ ===========
Tier 1 risk-based capital (4) 397,184 7.19% $ 220,941 4.00% $ 176,243 3.19%
------------ =========== ============ ========== ============ ===========
Adjustments for risk-based capital:
Subordinated capital debentures 250,000
Allowance for general loan losses 85,226
------------
Total supplementary capital 335,226
Excess allowance for loan losses (15,982)
------------
Adjusted supplementary capital 319,244
------------
Total available capital 716,428
Equity investments (3) (15,612)
------------
Total risk-based capital $ 700,816 13.21% $ 441,883 8.00% $ 258,933 5.21%
============ =========== ============ ========== ============ ===========
(1) Eligible for inclusion in core capital in an amount up to 25% of the Bank's
core capital pursuant to authorization from the OTS.
(2) Pursuant to OTS policy, net unrealized holding gains (losses) are excluded
from regulatory capital
(3) Reflects an aggregate offset of $1.0 million representing the allowance for
general loan losses maintained against the Bank's equity investments
and non-includable subsidiaries which, pursuant to OTS guidelines, is
available as a "credit" against the deductions from capital otherwise
required for such investments.
(4) Under the OTS "prompt corrective action" regulations, the standards for
classification as "well capitalized" are a leverage (or "core capital")
ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0%
and a total risk-based capital ratio of at least 10.0%.
</TABLE>
<PAGE>
OTS capital regulations provide a five-year holding period (or such longer
period as may be approved by the OTS) for REO to qualify for an exception from
treatment as an equity investment. If an REO property is considered an equity
investment, its then-current book value is deducted from total risk-based
capital. In November 1996, the Bank received from the OTS a one-year extension
of the holding periods for certain of its REO properties. The following table
sets forth the Bank's REO at June 30, 1997, after valuation allowances of $142.2
million, by the fiscal year in which the property was acquired through
foreclosure.
Fiscal Year (In thousands)
1990 (1) (2)......... $ 26,182
1991 (2)............... 58,410
1992 (2)............... 3,280
1993 .................... 4,077
1994 .................... 1,881
1995 .................... 7,974
1996 .................... -
1997 .................... 2,816
-----------
Total REO ...... $ 104,620
==========
- -----------------------
(1) Includes REO with an aggregate net book value of $15.6 million, which
the Bank treats as equity investments for regulatory capital purposes.
(2) Includes REO, with an aggregate net book value of $72.3 million, for
which the Bank received an extension of the holding periods through
November 12, 1997.
During the June 1997 quarter, the Bank securitized and sold $144.2 million of
amounts on deposit in certain spread accounts associated with certain of the
Bank's outstanding credit card securitizations. The effect of the transaction
was to transfer $144.2 million of existing recourse liabilities from the Bank to
investors in exchange for a cash payment to the Bank, remove certain amounts of
the securitized spread accounts from the Consolidated Balance Sheets, and reduce
the Bank's risk-based capital requirement by $144.2 million.
On December 3, 1996, the Bank sold $100.0 million principal amount of its 9 1/4%
Subordinated Debentures due 2008 (the "1996 Debentures"). The Bank received net
proceeds of $96.1 million from the sale of the 1996 Debentures which were used
for general corporate purposes. The OTS approved inclusion of the principal
amount of the 1996 Debentures in the Bank's supplementary capital for regulatory
capital purposes.
In addition, on December 3, 1996, a new real estate investment trust subsidiary
of the Bank (the "REIT Subsidiary") sold $150.0 million of its Noncumulative
Exchangeable Preferred Stock, Series A (the "REIT Preferred Stock") and received
net cash proceeds of $144.0 million. Cash dividends on the REIT Preferred Stock
are payable quarterly in arrears at an annual rate of 103/8%. The REIT Preferred
Stock is automatically exchangeable for a new series of preferred stock of the
Bank upon the occurrence of certain events (specifically, if the appropriate
federal regulatory agency directs in writing an exchange of the REIT Preferred
Stock for Chevy Chase Bank, F.S.B. 103/8% Noncumulative Preferred Stock, Series
B because (i) the Bank becomes "undercapitalized" under prompt corrective action
regulations established pursuant to FDICIA, (ii) the Bank is placed into
conservatorship or receivership, or (iii) the appropriate federal regulatory
agency, in its sole discretion and even if the Bank is not "undercapitalized",
anticipates the Bank becoming "undercapitalized" in the near term). The OTS
approved inclusion of the proceeds received from the sale of the REIT Preferred
Stock in the core capital of the Bank for regulatory capital purposes in an
amount up to 25% of the Bank's core capital. The REIT Preferred Stock is not
redeemable prior to January 15, 2007, and is redeemable thereafter at the option
of the REIT Subsidiary.
<PAGE>
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. 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 ("Unsecured Notes") sold to the public, the payment
of interest on its Senior Secured Notes (the "Secured Notes"), and the payment
of capital improvement costs. In the past, the Real Estate Trust had funded such
shortfalls through a combination of external funding sources, primarily new
financings (including the sale of Unsecured Notes), refinancings of maturing
mortgage debt, asset sales and tax sharing payments from the Bank.
Recent Liquidity Trends. In fiscal 1994, the Real Estate Trust refinanced a
significant portion of its outstanding secured indebtedness with the proceeds of
the issuance of $175.0 million aggregate principal amount of 11 5/8% Senior
Secured Notes due 2002 (the "Senior Secured Notes"). The indenture pursuant to
which the Senior Secured Notes were issued contains covenants that, among other
things, restrict the ability of the Trust and/or its subsidiaries (excluding, in
most cases, the Bank and the Bank's subsidiaries) to incur additional
indebtedness, make investments, sell assets or pay dividends and make other
distributions to holders of the Trust's capital stock.
Through August 1, 1997, the Trust has purchased either in the open market or
through dividend reinvestment 1.77 million shares of common stock of Saul
Centers (representing 14.4% of such company's outstanding common stock). These
shares have been deposited with the Trustee for the Senior Secured Notes to
satisfy in part the collateral requirements for those securities, thereby
permitting release to the Trust of a portion of the cash on deposit with the
Trustee.
The Real Estate Trust is currently selling Unsecured Notes, with a maturity
ranging from one to ten years, primarily to provide funds to repay maturing
Unsecured Notes. To the degree that the Real Estate Trust does not sell new
Unsecured Notes in an amount sufficient to finance completely the scheduled
repayment of maturing Unsecured Notes, it will finance such repayments from
other sources of funds.
In fiscal 1995, the Real Estate Trust established a $15.0 million secured
revolving credit line with an unrelated bank. This facility is for a two-year
period and may be extended for one or more additional one-year terms. Interest
is computed by reference to a floating rate index. At June 30,1997, there were
no borrowings under the facility and unrestricted availability on that date was
$9.0 million.
<PAGE>
In fiscal 1996, the Real Estate Trust established an $8.0 million secured
revolving credit line with an unrelated bank. This facility is for a one-year
term, after which the loan amount amortizes over a two-year period. Interest is
computed by reference to a floating rate index. At June 30,1997, there were no
borrowings under the facility. In July 1997, the commitment was increased to
$10.0 million and unrestricted availability was $8.5 million.
In the nine-month period ended June 30, 1997, the Real Estate Trust refinanced
two hotel and three office properties with five-year floating rate debt. After
payment of all financing costs, the Real Estate Trust received net proceeds of
approximately $11.0 million.
The maturity schedule for the Real Estate Trust's outstanding debt at June 30,
1997 for the balance of fiscal 1997 and subsequent years is set forth in the
following table:
Debt Maturity Schedule
(In thousands)
- -------------------------------------------------------------------
Fiscal Mortgage Notes Payable- Notes Payable-
Year Notes Secured Unsecured Total
- -------------------------------------------------------------------
1997 (1) $ 2,798 $ -- $ 758 $ 3,556
1998 11,264 -- 7,475 18,739
1999 9,954 -- 16,074 26,028
2000 18,770 -- 8,317 27,087
2001 9,966 -- 4,042 14,008
Thereafter 128,159 175,000 8,725 311,884
- -------------------------------------------------------------------
Total $180,911 $175,000 $45,391 $401,302
===================================================================
(1) July 1, 1997 - September 30, 1997
Of the $180.9 million of mortgage debt outstanding at June 30, 1997, $134.4
million was nonrecourse to Real Estate Trust.
The Real Estate Trust believes that its capital improvement costs in the next
several fiscal years will be in range of $5.0 to $8.0 million per year.
During the third quarter of fiscal 1997, the Real Estate Trust commenced
development of a 46,000 square foot single-story office/research and development
building on 3.2 acres of its Avenel Business Park land parcel. The project is
50% pre-leased. Construction is expected to be completed by December 1997 and
lease-up by mid-year 1998. The Real Estate Trust has obtained a construction
loan which will cover all costs except for the land and fees to related parties.
The Real Estate Trust's ability to meet its liquidity needs, including debt
service payments in fiscal 1997 and subsequent years, will depend in significant
part on its receipt of dividends from the Bank and tax sharing payments from the
Bank pursuant to the tax sharing agreement among the Trust, the Bank, and their
subsidiaries. The availability and amount of tax sharing payments and dividends
in future periods is dependent upon, among other things,
<PAGE>
the Bank's operating performance and income, regulatory restrictions on such
payments and (in the case of tax sharing payments) the continued consolidation
of the Bank and the Bank's subsidiaries with the Trust for federal income tax
purposes.
The Real Estate Trust believes that the financial condition and operating result
of the Bank in recent periods, as well as the Bank's board resolution adopted in
connection with the release of its written agreement with the OTS, should
enhance prospects for the Real Estate Trust to receive tax sharing payments and
dividends from the Bank. During the nine-month period ended June 30, 1997, the
Bank made tax sharing payments totalling of $3.2 million and dividend payments
totalling $7.2 million to the Real Estate Trust.
In recent years, the operations of the Trust have generated net operating losses
while the Bank has reported net income. It is anticipated that the Trust's
consolidation of the Bank's operations into the Trust's federal income tax
return will result in the use of the Trust's net operating losses to reduce the
federal income taxes the Bank would otherwise owe. If in any future year, the
Bank has taxable losses or unused credits, the Trust would be obligated to
reimburse the Bank for the greater of (i) the tax benefit to the group using
such tax losses or unused tax credits in the group's consolidated federal income
tax returns or (ii) the amount of tax refund which the Bank would otherwise have
been able to claim if it were not being included in the consolidated federal
income tax return of the group.
As the owner, directly and through two wholly-owned subsidiaries, of a 21.5%
limited partnership interest in Saul Holdings Limited Partnership ("Saul
Holdings 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 Partnership. The partnership agreement of
Saul Holdings Partnership provides for quarterly cash distributions to the
partners out of net cash flow. During the nine-month period ended June 30, 1997,
the Real Estate Trust received total cash distributions of $4.1 million from
Saul Holdings Partnership.
BANKING:
Liquidity. The Bank's average liquidity ratio for the month ended June 30, 1997
was 11.6%, compared to 8.7% for the month ended March 31, 1997. Additionally,
the Bank met the liquidity level requirements imposed by the OTS for each month
of the first nine months of fiscal 1997.
In recent periods, the proceeds from the securitization and sale of credit card,
home equity credit line, automobile and home loan receivables have been
significant sources of liquidity for the Bank. The Bank securitized and sold
$210.0 million of credit card receivables, $214.1 million of automobile loan
receivables and $216.3 million of mortgage loan receivables, consisting of home
equity credit line and home loan receivables, during the June 1997 quarter. The
Bank also securitized and sold $144.2 million of amounts on deposit in certain
spread accounts established in connection with certain of the Bank's credit card
securitizations during the current quarter. At June 30, 1997, the Bank was
considering the securitization and sale of the following receivables: (i)
approximately $450.0 million of credit card receivables, including $115.0
million of receivables outstanding at June 30, 1997 and $335.0 million of
receivables which the Bank expects to become available through additional
fundings or amortization of existing trusts, during the six months ending
December 31, 1997; (ii) approximately $475.0 million of automobile loan
receivables, including $75.0 million of receivables outstanding at June 30, 1997
and $400.0 million of receivables which the Bank expects to become available
through additional fundings during the six months ending December 31, 1997 and
(iii) approximately $21.0 million of home loan receivables. As part of its
operating strategy, the Bank will continue to explore opportunities to sell
assets and to securitize and sell credit card, home equity credit line,
automobile and home loan receivables to meet liquidity and other balance sheet
objectives. See Notes 4 and 7 to the Consolidated Financial Statements
in this report.
The Bank is obligated under various recourse provisions related to the
securitization and sale of receivables. Of the $6.0 billion of outstanding trust
certificate balances at June 30, 1997, the primary recourse to the Bank was
approximately $108.2 million. The Bank is also obligated under various recourse
provisions related to the swap of single-family residential loans for
participation certificates issued to the Bank by the Federal Home Loan Mortgage
Corporation. At June 30, 1997, recourse to the Bank under these arrangements was
approximately $4.2 million.
There were no material commitments for capital expenditures at June 30, 1997.
The Bank's liquidity requirements in fiscal 1997 and for years subsequent to
fiscal 1997 will continue to be affected both by the asset size of the Bank, the
growth of which will be constrained by capital requirements, and the composition
of the asset portfolio. Management believes that the Bank's primary sources of
funds, described above, will be sufficient to meet the Bank's foreseeable
long-term liquidity needs. The mix of funding sources utilized from time to time
will be determined by a number of factors, including capital planning
objectives, lending and investment strategies and market conditions.
<PAGE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1997 (the "1997 quarter") COMPARED TO THREE MONTHS
ENDED JUNE 30, 1996 (the "1996 quarter")
REAL ESTATE
The Real Estate Trust recorded income before depreciation and amortization of
$600,000 and an operating loss of $2.2 million for the 1997 quarter as compared
to a loss before depreciation and amortization of $2.0 million and an operating
loss of $4.6 million for the 1996 quarter. The 1997 quarter included a $724,000
gain on sale of a purchase leaseback property compared to a $1,000 reduction in
the loss on sale of a property in the 1996 quarter.
Income after direct operating expenses from hotel properties increased $892,000
(14.1%) in the 1997 quarter over the level achieved in the 1996 quarter. In the
current period, room sales increased $1,478,000 (13.0%), while food and beverage
sales increased $321,000(9.6%). The increase in revenue was due primarily to
improved market conditions, which permitted management to raise average room
rates while maintaining occupancy levels, and secondarily to the addition of a
new hotel in the current period.
Income after direct operating expenses from commercial properties, which
consists of office and industrial properties, increased $1,049,000 (42.8%) in
the 1997 quarter compared to such income in the 1996 quarter. This increase
reflected higher base rents due to an increase in the leasing rate. Gross income
in the 1997 quarter was $1,278,000(30.7%) above its level in the 1996 quarter.
Expenses increased by $229,000 (13.4%).
Interest expense increased $135,000(1.4%) in the 1997 quarter, primarily because
of the higher level of borrowings in the current quarter. Average balances of
the Real Estate Trust's outstanding borrowings increased to $402.4 million for
the 1997 quarter from $394.3 million for the 1996 quarter. This increase in
average borrowings was primarily the result of mortgage loan refinancings and
additional outstanding Unsecured Notes.
Amortization of debt expense increased $35,000(22.7%)in the 1997 quarter,
largely due to costs incurred in connection with the new line of credit.
Depreciation increased $139,000 (5.7%)in the 1997 quarter as a result of new
tenant improvements and capital replacements.
Advisory, management and leasing fees paid to related parties increased $151,000
(7.7%)in 1997 quarter from their expense level in the 1996 quarter. The monthly
advisory fee in the 1997 quarter was $311,000 compared to $306,000 in the 1996
quarter, which represented an aggregate increase of $16,000 (1.7%). Management
fees were higher by $135,000 (13.0%)in the current quarter due to the increased
level of gross revenue from operating properties.
General and administrative expense decreased $63,000(26.5%) in the 1997 quarter,
principally as a result of lower administrative costs.
<PAGE>
BANKING:
Overview. The Bank recorded operating income of $10.7 million for the 1997
quarter, compared to operating income of $31.6 million for the 1996 quarter. The
decrease in income for the 1997 quarter was primarily attributable to a $13.8
million increase in operating expenses and a $6.1 million increase in the
provision for loan losses. Also contributing to the decrease in income was a
decrease of $6.8 million in other (non-interest) income resulting primarily from
a decrease in loan and deposit servicing fee income. Partially offsetting these
decreases was a $5.6 million increase in net interest income before provision
for loan losses.
Net Interest Income. Net interest income, before the provision for loan losses,
increased $5.6 million (or 10.5%) in the 1997 quarter. The Bank would have
recorded additional interest income of $0.9 million for the 1997 quarter if the
Bank's non-accrual assets and restructured loans had been current in accordance
with their original terms. The Bank's net interest income in future periods will
continue to be adversely affected by the Bank's non-performing assets. See
"Financial Condition - Asset Quality - Non-Performing Assets."
The following table sets forth, for the periods indicated, information regarding
the total amount of income from interest-earning assets and the resulting
yields, the interest expense associated with interest-bearing liabilities,
expressed in dollars and rates, and the net interest spread and net yield on
interest-earning assets.
<PAGE>
<TABLE>
Net Interest Margin Analysis
(Dollars in thousands)
Three Months Ended June 30,
-----------------------------------------------------------------------------------------
1997 1996
------------------------------------------- ------------------------------------------
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) $ 3,679,076 $ 99,753 10.85% $ 2,935,309 $ 82,679 11.27%
Mortgage-backed securities 1,200,042 16,573 5.52 756,641 11,481 6.07
Federal funds sold and securities
purchased under agreements to
resell 86,669 1,187 5.48 230,889 3,066 5.31
Trading securities 15,754 284 7.21 16,396 281 6.86
Investment securities 8,173 118 5.78 5,532 74 5.35
Other interest-earning assets 244,646 2,833 4.63 155,837 1,673 4.29
-------------- ------------ ------------- -----------
Total 5,234,360 120,748 9.23 4,100,604 99,254 9.68
------------ ---------- ----------- ----------
Noninterest-earning assets:
Cash 193,765 169,883
Real estate held for investment or
sale 112,058 148,533
Property and equipment, net 256,453 202,515
Cost in excess of net assets
acquired, net 1,516 3,028
Other assets 416,178 268,322
-------------- -------------
Total assets $ 6,214,330 $ 4,892,885
============== =============
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits $ 1,022,162 5,594 2.19 $ 950,959 5,683 2.39
Savings deposits 987,812 8,370 3.39 954,954 8,038 3.37
Time deposits 1,507,664 20,070 5.32 1,249,602 16,770 5.37
Money market deposits 986,999 9,640 3.91 993,476 9,438 3.80
-------------- ------------ ------------- -----------
Total deposits 4,504,637 43,674 3.88 4,148,991 39,929 3.85
Borrowings 1,097,919 17,572 6.40 292,830 5,472 7.47
-------------- ------------ ------------- -----------
Total liabilities 5,602,556 61,246 4.37 4,441,821 45,401 4.09
------------ ---------- ----------- ----------
Noninterest-bearing items:
Noninterest-bearing deposits 96,178 80,336
Other liabilities 65,806 61,672
Minority interest 144,000 -
Stockholders' equity 305,790 309,056
-------------- -------------
Total liabilities and
stockholders' equity $ 6,214,330 $ 4,892,885
============== =============
Net interest income $ 59,502 $ 53,853
============ ===========
Net interest spread (2) 4.85% 5.59%
========== ==========
Net yield on interest-earning assets (3) 4.55% 5.25%
========== ==========
Interest-earning assets to interest-bearing liabilities 93.43% 92.32%
========== ==========
- ---------------------------------------------------------------------------------------------------------------------------------
(1) Includes loans held for sale and/or securitization. Interest on
non-accruing loans has been included only to the extent reflected in the
Consolidated Statements of Operations; however, the loan balance is
included in the average amount outstanding until transferred to real
estate acquired in settlement of loans.
(2) Equals weighted average yield on total interest-earning assets less weighted
average rate on total interest-bearing liabilities.
(3) Equals annualized net interest income divided by the average balances of
total interest-earning assets.
</TABLE>
<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.
<PAGE>
<TABLE>
Volume and Rate Changes in Net Interest Income
(In thousands)
Three Months Ended June 30, 1997
Compared to
Three Months Ended June 30, 1996
Increase (Decrease)
Due to Change in (1)
-----------------------------------------------------
Total
Volume Rate Change
--------------- --------------- ---------------
<S> <C> <C> <C>
Interest income:
Loans (2) $ 57,835 $ (40,761) $ 17,074
Mortgage-backed securities 11,619 (6,527) 5,092
Federal funds sold and securities
purchased under agreements to
resell (2,534) 655 (1,879)
Trading securities (49) 52 3
Investment securities 38 6 44
Other interest-earning assets 1,018 142 1,160
--------------- --------------- ---------------
Total interest income 67,927 (46,433) 21,494
--------------- --------------- ---------------
Interest expense:
Deposit accounts 3,433 312 3,745
Borrowings 17,457 (5,357) 12,100
--------------- --------------- ---------------
Total interest expense 20,890 (5,045) 15,845
--------------- --------------- ---------------
Increase in net interest income $ 47,037 $ (41,388) $ 5,649
=============== =============== ===============
(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.
</TABLE>
<PAGE>
Interest income in the 1997 quarter increased $21.5 million (or 21.7%) from the
level in the 1996 quarter as a result of higher average balances of loans
receivable and, to a lesser extent, mortgage-backed securities. Lower average
yields on the loan portfolio and mortgage-backed securities partially offset the
effect on interest income of the higher average balances.
The Bank's net yield on interest-earning assets decreased to 4.55% in the 1997
quarter from 5.25% in the 1996 quarter. The decrease in the net yield primarily
reflected lower yields earned on certain of the Bank's adjustable rate products,
reflecting lower introductory rates on certain adjustable-rate products which
the Bank has offered to new customers in the 1997 quarter.
Interest income on loans, the largest category of interest-earning assets,
increased by $17.1 million (or 20.7%) from the 1996 quarter primarily because of
higher average balances. Lower average yields on the loan portfolio partially
offset the positive effect of the higher average balances.
Higher average balances of credit card loans, which increased $259.6 million (or
28.3%), resulted primarily from the Bank's continued expansion of the credit
card loan program. The increase was primarily responsible for a $6.0 million (or
15.1%) increase in interest income from credit card loans. Increased
originations of the Bank's single-family residential loans resulted in an
average balance increase of $385.1 million (or 27.3%), and was largely
responsible for a $5.7 million (or 22.6%) increase in income earned on such
loans. Average balances of home equity credit line loans increased by $111.8
million (or 119.0%) primarily because of the $119.2 million purchase of such
loans in December 1996. Interest income on home equity credit line loans
increased by $2.5 million (or 168.0%) in the current quarter.
The average yield on the loan portfolio in the 1997 quarter decreased by 42
basis points (to 10.85% from 11.27%) from the average yield in the 1996 quarter.
The lower net yield was primarily due to a decrease in the average net yield on
credit card loans from 17.41% to 15.61%, which was primarily a result of
marketing strategies to introduce lower introductory rates to new customers. A
new program offering reduced interest rates to previously risk-repriced accounts
in an attempt to encourage payments from delinquent customers also contributed
to the decline in net yield. In addition, in the June 1996 quarter, the Bank
implemented risk-management strategies that repriced upward the yield on higher
risk credit card accounts. Also contributing to the decreased average yield on
the loan portfolio were decreases in the average yield on single-family
residential loans and home improvement loans from 7.19% to 6.92% and from 12.07%
to 11.68%, respectively. An increase in the average yield on automobile loans
from 12.27% to 17.42%, primarily due to higher yields earned on loans originated
by one of the Bank's operating subsidiaries, partially offset the negative
effect of the lower average yields discussed above, and was largely responsible
for a $2.3 million (or 33.3%) increase in interest income earned on automobile
loans.
Interest income on mortgage-backed securities increased $5.1 million (or 44.4%)
primarily because of higher average balances. The increased mortgage-backed
securities balances in the 1997 quarter reflected the purchase of $649.7 million
of mortgage-backed securities during fiscal 1996. The positive effect of the
higher average balances was partially offset by a decrease in the average
interest rates on these securities from 6.07% to 5.52%.
<PAGE>
Interest expense increased $15.8 million (or 34.9%) for the 1997 quarter
primarily because of an increase of $805.1 million (or 274.9%) in the average
balances of the Bank's borrowings. The increase in the average balances resulted
in an increase of $12.1 million (or 221.2%) in interest expense for the 1997
quarter for such liabilities. The increase in interest expense on borrowings is
comprised of a $5.1 million increase in interest expense on securities sold
under repurchase agreements, a $4.5 million increase in interest expense on
Federal Home Loan Bank ("FHLB") advances and a $2.1 million increase in interest
expense on the Bank's subordinated debentures, respectively, resulting from
higher average balances of such borrowings. See "Financial Condition Capital."
The negative effect of the higher average balances was partially offset by a
decrease in the average borrowing rate (to 6.40% from 7.47%), which reflected an
increase in lower-yielding FHLB advances and securities sold under repurchase
agreements.
A $3.7 million increase in interest expense on deposits, the largest category of
interest-bearing liabilities, also contributed to the higher interest expense
for the current quarter. Interest expense on deposits increased primarily
because of higher average balances which increased by $355.6 million (or 8.6%).
Provision for Loan Losses. The Bank's provision for loan losses increased to
$36.1 million in the 1997 quarter from $30.0 million in the 1996 quarter. The
$6.1 million increase was primarily due to a $10.7 million increase in the
provision for losses on credit card loans. Partially offsetting the increase was
a $6.0 million decrease in the unallocated provision for loan losses recorded
during the prior quarter. See "Financial Condition - Asset Quality - Allowances
for Losses."
Other Income. Other (non-interest) income totaled $90.1 million in the 1997
quarter compared to $96.9 million in the 1996 quarter. The $6.8 million decline
in such income was primarily attributable to a decrease in loan and deposit
servicing fees. Offsetting this decrease were increases in gain on sales of
loans and credit card fees.
The decrease of $25.7 million (or 33.0%) in loan and deposit servicing fees was
primarily due to a decline of $28.3 million in excess spread income earned by
the Bank for servicing its portfolio of securitized credit card loans. The
decrease in such excess spread income for the 1997 quarter was primarily a
result of an increase in charge-offs on securitized credit card loans, which is
consistent with an industry-wide decline in the performance of credit card loans
in recent periods. Partially offsetting this decrease was a $3.5 million
increase in fees recognized for servicing deposit accounts.
See "Financial Condition - Asset Quality - Allowances for Losses."
Gain on sales of loans increased $9.6 million to $21.5 million, as a result of
gains recognized on the securitization and sale of loans in the 1997 quarter in
accordance with SFAS 125. The increase of $9.6 million primarily includes a $3.7
million gain on the securitization and sale of credit card loan receivables,
$2.3 million of which represents the gain recognized on the securitization and
sale of $210.0 million of credit card loans in the 1997 quarter, and the
remaining portion represents gains recognized on the transfer of new receivables
into existing trusts. Also contributing to the increase were gains of $6.6
million, $8.3 million and $2.8 million recognized on the securitization and sale
of automobile loan, home equity credit line and home loan receivables,
respectively, compared to gains of $2.7 million and $9.5 million on the
securitization and sale of automobile loan and home loan receivables,
respectively, in the prior quarter. See Notes to the Consolidated
Financial Statements.
<PAGE>
Credit card fees, consisting of annual fees, late charges, cash advance charges
and overlimit fees increased to $14.9 million in the 1997 quarter from $8.0
million in the 1996 quarter. The $6.9 million (or 87.5%) increase was primarily
attributable to the impact of changes in the fee structure for the Bank's credit
card program which were implemented in fiscal 1996.
Operating Expenses. Operating expenses for the 1997 quarter increased $13.8
million (or 15.4%) from the level in the 1996 quarter, largely as a result of
the Bank's credit card lending program. The main components of the higher
operating expenses were increases in salaries and employee benefits, marketing
and data processing expenses. The $9.0 million increase in salaries and employee
benefits resulted primarily from the addition of staff to the Bank's credit
card, consumer lending, branch and systems operations. The $2.0 million increase
in marketing expenses was primarily attributable to a $1.7 million increase in
marketing expenses associated with deposits as the Bank continues to focus on
increasing its deposit base. The $2.7 million increase in data processing
expenses was principally attributable to an increase in the number of credit
card accounts outstanding and the activity generated by such accounts during the
1997 quarter.
<PAGE>
NINE MONTHS ENDED JUNE 30, 1997 (the "1997 period") COMPARED TO NINE MONTHS
ENDED JUNE 30, 1996 (the "1996 period")
REAL ESTATE
The Real Estate Trust recorded a loss before depreciation and amortization of
$7.6 million and an operating loss of $16.0 million in the 1997 period compared
to a loss before depreciation and amortization of $11.3 million and an operating
loss of $19.0 million in the 1995 period. The decrease in the operating loss was
largely attributable to improved results from income-producing properties. The
1997 period also included a $724,000 gain on sale of a purchase-leaseback
property compared to a loss on sale of a property of $56,000 in the 1996 period.
Income after direct operating expenses from hotel properties increased
$1,779,000 (13.2%) in the 1997 period over the level achieved in the 1996
period. In the current period, room sales increased $3,091,000(10.8%), while
food and beverage sales increased $400,000(4.2%). The increase in total revenue
of $3,539,000 (8.8%)exceeded the increase of $1,760,000 (6.6%)in direct
operating expenses. The revenue increases were due to improved market
conditions, which permitted management to raise average room rates while
maintaining or increasing occupancy at several of the hotels. The Real Estate
Trust also had a new hotel in the current period.
Income after direct operating expenses from commercial properties, which
consists of office and industrial properties, increased $2,273,000(29.7%) in the
1997 period compared to such income in the 1996 period. The improvement was
caused by a higher leasing rate which resulted in higher gross income of
$2,668,000 (20.8%). Expenses for the current period were $395,000(7.6%) above
last year due to higher property taxes and repair and maintenance expense.
Interest expense increased $175,000(0.6%) in the 1997 period, primarily because
of the higher level of borrowings in the current period. Average balances of the
Real Estate Trust's outstanding borrowings increased to $400.0 million for the
1997 period from $396.7 million for the prior period. This increase in average
borrowings occurred as a result of mortgage loan refinancings.
Amortization of debt expense increased $46,000(9.6%) in the 1997 period. This
increase reflected costs incurred for the two lines of credit.
Depreciation increased $599,000(8.2%)in the 1997 period as a result of new
tenant improvements, capital replacements, and the addition of a new
income-producing property.
Advisory, management and leasing fees paid to related parties increased $409,000
(7.4%) in 1997 period from their expense level in the 1996 period. The monthly
advisory fee was $311,000 in the 1997 period compared to $301,000 for the first
six months of the 1996 period and $306,000 for the months of April - June 1996,
which resulted in an aggregate increase of $77,000 (2.8%). The management fees
were higher by $332,000 (11.9%) in the current period as a result of increased
gross income on which fees are based.
General and administrative expense decreased $35,000(3.7%) in the 1997 period,
principally as a result of lower administrative costs.
<PAGE>
BANKING:
Overview. The Bank recorded operating income of $50.8 million for the 1997
period, compared to operating income of $68.9 million for the 1996 period. The
decrease in income for the 1997 period was primarily attributable to a $47.5
million increase in operating expenses and a $19.1 million increase in the
provision for loan losses. These decreases were partially offset by a $35.0
million increase in the Bank's net interest income before provision for loan
losses and a $13.4 million increase in the Bank's other (non-interest) income.
Net Interest Income. Net interest income, before the provision for loan losses,
increased $35.0 million (or 24.4%) in the 1997 period. The Bank would have
recorded additional interest income of $5.7 million for the 1997 period if the
Bank's non-accrual assets and restructured loans had been current in accordance
with their original terms. The Bank's net interest income in future periods will
continue to be adversely affected by the Bank's non-performing assets. See
"Financial Condition Asset Quality - Non-Performing Assets."
The following table sets forth, for the periods indicated, information regarding
the total amount of income from interest-earning assets and the resulting
yields, the interest expense associated with interest-bearing liabilities,
expressed in dollars and rates, and the net interest spread and net yield on
interest-earning assets.
<PAGE>
<TABLE>
Net Interest Margin Analysis
(Dollars in thousands)
Nine Months Ended June 30,
------------------------------------------------------------------------------------
1997 1996
------------------------------------------ -----------------------------------------
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) $ 3,602,641 $ 292,877 10.84% $ 2,876,044 $ 231,515 10.73%
Mortgage-backed securities 1,286,758 55,206 5.72 803,789 36,966 6.13
Federal funds sold and securities
purchased under agreements to resell 83,506 3,348 5.35 221,557 9,144 5.50
Trading securities 16,778 902 7.17 12,367 640 6.90
Investment securities 9,316 404 5.78 4,782 171 4.77
Other interest-earning assets 200,349 6,568 4.37 166,874 5,637 4.50
--------------- -------------- --------------- --------------
Total 5,199,348 359,305 9.21 4,085,413 284,073 9.27
-------------- ----------- -------------- ----------
Noninterest-earning assets:
Cash 189,045 160,496
Real estate held for investment or sale 117,407 169,164
Property and equipment, net 242,946 191,559
Cost in excess of net assets acquired, net 1,886 3,509
Other assets 374,090 240,349
--------------- ---------------
Total assets $ 6,124,722 $ 4,850,490
=============== ===============
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits $ 979,112 16,259 2.21 $ 914,928 17,781 2.59
Savings deposits 968,895 24,568 3.38 939,103 23,758 3.37
Time deposits 1,308,972 51,015 5.20 1,279,248 53,172 5.54
Money market deposits 994,029 28,858 3.87 985,186 28,622 3.87
--------------- -------------- --------------- --------------
Total deposits 4,251,008 120,700 3.79 4,118,465 123,333 3.99
Borrowings 1,311,484 60,001 6.10 306,371 17,137 7.46
--------------- -------------- --------------- --------------
Total liabilities 5,562,492 180,701 4.33 4,424,836 140,470 4.23
-------------- ----------- -------------- ----------
Noninterest-bearing items:
Noninterest-bearing deposits 89,769 71,332
Other liabilities 53,857 55,699
Minority interest 111,168 -
Stockholders' equity 307,436 298,623
--------------- ---------------
Total liabilities and stockholders' equity$ 6,124,722 $ 4,850,490
=============== ===============
Net interest income $ 178,604 $ 143,603
============== ==============
Net interest spread (2) 4.89% 5.04%
=========== ==========
Net yield on interest-earning assets (3) 4.58% 4.69%
=========== ==========
Interest-earning assets to interest-bearing liabilities 93.47% 92.33%
=========== ==========
- ----------------------------------------------------------------------------------------------------------------------------------
(1) Includes loans held for sale and/or securitization. Interest on
non-accruing loans has been included only to the extent reflected in the
Consolidated Statements of Operations; however, the loan balance is
included in the average amount outstanding until transferred to real
estate acquired in settlement of loans.
(2) Equals weighted average yield on total interest-earning assets less weighted
average rate on total interest-bearing liabilities.
(3) Equals annualized net interest income divided by the average balances of
total interest-earning assets.
</TABLE>
<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.
<PAGE>
<TABLE>
Volume and Rate Changes in Net Interest Income
(In thousands)
Nine Months Ended June 30, 1997
Compared to
Nine Months Ended June 30, 1996
Increase (Decrease)
Due to Change in (1)
-----------------------------------------------------
Total
Volume Rate Change
--------------- --------------- ---------------
<S> <C> <C> <C>
Interest income:
Loans (2) $ 65,050 $ (3,688) $ 61,362
Mortgage-backed securities 22,344 (4,104) 18,240
Federal funds sold and securities
purchased under agreements to
resell (5,553) (243) (5,796)
Trading securities 236 26 262
Investment securities 190 43 233
Other interest-earning assets 1,193 (262) 931
--------------- --------------- ---------------
Total interest income 83,461 (8,229) 75,232
--------------- --------------- ---------------
Interest expense:
Deposit accounts 5,412 (8,045) (2,633)
Borrowings 48,502 (5,638) 42,864
--------------- --------------- ---------------
Total interest expense 53,914 (13,683) 40,231
--------------- --------------- ---------------
Increase in net interest income $ 29,547 $ 5,454 $ 35,001
=============== =============== ===============
(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.
</TABLE>
<PAGE>
Interest income in the 1997 period increased $75.2 million (or 26.5%) from the
level in the 1996 period primarily as a result of higher average balances of
loans receivable and, to a lesser extent, mortgage-backed securities. Higher
average yields earned by the Bank on its loan portfolio also contributed to the
increase in interest income. Lower average yields on mortgage-backed securities
partially offset the effect on interest income of the higher average balances
and higher average yields related to the Bank's loan portfolio.
The Bank's net yield on interest-earning assets decreased to 4.58% in the 1997
period from 4.69% in the 1996 period. The decrease in the net yield primarily
reflected lower yields earned on certain of the Bank's interest-earning assets
resulting from a decline in market rates as well as lower introductory rates on
certain adjustable-rate products which the Bank has offered to new customers.
Interest income on loans, the largest category of interest-earning assets,
increased by $61.4 million (or 26.5%) from the 1996 period primarily because of
higher average balances and, to a lesser extent, higher average yields on the
loan portfolio.
Higher average balances on credit card loans, which increased $220.4 million (or
22.5%), resulted primarily from the Bank's continued expansion of the credit
card loan program. The increase was primarily responsible for a $26.8 million
(or 23.9%) increase in interest income from credit card loans. Higher average
balances of automobile loans, which increased $70.4 million (or 38.7%), resulted
primarily from the higher origination volume of such loans, and was largely
responsible for an $11.5 million (or 73.2%) increase in interest income on
automobile loans. Interest income on the Bank's single-family residential loans
increased by $16.3 million (or 21.9%) primarily because of increased
originations, which resulted in an increase of $350.6 million (or 25.5%) in the
average balances of such loans. Average balances of home equity credit line
loans increased by $91.3 million (or 129.7%) primarily because of the $119.2
million purchase of such loans in December 1996. Interest income on home equity
credit line loans increased by $5.5 million (or 194.7%) in the current period.
The average yield on the loan portfolio in the 1997 period increased by 10 basis
points (to 10.84% from 10.73%) from the average yield in the 1996 period. The
higher yields were primarily due to increases in the average net yield on credit
card loans from 15.33% to 15.50% and on automobile loans from 11.52% to 14.38%.
The increase in the net yield on credit card loans was primarily a result of
risk management strategies that have repriced upward the yield on higher risk
credit card accounts. The increase in the net yield on automobile loans was
primarily due to higher yields earned on loans originated by one of the Bank's
operating subsidiaries. Higher average yields on home equity credit line loans
increased from 5.39% to 6.91%, primarily because the $119.2 million of loans
purchased in December 1996 earn higher average yields.
Interest income on mortgage-backed securities increased $18.2 million (or 49.3%)
primarily because of higher average balances. The increased mortgage-backed
securities balances in the 1997 period reflected the effects of the purchase of
$649.7 million of mortgage-backed securities during fiscal 1996. The positive
effect of the higher average balances was partially offset by a decrease in the
average interest rates on these securities from 6.13% to 5.72%.
<PAGE>
Interest expense increased $40.2 million (or 28.6%) for the 1997 period
primarily because of an increase of $1.0 billion (or 328.1%) in the average
balances of the Bank's borrowings. The increase in the average balances of
borrowings resulted in an increase of $42.9 million in interest expense for the
1997 period for such liabilities. The increase in interest expense on borrowings
is primarily due to a $25.0 million, a $12.1 million and a $4.8 million increase
in interest expense on securities sold under repurchase agreements, Federal Home
Loan Bank advances and subordinated debentures, respectively, resulting from
higher average balances of such borrowings. See "Financial Condition - Capital."
The negative effect of the higher average balances was partially offset by a
decrease in the average borrowing rate (to 6.10% from 7.46%), which reflected an
increase in lower-yielding FHLB advances and securities sold under repurchase
agreements.
The increase in interest expense on borrowings was partially offset by a $2.6
million decrease in interest expense on deposits, the largest category of
interest-bearing liabilities. Interest expense on deposits decreased primarily
because of a decline in the average rates on deposits (to 3.79% from 3.99%).
Higher average balances partially offset the negative effect of the lower rates
on deposits.
Provision for Loan Losses. The Bank's provision for loan losses increased to
$89.9 million in the 1997 period from $70.8 million in the 1996 period. The
$19.1 million increase was primarily attributable to a $24.0 million increase in
the provision for losses on credit card loans primarily because of increased
charge-offs of such loans, reflecting an industry-wide decline in the
performance of credit card loans. Partially offsetting this increase was a $6.0
million decrease in the unallocated provision for loan losses from the prior
period. See "Financial Condition - Asset Quality Allowances for Losses."
Other Income. The $13.4 million increase in other (non-interest) income to
$265.9 million in the 1997 period from $252.5 million in the 1996 period was
primarily attributable to increases in gain on sales of loans and credit card
fees. Also contributing to the increase in other income was a decrease in loss
on real estate held for investment or sale. Partially offsetting these increases
was a decrease in loan and deposit servicing fees for the current period.
Gain on sales of loans increased $33.6 million to $50.7 million, primarily as a
result of $14.7 million in gains recorded on the securitization and sales of
credit card loan receivables resulting from the adoption of SFAS 125, $5.6
million of which was recognized on the securitization and sale of $296.5 million
and $210.0 million of such loans in March 1997 and June 1997, respectively, and
the remaining portion represents gains recognized on the transfer of new
receivables into existing trusts. See Notes to Consolidated Financial
Statements. Also contributing to the increase was a $19.5 million gain
recognized on the securitization and sale of $744.9 million of automobile loans
in the 1997 period, compared to a $7.3 million gain recognized on the
securitization and sale of $475.3 million of automobile loans in the 1996
period. In addition, the Bank recognized gains of $9.7 million and $5.7 million
on the sales of $170.6 million and $107.1 million of home equity credit line
receivables and home loan receivables, respectively, compared to a $9.5 million
gain recognized on the securitization and sale of $153.5 million of home loan
receivables in the 1996 period. There were no securitizations and sales of home
equity credit line loans during the prior period.
Credit card fees, consisting of annual fees, late charges, cash advance charges
and overlimit fees increased to $42.5 million in the 1997 period from $18.7
million in the 1996 period. The $23.8 million increase was primarily
attributable to the impact of changes in the fee structure for the Bank's credit
card program which were implemented in fiscal 1996.
<PAGE>
The $5.5 million (or 28.5%) decrease in loss on real estate held for investment
or sale was primarily attributable to a decrease of $4.5 million in the
provision for losses on such assets. See "Financial Condition - Asset Quality -
Allowance for Losses."
The decrease of $52.9 million (or 24.0%) in loan and deposit servicing fees was
primarily due to a decrease of $70.5 million in excess spread income earned by
the Bank for servicing its portfolios of securitized credit card loans. The
decrease in such excess spread income for the 1997 period, was primarily a
result of an increase in charge-offs on securitized credit card loans which is
consistent with an industry-wide decline in the performance of credit card loans
in recent periods. Partially offsetting this decrease was a $10.2 million
increase in fees recognized on the servicing of the bank's deposit accounts. See
"Financial Condition - Asset Quality - Allowances for Losses."
Operating Expenses. Operating expenses for the 1997 period increased $47.5
million (or 18.6%) from the level in the 1996 period, largely as a result of the
Bank's credit card lending program. The main components of the higher operating
expenses were increases in salaries and employee benefits, marketing and data
processing expenses. The $23.9 million increase in salaries and employee
benefits resulted from the addition of staff to the Bank's credit card, consumer
lending, branch and systems operations. The $19.6 million increase in marketing
expenses was primarily attributable to a $13.5 million increase in marketing
expenses associated with the credit card program as the Bank continues to focus
on increased originations of such loans, as well as a $5.7 million increase in
marketing expenses associated with the Bank's deposit base. The $8.7 million
increase in data processing expenses was principally attributable to an increase
in the number of credit card accounts outstanding and the activity generated by
such accounts during the 1997 period. Partially offsetting these increases was a
$3.8 million decrease in other expenses, which was primarily due to a decline in
credit card fraud losses, and a $4.0 million decrease in deposit insurance
premiums.
