As filed with the Securities and Exchange Commission on January 15, 1998.
Registration
No. 33-34930
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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POST-EFFECTIVE
AMENDMENT NO. 9
ON FORM S-2
TO
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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B.F. Saul Real Estate Investment Trust
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(Exact name of registrant as specified in its charter)
Maryland
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(State or other jurisdiction of incorporation or organization)
6798
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(Primary standard industrial classification code number)
52-6053341
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(I.R.S. employer identification number)
8401 Connecticut Avenue, Chevy Chase, Maryland 20815 301-986-6000
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(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
Henry Ravenel, Jr.
8401 Connecticut Avenue, Chevy Chase, Maryland 20815 301-986-6000
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(Name, address including zip code, and telephone number,
including area code, of agent for service)
Copies of correspondence to:
Thomas H. McCormick, Esq.
Shaw, Pittman, Potts & Trowbridge
2300 N Street, N.W.
Washington, D.C. 20037
(202) 663-8000
<PAGE>
Approximate date of commencement
of proposed sale to the public: AS SOON AS PRACTICABLE AFTER THE REGISTRATION
STATEMENT BECOMES EFFECTIVE.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. /X/
If the registrant elects to deliver its latest annual report to security
holders, or a complete and legible facsimile thereof, pursuant to Item 11(a)(1)
of this Form, check the following box. /X/
<PAGE>
B.F. SAUL REAL ESTATE INVESTMENT TRUST
CROSS-REFERENCE SHEET
PURSUANT TO ITEM 501(B) OF REGULATION S-K
BETWEEN ITEMS IN PART I OF FORM S-2 AND THE PROSPECTUS
ITEM IN FORM S-2 CAPTION IN PROSPECTUS
---------------- ---------------------
Item 1. Forepart of Registration Statement Facing Page; Cross Reference
and Outside Front Cover Page of Sheet; Front Cover Page of
Prospectus. . . . . . . . . . . . . Prospectus
Item 2. Inside Front and Outside Back Cover Available Information; Table of
Pages of Prospectus . . . . . . . . Contents
Item 3. Summary Information, Risk Factors
and Ratio of Earnings to Fixed Summary; The Trust; Risk Fac-
Charges . . . . . . . . . . . . . . tors and Other Considerations
Item 4. Use of Proceeds . . . . . . . . . . Use of Proceeds
Item 5. Determination of Offering Price . . Not applicable
Item 6. Dilution. . . . . . . . . . . . . . Not applicable
Item 7. Selling Security Holders. . . . . . Not applicable
Item 8. Plan of Distribution. . . . . . . . Front Cover Page of Prospectus;
Plan of Distribution; How to
Purchase Notes
Item 9. Description of Securities to be
Registered. . . . . . . . . . . . . Description of Notes
Item 10. Interest of Named Experts and
Counsel . . . . . . . . . . . . . . Legal Matters
Item 11. Information with Respect to the Available Information; The
Registrant. . . . . . . . . . . . . Trust; Incorporation of Certain
Documents by Reference
Item 12. Incorporation of Certain Informa- Available Information; Incorpo-
tion by Reference . . . . . . . . . ration of Certain Documents by
Reference
Item 13. Disclosure of Commission Position
on Indemnification for Securities
Act Liabilities . . . . . . . . . . Not applicable
<PAGE>
PROSPECTUS
$80,000,000
B.F. SAUL REAL ESTATE INVESTMENT TRUST
NOTES
DUE ONE YEAR TO TEN YEARS FROM DATE OF ISSUE
INTEREST PAYABLE EACH SIX MONTHS FROM DATE OF ISSUE AND AT MATURITY
Note Maturities INTEREST RATE
FROM ISSUE DATE PER ANNUM
One year . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5.0%
Two Years. . . . . . . . . . . . . . . . . . . . . . . . . . . . .7.0%
Three Years. . . . . . . . . . . . . . . . . . . . . . . . . . . .9.0%
Four Years . . . . . . . . . . . . . . . . . . . . . . . . . . . .9.5%
Five to Ten Years. . . . . . . . . . . . . . . . . . . . . . . . 10.0%
THE RATE OF INTEREST ON THE NOTES OFFERED HEREBY (THE "NOTES") MAY BE
CHANGED BY B.F. SAUL REAL ESTATE INVESTMENT TRUST (THE "TRUST") FROM TIME TO
TIME, BUT ANY SUCH CHANGE WILL NOT AFFECT THE RATE OF INTEREST ON ANY NOTE
PURCHASED PRIOR TO THE EFFECTIVE DATE OF THE CHANGE. BASED ON THE AMOUNT OF A
PROPOSED INVESTMENT IN NOTES OR THE AGGREGATE PRINCIPAL AMOUNT OF THE TRUST'S
OUTSTANDING UNSECURED NOTES HELD BY A PROSPECTIVE INVESTOR, THE TRUST MAY OFFER
TO PAY INTEREST ON A NOTE OF ANY MATURITY AT AN ANNUAL RATE OF UP TO 2.0% IN
EXCESS OF THE INTEREST RATE SHOWN ABOVE FOR A NOTE OF SUCH MATURITY.
(CONTINUED ON NEXT PAGE)
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
--------------------
THE NOTES ARE NOT GUARANTEED OR INSURED BY ANY GOVERNMENTAL AGENCY OR OTHERWISE.
AN INVESTMENT IN THE NOTES INVOLVES SIGNIFICANT RISKS, INCLUDING THE FOLLOWING,
DESCRIBED IN "RISK FACTORS AND OTHER CONSIDERATIONS":
- - THE NOTES ARE UNSECURED OBLIGATIONS AND RANK ON A PARITY WITH ALL OTHER
UNSECURED TRUST DEBT, WHICH CURRENTLY CONSISTS OF OUTSTANDING UNSECURED
NOTES AND ACCOUNTS PAYABLE AND ACCRUED EXPENSES. THE NOTES ARE EFFECTIVELY
SUBORDINATED TO THE TRUST'S SECURED DEBT.
- - THE INDENTURE PURSUANT TO WHICH THE NOTES WILL BE ISSUED DOES NOT RESTRICT
THE TRUST'S ABILITY TO PAY DIVIDENDS, ISSUE ADDITIONAL SECURITIES OR INCUR
ADDITIONAL DEBT.
- - THERE IS NO ESTABLISHED TRADING MARKET FOR THE NOTES AND THE TRUST DOES NOT
ANTICIPATE THAT AN ACTIVE TRADING MARKET WILL BE ESTABLISHED.
- - THE NOTES ARE SUBJECT TO REDEMPTION AT PAR AT THE TRUST'S OPTION, AS
DESCRIBED HEREIN.
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THE DATE OF THIS PROSPECTUS IS _________, 1998.
<PAGE>
The Notes are limited to $80,000,000 principal amount initially offered
hereby and are offered on a continuing basis for sale by the Trust directly to
investors through its office at the address set forth on the back cover hereof.
See "How to Purchase Notes." The Notes will mature one to ten years from date
of issue, as selected by the investor. The Notes will be sold only in fully
registered form in denominations of $5,000, or any amount in excess thereof
which is an integral multiple of $1,000, at 100% of the principal amount. The
Notes will be transferable without service charge. See "Description of Notes."
No commissions will be paid in connection with this offering. This
offering is not contingent on the sale of any minimum amount of Notes. See "Use
of Proceeds," "Plan of Distribution" and "How to Purchase Notes." The Trust
reserves the right to withdraw, cancel or modify the offer made hereby without
notice and to reject any order in whole or in part.
--------------------
Price to Underwriting Discounts Proceeds to
Public and Commissions Trust (1)
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Per Note ........... 100% None 100%
Total .............. $80,000,000 None $80,000,000
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(1) Before deduction of expenses payable by the Trust estimated at
$1,710,000, including $800,000 payable to B. F. Saul Advisory Company for
administering the Note program. B. F. Saul Advisory Company serves as the
Trust's investment advisor and is an affiliate of the Trust. See "Risk Factors
and Other Considerations - Possible Conflicts of Interest Affecting Real Estate
Trust."
--------------------
PURSUANT TO THE FLORIDA SECURITIES ACT (THE "FLORIDA ACT"), WHEN SALES ARE
MADE TO FIVE OR MORE PERSONS IN FLORIDA, ANY SALE IN FLORIDA MADE PURSUANT TO
SECTION 517.061(11) OF THE FLORIDA ACT SHALL BE VOIDABLE BY THE PURCHASER IN
SUCH SALE EITHER WITHIN THREE DAYS AFTER THE FIRST TENDER OF CONSIDERATION IS
MADE BY SUCH PURCHASER TO THE ISSUER, AN AGENT OF THE ISSUER OR AN ESCROW AGENT,
OR WITHIN THREE DAYS AFTER THE AVAILABILITY OF THAT PRIVILEGE IS COMMUNICATED TO
SUCH PURCHASER, WHICHEVER OCCURS LATER.
<PAGE>
AVAILABLE INFORMATION
The Trust has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-2 (the "Registration
Statement") pursuant to the Securities Act of 1933, as amended (the "Securities
Act"), and the rules and regulations promulgated thereunder, covering the Notes
being offered hereby. This Prospectus does not contain all the information set
forth in the Registration Statement, certain parts of which are omitted in
accordance with the rules and regulations of the Commission, and to which
reference is hereby made. Statements made in this Prospectus as to the contents
of any contract, agreement or other document referred to are not necessarily
complete. With respect to each such contract, agreement or other document filed
as an exhibit to the Registration Statement, reference is made to the exhibit
for a more complete description of the matter involved, and each such statement
shall be deemed qualified in its entirety by such reference.
The Trust is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports and other information with the Commission. Information
as of particular dates concerning the Trust's Trustees, officers and principal
holders of securities and any material interest of such persons in transactions
with the Trust is set forth in annual reports on Form 10-K with the Commission.
Such reports and other information filed by the Trust with the Commission may be
inspected and copied at the public reference facilities of the Commission,
located at 450 Fifth Street, N.W., Washington, D.C. 20549; Seven World Trade
Center, 13th Floor, New York, New York 10048; and 500 West Madison Street, Suite
1400, Chicago, Illinois 60661. Copies of this material may be obtained from the
Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates. In addition, certain of these
materials are publicly available through the Commission's web site located at
http://www.sec.gov.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents are incorporated in this Prospectus by reference
and made a part hereof:
1. Annual Report on Form 10-K of the Trust for the fiscal year ended
September 30, 1997, which has been filed with the Commission pursuant
to the Exchange Act.
2. Annual Report of the Trust to security holders for the fiscal year
ended September 30, 1997, which accompanies this Prospectus.
Any statement contained in a document incorporated by reference herein
shall be deemed to be modified or superseded for purposes of this Prospectus to
the extent that a statement contained herein modifies or supersedes such
statement. Any such statement so modified or superseded shall not be deemed,
except as so modified or superseded, to constitute a part of this Prospectus.
The Trust will provide without charge to each person to whom a copy of this
Prospectus is delivered, upon the written or oral request of such person, a copy
of any or all of the documents incorporated by reference herein, except for the
exhibits to such documents. Such request should be directed to B.F. Saul Real
Estate Investment Trust, 7200 Wisconsin Avenue, Suite 903, Bethesda, Maryland
20814, Attention: Henry Ravenel, Jr. (telephone number (301) 986-6207).
<PAGE>
SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN
THIS PROSPECTUS OR IN THE DOCUMENTS INCORPORATED IN THIS PROSPECTUS BY
REFERENCE. CAPITALIZED TERMS USED IN THE SUMMARY AND NOT DEFINED THEREIN HAVE
THE MEANINGS ASCRIBED TO SUCH TERMS ELSEWHERE IN THIS PROSPECTUS.
The Trust
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B.F. Saul Real Estate Investment Trust (the "Trust") operates as a Maryland
real estate investment trust. The Trust began its operations in 1964 as an
unincorporated business trust organized under a Declaration of Trust governed by
District of Columbia law. The Trust terminated its status as a qualified real
estate investment trust for federal income tax purposes in 1978 and is now
taxable as a corporation. On October 24, 1988, the Trust amended its
Declaration of Trust to qualify the Trust as a statutory real estate investment
trust under Maryland law.
The principal business activity of the Trust and its real estate
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"), whose assets accounted for 95% of the Trust's
consolidated assets at September 30, 1997. The Trust is a savings and loan
holding company by virtue of its ownership of a majority interest in Chevy
Chase.
The Trust recorded net income of $18.9 million in the fiscal year ended
September 30, 1997, compared to a net loss of $78,000 in the fiscal year ended
September 30, 1996 and net income of $10.9 million in the fiscal year ended
September 30, 1995.
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 Chevy Chase and its
subsidiaries is identified by the term "Banking."
The Real Estate Trust's long-term objectives are to increase cash flow from
operations and to maximize capital appreciation of its real estate. The
properties owned by the Real Estate Trust are located predominantly in the
Mid-Atlantic and Southeastern regions of the United States and consist
principally of office and industrial projects, hotels and undeveloped land
parcels.
In August 1993, the Real Estate Trust consummated a series of transactions
in which it transferred its 22 shopping center properties and one of its office
properties and the debt associated with such properties to a newly organized
limited partnership, Saul Holdings Limited Partnership ("Saul Holdings
Partnership"), and one of two newly organized subsidiary limited partnerships of
Saul Holdings Partnership. In exchange for the transferred properties, the Real
Estate Trust received a 21.5% limited partnership interest in Saul Holdings
Partnership. Saul Centers, Inc. ("Saul Centers"), a newly organized, publicly
held real estate investment trust, received a 73.0% general partnership interest
in Saul Holdings Partnership in exchange for the contribution of approximately
$220.7 million to Saul Holdings Partnership. Saul Centers and a wholly-owned
subsidiary, which are the sole general partners of Saul Holdings Partnership and
the two subsidiary limited partnerships, generally have full, exclusive and
complete responsibility and discretion in the management and control of each
such partnership. B. Francis Saul II, the Chairman of the Board of Trustees and
Chief Executive Officer of the Trust, serves as Chairman of the Board of
Directors and Chief Executive Officer of Saul Centers. See "Risk Factors and
Other Considerations - Potential Conflicts of Interest Affecting Real Estate
Trust."
Chevy Chase
-----------
Chevy Chase Bank is a federally chartered and federally insured stock
savings bank which at September 30, 1997 was conducting business from 128 full
service offices and 614 automated teller machines ("ATMs")
<PAGE>
in Maryland, Virginia and the District of Columbia. The Bank has its home office
in McLean, Virginia and its executive offices in Chevy Chase, Maryland, both
suburban communities of Washington, D.C. The Bank also maintains 18 mortgage
loan production offices in the mid-Atlantic region, 17 of which are operated by
a wholly-owned mortgage banking subsidiary, and 18 consumer loan production
offices, 10 of which are operated by a wholly-owned finance subsidiary of the
Bank. At September 30, 1997, the Bank had total assets of $6.1 billion and total
deposits of $4.9 billion. Based on total consolidated assets at September 30,
1997, Chevy Chase is the largest bank headquartered in the Washington, D.C.
metropolitan area.
Chevy Chase recorded operating income of $80.2 million for the year ended
September 30, 1997, compared to operating income of $46.1 million for the year
ended September 30, 1996. At September 30, 1997, the Bank's tangible, core, tier
1 risk-based and total risk-based regulatory capital ratios were 6.96%, 6.96%,
7.24% and 13.50%, respectively. The Bank's capital ratios exceeded the
requirements under the Financial Institutions Reform, Recovery, and Enforcement
Act of 1989 ("FIRREA") as well as the standards established for "well
capitalized" institutions under the prompt corrective action regulations
established pursuant to the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA"). In addition, the Bank's capital levels immediately
following the acquisition of ASB discussed above, remained above the levels
established for well-capitalized institutions.
Chevy Chase is a consumer oriented, full service banking institution
principally engaged in the business of attracting deposits from the public and
using such deposits, together with borrowings and other funds, to make loans
secured by real estate, primarily residential mortgage loans, and credit card
and other types of consumer loans. The Bank also has an active commercial
lending program. The Bank's principal deposit and lending markets are located in
the Washington, D.C. metropolitan area. As a complement to its basic deposit and
lending activities, the Bank provides a number of related financial services to
its customers, including securities brokerage and insurance products offered
through its subsidiaries. On November 12, 1997, the Bank acquired ASB Capital
Management, Inc. ("ASB"), one of the largest SEC-registered investment managers
headquartered in the Washington, D.C. metropolitan area, through which the Bank
will provide a variety of investment products and fiduciary services to a
primarily institutional customer base.
According to industry statistics, the Bank was the third largest thrift
issuer of credit cards, based on managed credit card loans outstanding at June
30, 1997. At September 30, 1997, credit card loans outstanding totaled $1.1
billion and managed credit card receivables, including receivables owned by the
Bank and receivables securitized, sold and serviced by the Bank, totaled $5.1
billion. See "Risk Factors and Other Considerations - Risks of Credit Card
Lending by Chevy Chase." The Bank's portfolio of automobile loans, home
improvement loans, and overdraft lines of credit and other consumer loans
totaled $302.7 million at September 30, 1997.
Chevy Chase was the first major Washington, D.C. metropolitan area
financial institution to offer revolving home equity credit line loans, and is a
leading originator of home equity credit lines in its primary market area. The
Bank's home equity credit line loan provides revolving credit secured
principally by a second mortgage on the borrower's home. At September 30, 1997,
the Bank had over 22,000 individual credit lines totaling $1.1 billion in
available credit and $553.2 million in managed home equity credit line
receivables, including receivables owned by the Bank and receivables
securitized, sold and serviced by the Bank.
The Bank historically has relied on retail deposits originated in its
branch network as its primary funding source. Chevy Chase has developed its
branch network in furtherance of its corporate strategy to solidify its
relationships with existing customers, achieve a broader retail base to support
future growth and improve its ability to compete with other depository
institutions in the Washington, D.C. metropolitan area. With 47 of its 128
branches located in Montgomery County, which has one of the nation's highest per
capita incomes, the Bank has the leading market share of retail deposits in that
community. The Bank's branch network also includes locations in Northern
Virginia (38 branches), other Maryland counties (34 branches) and the District
of Columbia (9 branches). In addition to locations at deposit branch sites, the
Bank's network of ATMs includes ATMs located in shopping malls, museums, family
entertainment and sports parks, 132 ATMs located in stores operated by Safeway
Inc. and 57 ATMs located in stores operated by Superfresh Food Markets.
Chevy Chase has accessed the capital markets as an additional means of
funding its operations and managing its capital ratios and asset growth. Since
1988, the Bank has securitized approximately $10.6 billion of credit
<PAGE>
card, home equity credit line, automobile and home loan receivables. These
transactions depend on sophisticated back-office systems to service complex
securitization structures and on personnel with the experience to design,
install and manage those systems. At September 30, 1997, the Bank serviced $4.0
billion, $459.1 million, $1.1 billion, and $244.1 million of securitized
credit card, home equity credit line, automobile and home loan receivables,
respectively. Chevy Chase derives fee-based income from servicing these
securitized portfolios. However, such fee based income may be adversely
affected by increases in delinquencies and charge-offs related to the
receivables placed in these securitized pools. See "Risk Factors and Other
Considerations - Reliance on Non-Interest Income by Chevy Chase."
On December 3, 1996, the Bank sold $100.0 million of 9 1/4% Subordinated
Debentures due 2008 (the "1996 Debentures"), the principal amount of which is
includable in the Bank's supplementary capital. In addition, on December 3,
1996, a new real estate investment trust subsidiary of the Bank sold $150.0
million of its Noncumulative Exchangeable Preferred Stock, Series A (the "REIT
Preferred Stock"), which is eligible for inclusion as core capital of the Bank
in an amount up to 25% of the Bank's total core capital.
Chevy Chase is subject to comprehensive regulation, examination and
supervision by the Office of Thrift Supervision (the "OTS") and, to a lesser
extent, by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank's
deposit accounts are fully insured up to $100,000 per insured depositor by the
Savings Association Insurance Fund (the "SAIF"), which is administered by the
FDIC.
<PAGE>
The Offering
------------
Securities Offered The Trust is offering $80,000,000 in principal amount
of notes of the Trust with varying interest rates as
fixed from time to time by the Trust (the "Notes"). At
December 31, 1997, $24.4 million in principal amount of
Notes was available to be issued.
Maturity Date The Notes will mature from one to ten years from the
date of issue, as selected by the investor.
Interest Payment Dates Interest on the Notes will be payable semi-annually
(six months from the date of issue and each six months
thereafter) and at maturity.
Ranking The Notes will be unsecured obligations and will rank
on a parity with all unsecured debt of the Real Estate
Trust. At September 30, 1997, the Real Estate Trust's
unsecured debt, consisting of outstanding unsecured
notes (referred to in this Prospectus as "Outstanding
Notes" and reflected in the Trust's Consolidated
Balance Sheets as Notes Payable - Unsecured) and
accounts payable and accrued expenses, totaled $82.9
million. At such date, there was no debt of the Real
Estate Trust which was subordinated to the Real Estate
Trust's unsecured debt. At September 30, 1997, the
Real Estate Trust had $353.7 million of secured debt,
which effectively will be prior in right of payment to
the Notes. Of such indebtedness, $178.7 million
consisted of mortgage notes payable, and $175.0 million
consisted of notes secured by the Chevy Chase common
stock owned by the Trust and other Trust assets. See
"Risk Factors and Other Considerations - Notes Unsecured
General Obligations of the Trust and Subordinated to
Secured Trust Debt."
Redemption The Trust, at its sole election, may redeem any of the
Notes having a Stated Maturity of more than one year
from the date of issue on any Interest Payment Date
with respect to such Note on or after the first
anniversary of the date of issue of such Note at a
Redemption Price equal to the Principal Amount of the
Note redeemed. See "Description of Notes - Redemption
of Certain Notes."
<PAGE>
Covenants The Indenture does not impose any restrictions on the
Trust's ability to pay dividends or other distributions
to its shareholders, to incur debt, or to issue
additional securities. See "Risk Factors and Other
Considerations - No Limitation in Indenture on
Dividends, Distributions, Issuance of Securities or
Incurrence of Additional Indebtedness."
Claims of Noteholders Prospective Noteholders will not have any claim on any
of the assets of the Bank and may look only to the Real
Estate Trust's earnings and, subject to payment of the
Real Estate Trust's secured debt and other prior
claims, the Real Estate Trust's assets for the payment
of interest and principal due under the Notes.
Use of Proceeds The Trust will use the net proceeds of the offering of
the Notes hereunder primarily to retire maturing
Outstanding Notes (including the Notes offered hereby).
Any proceeds not applied to pay Outstanding Notes will
be used for other general corporate purposes.
RISK FACTORS AND OTHER CONSIDERATIONS
-------------------------------------
PROSPECTIVE INVESTORS ARE URGED TO READ THE SECTION OF THIS PROSPECTUS
ENTITLED "RISK FACTORS AND OTHER CONSIDERATIONS" FOR A DESCRIPTION OF CERTAIN
RISK FACTORS AND OTHER CONSIDERATIONS RELATING TO THE TRUST AND THE NOTES,
INCLUDING THE RISKS DISCUSSED UNDER THE CAPTIONS "NOTES UNSECURED GENERAL
OBLIGATIONS AND SUBORDINATED TO SECURED REAL ESTATE TRUST DEBT," "CONTINGENCIES
AFFECTING LIQUIDITY OF THE REAL ESTATE TRUST" AND "NO LIMITATION IN INDENTURE ON
DIVIDENDS, DISTRIBUTIONS, ISSUANCE OF SECURITIES OR INCURRENCE OF ADDITIONAL
INDEBTEDNESS."
<PAGE>
THE TRUST
The Trust operates as a Maryland real estate investment trust. The
principal business activity of the Trust historically has been the ownership and
development of income-producing properties. The Trust is a savings and loan
holding company by virtue of its 80% equity ownership in Chevy Chase Bank,
F.S.B. ("Chevy Chase" or the "Bank"). At September 30, 1997, Chevy Chase's
assets accounted for approximately 95% of the Trust's consolidated assets.
The Trust has prepared its financial statements and other disclosures on a
fully consolidated basis. The term "Trust" used in the text and the financial
statements included herein refers to the combined entity, which includes 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 Chevy Chase and its
subsidiaries is identified by the term "Banking."
The principal offices of the Trust are located at 8401 Connecticut
Avenue, Chevy Chase, Maryland 20815, and the Trust's telephone number is
(301) 986-6000.
RISK FACTORS AND OTHER CONSIDERATIONS
PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS
AND OTHER CONSIDERATIONS RELATING TO THE TRUST AND THE NOTES BEFORE DECIDING
WHETHER TO INVEST IN THE NOTES.
1. NOTES UNSECURED GENERAL OBLIGATIONS AND SUBORDINATED TO SECURED
REAL ESTATE TRUST DEBT. The Notes are general unsecured obligations of the
Trust. Prospective Noteholders may look only to the Real Estate Trust's
earnings and, subject to payment of the Real Estate Trust's secured debt and
other prior claims, the Real Estate Trust's assets for payment of principal and
interest due under the Notes. See "Contingencies Affecting Liquidity of the
Real Estate Trust" below and Note 35 to the Consolidated Financial Statements
included in the Trust's 1997 Annual Report to security holders which accompanies
this Prospectus (the "Annual Report") for condensed financial statement
information on the Trust without consolidation of balance sheet and operating
data of the Bank and the Bank's subsidiaries. Prospective Noteholders will not
have any claim on any of the assets of the Bank for payment under the Notes.
The Notes will rank equal in priority of payment with other unsecured debt
of the Real Estate Trust, including Outstanding Notes. At September 30, 1997,
unsecured debt, consisting of Outstanding Notes and accounts payable and accrued
expenses, totaled $82.9 million. At September 30, 1997, the Real Estate Trust
had $353.7 million of secured debt, which effectively will be prior in right of
payment to the Notes. Of such indebtedness, $178.7 million consisted of
mortgage notes payable, and $175.0 million consisted of notes secured by the
Chevy Chase common stock owned by the Trust and other Trust assets.
2. CONTINGENCIES AFFECTING LIQUIDITY OF THE REAL ESTATE TRUST. The
Real Estate Trust relies on external sources of funds to repay the principal of
maturing debt, including Outstanding Notes, to pay interest on its Senior
Secured Notes and to make capital improvements. As reflected in Note 35 to the
Consolidated Financial Statements included in the Annual Report, the Real Estate
Trust had positive cash flow from operating activities of $6.9, $9.0 and $4.3
million in fiscal 1997, 1996 and 1995, respectively. In the past, the Real
Estate Trust funded debt repayment and capital improvements by new financings
(including the public sale of unsecured notes), refinancings of maturing
mortgage debt, asset sales and tax sharing payments from the Bank pursuant to a
tax sharing agreement among the Trust, the Bank and their subsidiaries (the "Tax
Sharing Agreement"). See Cash Flows from Investing Activities in the
Consolidated Financial Statements in the Annual Report. In order to fund these
requirements in fiscal 1998 and future years, the Real Estate Trust will be
required to raise substantial amounts of cash from a combination of such
sources, which are subject to various contingencies, as described below.
<PAGE>
The Real Estate Trust's ongoing program of public Note sales was initiated
in the 1970's as a vehicle for supplementing other external funding sources. In
fiscal 1997, the Real Estate Trust sold $10.0 million of Notes. The Real Estate
Trust is currently selling Notes principally to pay outstanding Notes as they
mature. See "Use of Proceeds." To the degree that the Real Estate Trust does
not sell new Notes in an amount sufficient to finance completely the scheduled
repayment of outstanding Notes as they mature, it believes it will be able to
finance such repayments from other sources of funds.
The Real Estate Trust's ability to meet its liquidity needs, including debt
service payments, 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. The availability and amount of tax sharing payments and dividends in
future periods is dependent upon, among other things, 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.
OTS regulations tie Chevy Chase's ability to pay dividends to specific
levels of regulatory capital and earnings. During fiscal 1997, the Real Estate
Trust received $7.2 million in dividends from the Bank. There can be no
assurances, however, that the Bank can pay dividends in similar amounts during
fiscal 1998.
3. REAL ESTATE TRUST OPERATING LOSSES AND TRUST DEFICIT IN
SHAREHOLDERS' EQUITY. The operations of the Real Estate Trust, before the
consolidation of Chevy Chase's results, reflect a loss from continuing
operations before gain on sale of properties in each of the Real Estate Trust's
last ten fiscal years. As reflected in Note 35 to the Consolidated Financial
Statements in the Annual Report, which presents condensed financial statement
information on the Trust without consolidation of balance sheet and operating
data of the Bank and the Bank's subsidiaries, the operating loss of the Trust in
recent periods would have been significantly higher without the consolidation of
the Bank's results.
The Real Estate Trust, like most real estate investors, employs significant
amounts of debt to finance its investments and operations. At September 30,
1997, its total debt, excluding debt of Chevy Chase, was $431.1 million. The
Trust's consolidated shareholders' equity at September 30, 1997 reflected a
deficit of $89.7 million.
4. FIXED CHARGES IN EXCESS OF AVAILABLE EARNINGS. The Real Estate
Trust's ratios of available earnings to fixed charges were less than 1:1 in each
of the last three fiscal years. These ratios represent a measure of the ability
to meet debt service obligations from funds generated by operations. For
purposes of computing the fixed-charges ratios, "available earnings" consist of
income (loss) from continuing operations plus (i) provisions for income taxes,
(ii) ground rent expense and (iii) interest and debt expense reduced by interest
capitalized. This sum is divided by the total of interest and debt expense and
ground rent expense to arrive at the ratio of available earnings to fixed
charges. For the Real Estate Trust, fixed charges exceeded available earnings
by $19.0 million in fiscal 1997, $ 24.2 million in fiscal 1996 and $27.3 million
in fiscal 1995.
5. RISKS OF CREDIT CARD LENDING BY CHEVY CHASE. At September 30,
1997, Chevy Chase's credit card loans of $1.1 billion constituted approximately
42.6% of the Bank's loan portfolio. In addition, at September 30, 1997, the
Bank managed $4.0 billion in securitized credit card loans which were not
reflected on the Bank's balance sheet. Credit card loans entail greater credit
risks than residential mortgage loans. Changes in credit card use and payment
patterns by cardholders, including increased defaults, may result from a variety
of social, legal and economic factors. Chevy Chase currently offers
introductory periodic interest rates for varying initial periods which, at the
conclusion of such periods, revert to the Bank's regular variable interest rate.
If account holders choose to use competing sources of credit, the rate at which
new receivables are generated may be reduced and certain purchase and payment
patterns with respect to the receivables may be affected. Economic factors
affecting credit card use include the rate of inflation and relative interest
rates offered for various types of loans. Adverse changes in economic
conditions could have a direct impact on the timing and amount of payments by
borrowers. Default rates on credit card loans generally may be expected to
exceed default rates on residential mortgage loans.
<PAGE>
Primarily reflecting the industry-wide decline in the performance of credit
card loans, credit card delinquencies and net charge-offs on credit card loans
have increased since September 1995. The Bank regularly reviews the reasons for
delinquency and charge-off as compared to information available at the time an
account was originated to determine if such information should have indicated
the propensity for delinquency and/or loss. The results of these reviews are
used to adjust the Bank's underwriting criteria, as necessary. Although the Bank
believes it has appropriate underwriting criteria to mitigate the risks
associated with its credit card accounts, there can be no assurance that
charge-offs and delinquencies will not increase. The Bank increased its
allowance for losses on credit card loans during fiscal 1997 by $9.7 million to
$89.4 million at September 30, 1997. An increase in credit card delinquencies
and charge-offs also may affect the Bank's income from loan servicing fees by
reducing the amount earned on securitized credit card receivables.
Certain jurisdictions and their residents may attempt to require
out-of-state credit card issuers such as the Bank to comply with the consumer
protection laws of those jurisdictions (including laws limiting the charges
imposed by such credit card issuers) in connection with their operations in such
jurisdictions. For example, in recent years a number of lawsuits and
administrative actions have been filed in several states against out-of-state
credit card issuers (including both federally chartered and state chartered
insured depository institutions) challenging various fees and charges (such as
late fees, over-the-limit fees, returned check fees and annual membership fees)
assessed against residents of the states in which such lawsuits were filed,
based on restrictions or prohibitions under the laws of such states. The
Supreme Court recently ruled that national banks may export late fees on credit
cards as interest regardless of states' usury laws, however the law is not
settled with respect to all types of fees and charges. If it were determined
that out-of-state credit card issuers must comply with a jurisdiction's laws
limiting the charges imposed by credit card issuers, such an action could have
an adverse impact on the Bank's credit card operations.
The credit card industry is highly competitive and characterized by
increased pricing competition in interest rates and annual membership fees, use
of advertising, target marketing and other features (such as buyer protection
plans), as both established and new card issuers seek to expand or to enter the
market and to retain their existing customers. The Bank has issued credit cards
to customers nationwide, and competes for those customers with certain money
center banks and other large nationwide issuers, as well as with regional and
local depository institutions and other issuers, many of whom have sizable
branch systems or other customer relationships through which such issuers market
their credit cards. The Bank anticipates that competitive pressures will
require adjustments from time to time to the pricing of the Bank's credit card
accounts.
6. RISKS RELATING TO ALLOWANCE FOR LOSSES LEVELS AND REO OF CHEVY
CHASE. At September 30, 1997, the ratio of the Bank's allowance for losses to
non-performing assets was 100.6%. The Bank reviews on a quarterly basis the
carrying value of its REO in order to make any adjustments required to present
such assets at fair value. Although the Bank believes it has a reasonable basis
for estimating allowance for losses, no assurance can be given that the Bank
will not sustain losses in any particular period that exceed the amount of the
allowance for losses at the beginning of that period, or that subsequent
evaluations of the asset portfolio, in light of factors then prevailing
(including economic conditions, the Bank's internal review process and the
results of regulatory examinations), will not require significant increases in
the allowance for losses.
At September 30, 1997, approximately $67.6 million (or 74.5%), after all
valuation allowances, of the Bank's aggregate book value of REO was attributable
to its five planned unit developments (the "Communities"), four of which are
under active development. The Bank obtains updated appraisals on its REO from
time to time and, in the past, has been directed to do so by the OTS in
connection with regulatory examinations. As a result of such updated
appraisals, the Bank could be required to increase its allowance for losses.
7. RELIANCE ON NON-INTEREST INCOME BY CHEVY CHASE. In recent years,
non-interest income has become an increasingly large component of the Bank's net
income. The Bank has earned non-interest income primarily from credit card, loan
servicing and deposit servicing fees and gains on sales of loans. In fiscal
1997, 1996 and 1995, the Bank recognized non-interest income of $413.0 million,
$344.5 million and $232.6 million, respectively. Of those amounts, $227.8
million, $264.1 million and $184.3 million, respectively, or 45.7%, 61.8% and
52.1%, respectively, of total operating income was income from loan servicing
fees. The Bank's ability to realize non-interest income is dependent upon market
interest rates, the demand for mortgage and credit card loans, conditions in the
loan sale market, the level of securitized receivables and other factors. The
level of such income, therefore, is subject to substantial fluctuations. An
increase in
<PAGE>
credit card delinquencies and charge-offs may affect the Bank's income from loan
servicing fees by reducing the amount earned on securitized credit card
receivables. Such charge-offs have increased significantly during recent
periods, although the Bank's income has not been significantly affected to date
as a result of the counterbalancing effects of such items as the expiration of
introductory rates, repricing of existing portfolios and new fee-based
strategies.
8. EFFECT OF AN INCREASE IN INTEREST RATES ON OPERATING RESULTS OF
CHEVY CHASE. The Bank's operating results depend to a large extent on its net
interest income, which is the difference between the interest the Bank receives
from its loans, securities and other assets and the interest the Bank pays on
its deposits and other liabilities. Interest rates are highly sensitive to many
factors, including governmental monetary policies and domestic and international
economic and political conditions. Conditions such as inflation, recession,
unemployment, money supply, international disorders and other factors beyond the
control of the Bank may affect interest rates. If generally prevailing interest
rates increase, the "net interest spread" of the Bank, which is the difference
between the rates of interest earned and the rates of interest paid by the Bank,
is likely to contract, resulting in less net interest income.
Although the Bank pursues an asset-liability management strategy designed
to control its risk from changes in market interest rates, the Bank's
liabilities have shorter terms and are more interest-sensitive than its assets.
At September 30, 1997, the Bank's one-year interest-sensitivity "gap" (the sum
of all interest earning assets to be re-priced within one year minus all
interest-bearing liabilities to be re-priced within one year, as a percentage of
total assets) adjusted for the effect of the Bank's interest rate caps was 4.5%.
As a result of its gap positions, the Bank's net interest spread will narrow,
and its operating results will be adversely affected, during periods of rising
market interest rates if the Bank is unable to reduce its gap. There can be no
assurance that the Bank will be able to adjust its gap sufficiently to offset
any negative effect of changing market interest rates.
9. RISKS OF OTHER CONSUMER LENDING OF CHEVY CHASE. Chevy Chase is
actively expanding its non-credit card consumer lending business, focusing on
automobile and home improvement loans. While such loans generally have shorter
terms to maturity and carry higher rates than residential mortgage loans, they
generally entail greater risk than residential mortgage loans, particularly when
secured by rapidly depreciable assets, such as automobiles. In such cases, any
collateral repossessed for a defaulted consumer loan may not provide an adequate
source of repayment of the outstanding loan balance as a result of damage, loss
or depreciation. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability and, thus, are more likely to be
affected by adverse personal circumstances.
The Bank also makes automobile loans through one of its operating
subsidiaries. The underwriting guidelines for this subsidiary apply to a
category of lending in which loans may be made to applicants who have
experienced certain adverse credit events (and, therefore, would not necessarily
meet all of the Bank's guidelines for its traditional loan program), but who
meet certain other creditworthiness tests. Such loans may experience higher
rates of delinquencies, repossessions and losses, especially under adverse
economic conditions, compared with loans originated pursuant to the Bank's
traditional lending program.
10. REGULATORY CAPITAL LEVELS OF CHEVY CHASE. At September 30, 1997,
the Bank's tangible, core, tier 1 risk-based and total risk-based regulatory
capital ratios were 6.96%, 6.96%, 7.24% and 13.50%, respectively. The Bank's
capital ratios exceeded the requirements under FIRREA as well as the standards
established for "well capitalized" institutions under the prompt
corrective action regulations established pursuant to FDICIA.
The OTS has the discretion under the prompt corrective action regulations
to reclassify an institution from one category to the next lower category, for
example, from "well capitalized" to "adequately capitalized," if, after notice
and an opportunity for a hearing, the OTS determines that the institution is in
an unsafe or unsound
<PAGE>
condition or has received and has not corrected a less than satisfactory
examination rating for asset quality, management, earnings or liquidity.
Chevy Chase's levels of non-performing assets may result in reductions in
capital to the extent losses are recognized as a result of deteriorating
collateral values or general economic conditions. OTS capital regulations
provide a five-year holding period (or such longer period approved by the OTS)
for REO to qualify for an exception from treatment as an equity investment. If
an REO property is considered an equity investment, its then-current book value
is deducted from total risk-based capital. Accordingly, if the Bank is unable
to dispose of any REO property (through bulk sales or otherwise) prior to the
end of its applicable five-year holding period and is unable to obtain an
extension of such five-year holding period from the OTS, the Bank could be
required to deduct the then-current book value of the REO from risk-based
capital. In November 1996, the Bank received from the OTS an extension through
November 12, 1997 of the five-year holding period for certain of its REO
properties acquired through foreclosure in fiscal 1990, 1991 and 1992.
In addition, the Bank has submitted to the OTS a request for a further extension
of the holding periods through fiscal 1998 for certain of its REO properties.
There can be no assurance that the Bank will be able to dispose of all of its
REO properties within the applicable five-year period or obtain any necessary
further extensions. Accordingly, there can be no assurances that Chevy Chase
will be able to maintain levels of capital sufficient to meet the standards for
classification as "well capitalized" under prompt corrective action
regulations.
The Bank's ability to maintain or increase its capital levels in future
periods will be subject to general economic conditions, particularly in the
Bank's local markets. Adverse general economic conditions or a renewed downturn
in local real estate markets could require further additions to the Bank's
allowances for losses and further charge-offs. Any such developments would
adversely affect the Bank's earnings and thus its regulatory capital levels.
As a result of the foregoing factors, although the Bank's regulatory
capital ratios at September 30, 1997 would meet the ratios established for "well
capitalized" institutions, there can be no assurance that the Bank will be able
to maintain levels of capital sufficient to continue to meet the standards for
classification as "well capitalized" under the prompt corrective action
standards.
11. RISKS RELATING TO THRIFT CHARTER. Legislation passed in 1996
requires the merger of the BIF and the SAIF into a single Deposit Insurance Fund
on January 1, 1999, but only if the thrift charter is eliminated by that date.
Congress is considering legislation in various forms that would require federal
thrifts, like the Bank, to convert their charters to national or state bank
charters. The House Banking Committee approved a version of such legislation on
June 20, 1997 and the House Commerce Committee approved its version of the
legislation on October 30, 1997. The current session of Congress adjourned
without further action on the bills and leadership of the House has announced
its intention to resume consideration of the legislation when Congress returns
for the second session in January 1998. In the absence of appropriate
"grandfather" provisions, such legislation could have an adverse effect on the
Bank and the Trust because, among other things, the Trust engages in activities
that are not permissible for bank holding companies and the regulatory capital
and accounting treatment for banks and thrifts differs in certain significant
respects. While the versions of the bill approved by the House Banking and
Commerce Committees both contain grandfather provisions that address many of
these issues, the Bank cannot determine at this time whether, or in what form,
such legislation may eventually be enacted, and there can be no assurances that
any such legislation that is enacted will contain adequate grandfather rights
for the Bank or the Trust.
12. CAPITAL MAINTENANCE AGREEMENT BY THE TRUST. The Trust has
entered into an agreement with OTS's predecessor agency to maintain Chevy
Chase's regulatory capital at the level prescribed by applicable regulatory
requirements and, if necessary, to infuse additional capital to enable Chevy
Chase to meet those
<PAGE>
requirements. If the Bank is unable to meet its capital requirements in the
future, the OTS could seek to enforce the Trust's obligations under the
agreement. To the extent additional capital infusions may be required pursuant
to the Trust's capital maintenance agreement, the funds available to repay Notes
would be reduced.
In addition, if the Bank were to become "undercapitalized" under the prompt
corrective action regulations, it would be required by statute to file a capital
restoration plan with the OTS setting forth, among other things, the steps the
Bank would take to become "adequately capitalized." The OTS could not accept
the plan unless the Trust guaranteed in writing the Bank's compliance with the
plan. The aggregate liability of the Trust under such a commitment would be
limited to the lesser of (i) an amount equal to 5.0% of the Bank's total assets
at the time the Bank became "undercapitalized" and (ii) the amount necessary to
bring the Bank into compliance with all applicable capital standards as of the
time the Bank fails to comply with its capital plan. If the Trust refused to
provide the guarantee, the Bank would be subject to the more restrictive
supervisory actions applicable to "significantly undercapitalized" institutions.
13. POTENTIAL EFFECT OF TAX SHARING REIMBURSEMENT OBLIGATION ON TRUST
LIQUIDITY. If Chevy Chase has net operating losses in the current year or in
any future year, the Trust could be obligated under the Tax Sharing Agreement to
make certain payments to Chevy Chase.
If in any year Chevy Chase has net operating losses and the Trust group
uses such losses to offset taxable income of the Trust (or other members of the
Trust group), the Trust (or other members of the Trust group) would be required
to make tax sharing payments to Chevy Chase. The sum of any such payments and
any payments actually made to the Internal Revenue Service (the "IRS") would not
exceed the amount otherwise required to be paid to the IRS if the Trust group
had not been able to use the Chevy Chase net operating losses.
In addition, to the extent that in any year Chevy Chase has net operating
losses that are not used in that year to offset taxable income of the Trust (or
other members of the Trust group), Chevy Chase would carry back such losses,
obtaining a refund of taxes it paid to the IRS or a reimbursement of tax sharing
payments it made to the Trust, or both, depending on the amount of the losses
and the taxable year in which they occur. At September 30, 1997, the maximum
amount the Trust could be required to reimburse Chevy Chase in the event of a
carryback of Chevy Chase losses, based on tax sharing payments received through
that date, was $69.7 million. Any such payments made by the Trust to Chevy
Chase could have a material adverse effect on the Trust's liquidity and, in any
event, would reduce funds available to repay the Notes.
14. NO LIMITATION IN INDENTURE ON DIVIDENDS, DISTRIBUTIONS, ISSUANCE
OF SECURITIES OR INCURRENCE OF ADDITIONAL INDEBTEDNESS. The indenture pursuant
to which the Notes will be issued (the "Indenture") does not include certain
covenants which are customary in negotiated indentures governing the issuance of
public debt securities similar to the Notes and which are intended to protect
the rights of security holders. The Indenture does not impose any restrictions
on the Trust with respect to the payment of dividends or distributions on its
capital stock or the issuance of additional securities, nor does the Indenture
limit the incurrence by the Trust of additional indebtedness. The Trust's
ability to pay dividends, issue additional securities and incur additional debt,
however, is currently subject to restrictions under various other loan
agreements to which the Trust is a party, including the indenture pursuant to
which the Trust has issued its 11-5/8% Senior Secured Notes due 2002.
15. TRUST OPTION TO REDEEM NOTES. The Trust, at its sole option, may
call for the redemption, at face value, of any Note with a Stated Maturity of
more than one year from the date of issue on any Interest Payment Date on or
after the first anniversary of its date of issue. See "Description of Notes -
Redemption of Certain Notes." Such early redemptions, if made, would reduce the
funds available to pay Notes maturing thereafter.
16. RISKS TO REAL ESTATE TRUST OF PROPERTY OWNERSHIP AND DEVELOPMENT.
Most of the operating expenses and virtually all of the debt service payments
associated with income-producing properties are fixed; they are not decreased by
reductions in occupancy or rental income. Operating expenses are also subject
to inflationary increases. Therefore, the ability of the Real Estate Trust to
meet its fixed obligations with cash flow from its income-producing properties
is highly dependent on its ability to maintain or increase their levels of
rental income and hotel sales revenues.
<PAGE>
Rental income is subject to a number of risks, including adverse changes in
national or local economic conditions and other factors which might impair the
ability of existing tenants to maintain their rental payments and which might
reduce the potential demand by prospective new tenants for vacant space. Any of
the Real Estate Trust's commercial properties and hotels also could be adversely
affected by governmental actions such as increases in real estate tax rates.
Hotel revenues are subject to rapid declines if customer demand should be
impaired for any reason, since advance bookings represent only a limited portion
of overall revenues and are subject to cancellation.
Real estate investments tend to be relatively illiquid; they cannot be
converted quickly and readily to cash, although, under normal market conditions,
they can be so converted on an orderly basis over a period of time. This lack
of liquidity tends to limit the ability of the Real Estate Trust to vary its
portfolio promptly in response to changes in economic, demographic, social,
financial and investment conditions.
Real estate development and ownership in certain areas of the country is
currently suffering from overbuilding or adverse local economic conditions, or
both. In recent periods, the Real Estate Trust's office building leasing rates
have experienced a decline due to recessionary economic conditions in the
metropolitan areas in which the office properties are located.
17. POSSIBLE CONFLICTS OF INTEREST AFFECTING REAL ESTATE TRUST.
B. Francis Saul II, Chairman of the Trust, and his affiliates own 100% of the
Trust's common shares of beneficial interest and thus control the Trust.
Mr. Saul also controls B. F. Saul Company (the "Saul Company"), which in turn
controls B. F. Saul Advisory Company (the "Advisor") and Franklin Property
Company ("Franklin"). The Advisor acts as the Real Estate Trust's investment
advisor and carries on the day-to-day general management, financial, accounting,
legal and administrative affairs of the Real Estate Trust. Franklin acts as
leasing and management agent for most of the income-producing properties owned
by the Real Estate Trust and plans and oversees the development of other new
properties and the expansion and renovation of existing properties. The
compensation received by the Advisor and Franklin is determined by the Trustees,
including the independent trustees, who have no current affiliation with the
Saul Company or its subsidiaries. Since only two of the Trust's five trustees
are considered independent, the independent trustees represent a minority of the
Board of Trustees. There is no requirement in the Trust's Declaration of Trust
or in the Indenture, or elsewhere, that the Trust have a certain number or
percentage of independent Trustees.
The Saul Company, its affiliated companies, their officers and directors,
and two of the trustees of the Trust actively engage in various activities
relating to the general business of real estate development and finance. The
Saul Company and related companies have many clients other than the Real Estate
Trust with investment interests in real estate and are engaged in such
activities on their own behalf and as agents for and advisors to others. No
provision in the Declaration of Trust or the advisory contract with the Advisor
(the "Advisory Contract") prohibits the Advisor, Franklin, the Saul Company,
their affiliates, any officer, director or employee of such companies, or any
Trustee of the Trust from performing investment advisory services for parties
other than the Real Estate Trust, engaging in activities similar to or
competitive with the investment operations of the Real Estate Trust, or making
real estate investments that might be suitable or desirable for the Real Estate
Trust. The Advisory Contract provides that the Real Estate Trust has priority
with respect to any investment made by the Saul Company, the Advisor and their
directors and officers, for their account or for the account of any enterprise
(other than a savings and loan institution) in which they have a beneficial
interest aggregating 40% or more. There are no procedural safeguards to ensure
this priority, although the entities normally do not compete for the same type
of investments and thus conflicts generally have not arisen. Relevant personnel
have been advised concerning the conflict provision in the Advisory Contract and
have been instructed to comply with such provisions.
Potential conflicts of interest may arise from Mr. Saul's role as Chairman
of the Board and Chief Executive Officer of Saul Centers, the general partner of
Saul Holdings Partnership. See "Summary - The Trust." The Trust has entered
into an Exclusivity Agreement (the "Exclusivity Agreement") with, and has
granted a right of first refusal (the "Right of First Refusal") to, Saul
Centers, Saul Holdings Partnership and its two subsidiary limited partnerships
(collectively, the "Company"). The purpose of these agreements is to minimize
potential conflicts of interest between the Real Estate Trust and the Company.
The Exclusivity Agreement and Right of First Refusal generally require the Real
Estate Trust to conduct its shopping center business exclusively through the
Company and to grant the Company a right of first refusal to purchase commercial
properties and development sites that become available to the Real Estate Trust
in the District of Columbia or adjacent suburban Maryland. Subject to the
Exclusivity Agreement and Right of First Refusal, the Real Estate Trust may
continue to develop, acquire, own and
<PAGE>
manage commercial properties and own land suitable for development as, among
other things, shopping centers and other commercial properties.
18. LACK OF INVESTMENT AND BORROWING LIMITATIONS IN DECLARATION OF
TRUST. With certain exceptions, the Trust's Declaration of Trust does not
specify the proportion of the Trust's assets which may or shall be committed to
each of the several types of investments which the Trust may make. The Trustees
may change the mix of the Trust's investment portfolio at any time or make
investments of a type not currently made by the Trust, provided that such
investments are not prohibited by the Declaration of Trust or by any indenture,
loan agreement or other instrument to which the Trust is a party. The
Declaration of Trust does not place any limitations on the amount of funds which
the Trust may borrow or on the types of short-term or long-term debt securities
which it may issue, including additional Notes or indebtedness senior to the
Notes.
19. LIMITATIONS ON LIABILITY OF SHAREHOLDERS, TRUSTEES AND OFFICERS
OF THE TRUST. The name "B.F. Saul Real Estate Investment Trust" is the
designation of the Trust under its Declaration of Trust currently in effect. In
accordance with the Declaration of Trust, all persons dealing with the Trust
must look solely to the Trust's property for the enforcement of any claims
against the Trust, since none of the Trustees, officers, agents or shareholders
of the Trust assumes any personal liability for obligations entered into on
behalf of the Trust. Further, as required by the Declaration of Trust, the
Indenture provides that covenants and obligations for the benefit of Noteholders
contained in the Indenture bind only the property of the Trust and are not
binding upon, and cannot be enforced against, the shareholders, Trustees,
officers, employees or agents of the Trust or their private property. In the
event of a default by the Trust under a Note, a Noteholder may have a more
limited right of action than such Noteholder would have absent such provisions
in the Declaration of Trust and Indenture.
20. ABSENCE OF BROKER OR DEALER. The Trust has not used and does not
intend to use an underwriter or selling agent in connection with the offering
and sale of the Notes. Purchasers, therefore, will not have the benefit of the
independent review of the Trust, the terms of the Notes, and the accuracy and
completeness of the information contained in the Prospectus that might be
provided by an underwriter or other selling agent involved in an offering of the
Notes. Also, because the offering of Notes will be conducted exclusively by
officers of the Trust who are not registered with the Securities and Exchange
Commission as brokers or dealers, such officers will not be in a position to
determine the suitability of the Notes for investors. EACH INVESTOR SHOULD
DETERMINE INDEPENDENTLY OR SEEK INDEPENDENT INVESTMENT ADVICE AS TO WHETHER THE
NOTES REPRESENT A SUITABLE INVESTMENT FOR SUCH INVESTOR.
USE OF PROCEEDS
The Trust will use the net proceeds from the sale of the Notes offered
hereby primarily to retire maturing Outstanding Notes (including the Notes
offered hereby). At December 31, 1997, $5.6 million and $16.1 million principal
amount of Outstanding Notes were scheduled to mature in fiscal 1998 and fiscal
1999, respectively. The interest rates on Outstanding Notes scheduled to mature
during this period vary from 7.0% to 15.0% per annum. Any proceeds not applied
to pay Outstanding Notes will be used for other general corporate purposes.
This offering is not contingent on the sale of any minimum amount of Notes.
PLAN OF DISTRIBUTION
The Notes will not be distributed through underwriters, brokers or dealers.
The Notes will be sold only by the Trust acting through one or more of its duly
authorized officers. Such officers are salaried employees of the Saul Company,
the parent of the Advisor, and do not receive any compensation in connection
with their participation in the offering and sale of the Notes in the form of
commissions or other remuneration based either directly or indirectly on sales
of the Notes. Although the Trust does not compensate the officers who
participate in the offering and sale of the Notes, the Trust does pay the
Advisor a fee of 1% of the principal amount of the Notes as they are issued to
offset its costs of administering the Note program. Notes will be available for
sale only at the Trust's office in Bethesda, Maryland. See "How to Purchase
Notes."
<PAGE>
The offering of the Notes by this Prospectus will terminate when all of the
Notes have been sold. See "Description of Notes - General." The Trust may
terminate the offering of the Notes at any time without notice.
HOW TO PURCHASE NOTES
Notes may be purchased in person at the sales office of the Trust, 7200
Wisconsin Avenue, Suite 903, Bethesda, Maryland 20814, or by mail by completing
the applicable Note Order Form, which may be found at the end of this
Prospectus, and mailing the form and a check payable to the Trust in the
enclosed envelope. In either case, the Note, in registered form, will be mailed
directly to the purchaser by First Trust of New York, National Association, the
Indenture Trustee for the Notes. For further information on how to purchase
Notes, please telephone (301) 986-6207.
DESCRIPTION OF NOTES
The Notes will be issued under an Indenture dated as of September 1,
1992, as supplemented by the First Supplemental Indenture dated as of
January 16, 1997 (as supplemented, the "Indenture") between the Trust and
First Trust of New York, National Association (the "Indenture Trustee").
Included below is a summary of the material terms of the Notes and the
material provisions of the Indenture. The summary does not purport to be
complete and is subject in all respects to the provisions of, and is
qualified in its entirety by express reference to, the cited Sections and
Articles of, and definitions contained in, the Indenture, a copy of which has
been filed with the Commission as an exhibit to the Registration Statement of
which this Prospectus forms a part, and which is available as described under
Available Information.
GENERAL
The Notes are limited to the aggregate principal amount of $80 million
initially offered hereby (Section 3.01). At December 31, 1997, $24.4 million in
principal amount of Notes was available to be issued under the Indenture. The
Trust from time to time may enter into one or more supplemental indentures
providing for the issuance of additional notes without the consent of the
holders of outstanding Notes (Section 9.01).
The Notes will be issued in denominations of $5,000 or any amount in excess
thereof which is an integral multiple of $1,000. They will be issued in
registered form only, without coupons, to mature one to ten years from the date
of issue, as selected by the investor. The Notes will be unsecured general
obligations of the Trust and will be identical except for interest rate, issue
date and maturity date (Section 3.02). Except as described below under
"Redemption of Certain Notes," the Notes will not contain any provisions for
conversion, redemption, amortization, sinking fund or retirement prior to
maturity.
THE NOTES ARE NOT GUARANTEED OR INSURED AND ARE NOT SECURED BY ANY
MORTGAGE, PLEDGE OR LIEN. The Notes will rank on a parity in right of payment
with all unsecured debt of the Real Estate Trust. At September 30, 1997, the
Real Estate Trust's unsecured debt (consisting of Notes and accounts payable and
accrued expenses) totaled $82.9 million.
Each Note will bear interest from the date of issue to the date of maturity
at the annual rate stated on the face thereof. Such interest will be payable
semi-annually, six months from the date of issue and each six months thereafter,
and at maturity, to the persons in whose names the Notes are registered at the
close of business on the 20th day preceding such Interest Payment Dates.
Interest rates applicable to Notes will be subject to change by the Trust from
time to time, but no such change will affect any Notes issued prior to the
effective date of such change (Section 3.01). Based on the amount of a proposed
investment in Notes or the aggregate principal amount of the Trust's outstanding
unsecured notes held by a prospective investor, the Trust may offer to pay
interest on a Note of any maturity at an annual rate of up to 2% in excess of
the interest rate shown on the cover page of this Prospectus for a Note of such
maturity.
At maturity of any Note, principal will be payable upon surrender of such
Note without endorsement at First Trust of New York, National Association, 100
Wall Street, Suite 1600, New York, New York 10005. Interest
<PAGE>
payments will be made by the Trust by check mailed to the person entitled
thereto (Sections 3.01 and 10.02). NOTES MUST BE PRESENTED AT THE ABOVE OFFICE
OF THE INDENTURE TRUSTEE FOR REGISTRATION OF TRANSFER OR EXCHANGE AND FOR
PAYMENT AT MATURITY. No service charge will be imposed for any transfer or
exchange of Notes, but the Trust may require payment to cover taxes or other
governmental charges that may be assessed in connection with any such transfer
or exchange (Section 3.05).
THE INDENTURE DOES NOT IMPOSE ANY RESTRICTIONS ON THE TRUST'S ABILITY TO
PAY DIVIDENDS OR OTHER DISTRIBUTIONS TO ITS SHAREHOLDERS, TO INCUR DEBT OR TO
ISSUE ADDITIONAL SECURITIES. SEE "RISK FACTORS AND OTHER CONSIDERATIONS - NO
LIMITATION IN INDENTURE ON DIVIDENDS, DISTRIBUTIONS, ISSUANCE OF SECURITIES OR
INCURRENCE OF ADDITIONAL INDEBTEDNESS."
There is no established trading market for the Notes, and the Trust does
not anticipate that an active trading market will be established.
REDEMPTION OF CERTAIN NOTES
The Trust may, at its sole election, redeem any of the Notes having a
Stated Maturity of more than one year from date of issue on any Interest Payment
Date with respect to such Note on or after the first anniversary of the date of
issue of such Note at a Redemption Price (exclusive of the installment of
interest due on the Redemption Date, payment of which shall have been made or
duly provided for to the registered holder on the relevant Record Date) equal to
the Principal Amount of the Note so redeemed. (Section 11.01). Notes called for
redemption will not bear interest after the Redemption Date. (Section 11.07).
If fewer than all of the Notes having a Stated Maturity of more than one
year and the same Interest Payment Date as the Redemption Date are to be
redeemed, the particular Notes to be redeemed will be selected by such method as
the Trust shall deem appropriate and may include redemption of Notes with higher
interest rates first (Section 11.04).
EVENTS OF DEFAULT AND NOTICE THEREOF
The Indenture provides that an "Event of Default" with respect to the Notes
will result upon the occurrence of any of the following:
(a) default in the payment of any interest upon any Note when it
becomes due and payable, and continuance of such default for a period
of 30 days;
(b) default in the payment of the principal of (and premium, if any,
on) any Note at its Maturity;
(c) default in the performance, or breach, of any covenant or
warranty of the Trust in the Indenture (other than a covenant or
warranty a default in whose performance or whose breach is elsewhere
in the Indenture specifically dealt with), and continuance of such
default or breach for a period of 60 days after there has been given,
by registered or certified mail, to the Trust by the Indenture Trustee
or to the Trust and the Indenture Trustee by the Holders of at least
10% in principal amount of the Notes Outstanding, a written notice
specifying such default or breach and requiring it to be remedied and
stating that such notice is a "Notice of Default" under the Indenture;
(d) certain events of bankruptcy or insolvency affecting the Trust;
or
(e) B. F. Saul Advisory Company ceases to be the investment advisor
to the Trust without being immediately replaced by another entity the
majority voting interest of which is owned by the Saul Company or
B. Francis Saul II (Section 5.01).
Within 90 days after the occurrence of a default, the Indenture Trustee is
required to give the Noteholders notice of all defaults known to it; provided
that, except in the case of a default in the payment of principal of, and
premium, if any, or interest on, any of the Notes, the Indenture Trustee will be
protected in withholding such notice if it in good faith determines that the
withholding of such notice is in the interest of the Noteholders (Section 6.02).
If an Event of Default occurs and is continuing, the Indenture Trustee or the
Holders of not less than 25% in
<PAGE>
principal amount of the Notes Outstanding may declare the principal of all the
Notes to be due and payable immediately, by a notice in writing to the Trust
(and to the Indenture Trustee if given by Noteholders), and upon any such
declaration such principal will become immediately due and payable (Section
5.02). At any time after such a declaration of acceleration has been made and
before a judgment or decree for payment of the money due has been obtained by
the Indenture Trustee, the Holders of a majority in principal amount of the
Notes Outstanding, by written notice to the Trust and the Indenture Trustee, may
rescind and annul such declaration and its consequences if (i) the Trust has
paid or deposited with the Indenture Trustee a sum sufficient to pay
(A) all overdue installments of interest on all Notes,
(B) the principal of (and premium, if any, on) any Notes which have
become due otherwise than by such declaration of acceleration and
interest thereon at the rate borne by the Notes,
(C) to the extent that payment of such interest is lawful, interest
upon overdue installments of interest at the rate borne by the Notes,
and
(D) all sums paid or advanced by the Indenture Trustee under the
Indenture and the reasonable compensation, expenses, disbursements and
advances of the Indenture Trustee, its agents and counsel; and
(ii) all Events of Default, other than the non-payment of the principal of Notes
which have become due solely by such acceleration, have been cured or have been
waived as provided in the Indenture (Section 5.02).
The Indenture provides that if (i) default is made in the payment of any
interest on any Note when such interest becomes due and payable and such default
continues for a period of 30 days, or (ii) default is made in the payment of the
principal of (or premium, if any, on) any Note at the Maturity thereof, the
Trust will, upon demand of the Indenture Trustee, pay to it, for the benefit of
the Holders of such Notes, the whole amount then due and payable on such Notes
for principal (and premium, if any) and interest, with interest upon the overdue
principal (and premium, if any) and, to the extent that payment of such interest
is legally enforceable, upon overdue installments of interest, at the rate borne
by the Notes. (Section 5.03).
In the case of an Event of Default which is not cured or waived, the
Indenture Trustee will be required to exercise such of its rights and powers
under the Indenture, and to use the degree of care and skill in their exercise,
that a prudent man would exercise or use under the circumstances in the conduct
of his own affairs, but it otherwise need only perform such duties as are
specifically set forth in the Indenture (Section 6.01). Subject to such
provisions, the Indenture Trustee will be under no obligation to exercise any of
its rights or powers under the Indenture at the request of any of the
Noteholders unless they offer to the Indenture Trustee reasonable security or
indemnity (Section 6.03).
MODIFICATION OF INDENTURE
The Indenture, the rights and obligations of the Trust and the rights of
the Noteholders may be modified by the Trust and the Indenture Trustee without
the consent of the Noteholders (i) to evidence the succession of a corporation
or other entity to the Trust, and the assumption by any such successor of the
covenants of the Trust in the Indenture and the Notes, (ii) to add to the
covenants of the Trust, for the benefit of the Noteholders, or to surrender any
right or power conferred in the Indenture upon the Trust, (iii) to cure any
ambiguity, to correct or supplement any provision of the Indenture which may be
defective or inconsistent with any other provisions, or to make any other
provisions with respect to matters or questions arising under the Indenture
which are not inconsistent with the Indenture, provided such action does not
adversely affect the interests of the Noteholders, (iv) to create, from time to
time, notes in addition to the Notes initially issuable under the Indenture and
any supplemental indenture thereto, which subsequently created notes are
identical to the Notes initially issuable under the Indenture and any
supplemental indenture thereto, except for interest rate, issue date and
maturity date, or (v) to modify, amend or supplement the Indenture to effect the
qualification of the Indenture under the Trust Indenture Act of 1939 and to add
to the Indenture specified provisions permitted by such Act (Section 9.01).
With certain exceptions, the Indenture, the rights and obligations of the
Trust and the rights of the Noteholders may be modified in any manner by the
Trust with the consent of the holders of not less than 66-2/3% in
<PAGE>
aggregate principal amount of the Notes Outstanding; but no such modification
may be made without the consent of each Noteholder affected thereby which would
(i) change the maturity of the principal of, or any installment of interest on,
any Note or reduce the principal amount thereof or the interest thereon, or
impair the right of such Noteholder to institute suit for the enforcement of any
such payment on or after the maturity thereof, or (ii) reduce the percentage in
principal amount of the Notes Outstanding, the consent of whose holders is
required for any modification of the Indenture, or the consent of whose holders
is required for any waiver of compliance with certain provisions of the
Indenture or certain defaults thereunder and the consequences thereof provided
for in the Indenture (Section 9.02).
COMPLIANCE REPORTS
The Trust and each other obligor on the Notes, if any, must deliver
annually to the Trustee, within 120 days after the end of each fiscal year, an
officers' certificate stating whether the Trust is in default in the performance
and observance of any of the conditions or covenants of the Indenture, and if
the Trust is in default, specifying all such defaults and the nature and status
thereof (Section 10.06).
REPORTS TO NOTEHOLDERS
The Trust will furnish to the holders of Notes such summaries of all
quarterly and annual reports which it files with the Commission as may be
required by the rules and regulations of the Commission to be furnished to
holders of any Notes (Section 7.04).
EXPERTS
The Trust's Consolidated Financial Statements and related schedules
included in the Trust's Annual Report on Form 10-K at September 30, 1997 and
1996, for the years ended September 30, 1997, 1996 and 1995 have been audited
by Arthur Andersen LLP, independent public accountants, as indicated in their
reports with respect thereto, and are incorporated herein by reference in
reliance upon the authority of said firm as experts in giving said reports.
Reference is made to the report with respect to the Trust's Consolidated
Financial Statements at September 30, 1997 and 1996 and for the years ended
September 30, 1997, 1996 and 1995, which includes an explanatory paragraph
with respect to the changes in the method of accounting for (i) income taxes,
impaired loans and investments in securities and mortgage-backed securities,
(ii) mortgage servicing rights and (iii) foreclosed assets.
LEGAL MATTERS
The legality of the securities offered by this Prospectus has been passed
upon for the Trust by the firm of Shaw, Pittman, Potts & Trowbridge, Washington,
D.C., a partnership including professional corporations. George M. Rogers, Jr.,
a member of that firm, is a trustee of the Trust and a director of B. F. Saul
Company and of Chevy Chase.
<PAGE>
NOTE ORDER FORM
B. F. SAUL REAL ESTATE INVESTMENT TRUST
7200 Wisconsin Avenue, Suite 903
Bethesda, Maryland 20814
PLEASE ISSUE A NOTE EXACTLY AS INDICATED BELOW AT THE INTEREST RATE SHOWN
ON YOUR CURRENT PROSPECTUS OR SUPPLEMENT THERETO. MY CHECK FOR 100% OF THE
PRINCIPAL AMOUNT IS ENCLOSED. I UNDERSTAND THAT MY NOTE WILL BE ISSUED AS OF THE
DATE THIS ORDER IS RECEIVED (IF RECEIVED BY NOON) AND THAT YOUR OFFER MAY BE
WITHDRAWN WITHOUT NOTICE.
===============================================================================
Owner's Name:
-------------------------------------------------------
-------------------------------------------------------
-------------------------------------------------------
Address:
-------------------------------------------------------
-------------------------------------------------------
Taxpayer Identification
(Social Security) Number:
-----------------------------------------------------
- -------------------------------------------------------------------------------
Principal Amount of Note Maturity from date of issue
(Minimum $5,000):$ (circle one): 1 2 3 4 5 6 7 8 9 10 year(s)
If the maturity date falls on a Saturday, Sunday, or holiday, it will be
changed to the nearest business day. This change will not alter the interest
rate.
Under penalties of perjury, I certify (1) that the number shown on this
form is my correct taxpayer identification number, and (2) that I am not subject
to backup withholding because (a) I have not been notified that I am subject to
backup withholding as a result of a failure to report all interest or dividends,
or (b) the Internal Revenue Service has notified me that I am no longer subject
to backup withholding; or all of the account owners are neither citizens nor
residents of the United States and therefore exempt from withholding.
Note: Strike out the language certifying that you are not subject to
backup withholding due to notified payee underreporting if the Internal Revenue
Service has notified you that you are subject to backup withholding and you have
not received notice from the Internal Revenue Service advising that backup
withholding has terminated.
- ----------------------------------- ----------------------------------------
Date Signature
----------------------------------------
For office use only: Print Name
- --------------------
----------- ----------------------------------------
Date rec'd Address (if different from above)
----------- ----------------------------------------
Issue date City, State & Zip Code
----------- ----------------------------------------
Interest rate (Area Code) Telephone Number
<PAGE>
B. F. SAUL REAL ESTATE INVESTMENT TRUST
7200 Wisconsin Avenue, Suite 903
Bethesda, Maryland 20814
Gentlemen:
I (We) hold a Note,
number
------------------------------
for the principal amount of $
------------------------------
which matures on
------------------------------
CHECK ONE OF THE FOLLOWING BOXES:
1 I (We) wish to receive a check for the principal amount
- if so, please send note
to First Trust of New York, National Association
2 I (We) wish to reinvest the principal amount in a new
Note as follows:
Principal Amount of New Note Maturity from date of issue
(Minimum $5,000):$ (circle one): 1 2 3 4 5 6 7 8 9 10 year(s)
The principal amount of the new note may be either increased or decreased in
increments of $1,000. In no case can the new principal be less than $5,000. If
increased, please send a check payable to B.F. Saul Real Estate Investment Trust
for the amount of the increase.
PLEASE ENCLOSE THE MATURING NOTE AND RETURN TO US
IF THE NEW NOTE TO BE ISSUED IS TO BE REGISTERED IN A NAME OTHER THAN THAT OF
THE PRESENT HOLDER(S), OR IF ANY OTHER ALTERATIONS IN THE FORM OF THE
REGISTRATION ARE REQUIRED,
PLEASE PRINT OR TYPE IN THE NEW INFORMATION BELOW.
Name of Owner(s)
---------------------------------------------
Printed
---------------------------------------------
Printed
Address:
---------------------------------------------
No. Street Apt.
---------------------------------------------
City State Zip Code
Telephone Number:
---------------------------------------------
Area Code
Federal Identification or
Social Security Number:
---------------------------------------------
- ------------------------------------------------------------ ---------------
Signature Date
<PAGE>
ACKNOWLEDGMENT
B.F. SAUL REAL ESTATE INVESTMENT TRUST
7200 Wisconsin Avenue, Suite 903
Bethesda, MD 20814
Gentlemen:
I understand and acknowledge that (1) the Note I am purchasing is not a
savings account or a deposit and (2) the Note is not insured or guaranteed by
any federal governmental agency, including the Federal Deposit Insurance
Corporation, or by any state governmental agency.
- ----------------------------------- ----------------------------------------
Date Signature
- ----------------------------------- ----------------------------------------
Printed Name
<PAGE>
================================================================================
No person has been authorized to give any information or to make any
representation not contained in this Prospectus, and, if given or made, such
information or representation must not be relied upon. This Prospectus does not
constitute an offer to sell or a solicitation of an offer to buy any securities
not offered hereby, or an offer to sell or a solicitation of any offer to buy
the securities offered hereby in any jurisdiction in which (or to any person to
whom) it is unlawful to make such offer or solicitation, and this Prospectus may
not be used to make any such offer or solicitation by a person who is not
qualified to do so under the laws of the jurisdiction in which the offer or
solicitation is made. Neither the delivery of this Prospectus nor any sale
hereunder shall under any circumstances create any implication that there has
been no change in the affairs of the Trust since the date on the cover page
hereof.
TABLE OF CONTENTS
Available Information . . . . . . . . . . . . . . . . . . . . . .
Incorporation of Certain Documents by Reference . . . . . . . . .
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Risk Factors and Other Considerations . . . . . . . . . . . . . .
Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . . .
Plan of Distribution. . . . . . . . . . . . . . . . . . . . . . .
How to Purchase Notes . . . . . . . . . . . . . . . . . . . . . .
Description of Notes. . . . . . . . . . . . . . . . . . . . . . .
Experts . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Legal Matters . . . . . . . . . . . . . . . . . . . . . . . . . .
Note Order Forms. . . . . . . . . . . . . . . . . . . . . . . . .
B. F. SAUL REAL ESTATE
INVESTMENT TRUST
Notes Due One Year
To Ten Years
from Date of Issue
--------------------
P R O S P E C T U S
--------------------
7200 Wisconsin Avenue
Suite 903
Bethesda, Maryland 20814
Telephone: (301) 986-6207
================================================================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
It is estimated that the expenses in connection with the issuance and
distribution of the securities are as follows:
Registration fee. . . . . . . . . . . . . . . . . $ 20,000
Cost of printing and engraving. . . . . . . . . . 18,500
Indenture Trustee & Registrar's Fees. . . . . . . 80,000
Legal fees of counsel for registrant. . . . . . . 400,000
Accountants' fees . . . . . . . . . . . . . . . . 25,000
Payment to B. F. Saul Advisory Company for
Administering Note Program. . . . . . . . . . 800,000
Miscellaneous and Advertising . . . . . . . . . . 367,000
----------
Total . . . . . . . . . . . . . . . . . . . . $1,710,000
===========
Item 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Declaration of Trust (Article III) provides that no Trustee or officer
of the Trust shall be liable for any action or failure to act except for his own
bad faith, willful misfeasance, gross negligence or reckless disregard of his
duties, and, except as stated, Trustees and officers are entitled to be
reimbursed and indemnified for all loss, expenses, and outlays which they may
suffer because they are Trustees or officers of the Trust.
Item 16. EXHIBITS.
EXHIBITS DESCRIPTION
- ------------ -----------------------------------------------------------------
3. *(a) Amended and Restated Declaration of Trust filed with the
Maryland State Department of Assessments and Taxation on
June 22, 1990.
*(b) Amendment to Amended and Restated Declaration of Trust reflected
in Secretary Certificate filed with the Maryland State Department
of Assessments and Taxation on June 26, 1990.
(c) Amended and Restated By-Laws of the Trust dated as of
February 28, 1991 as filed as Exhibit T3B to the Trust's Form T-3
Application for Qualification of Indentures under the Trust
Indenture Act of 1939 (File No. 22-20838) is hereby incorporated
by reference.
4.* (a) Indenture dated as of September 1, 1992 with respect to the
Trust's Notes due from One to Ten Years from Date of Issue.
* (b) First Supplemental Indenture dated as of January 16, 1997 with
respect to the Trust's Notes due from One to Ten Years from
Date of Issue. The text of the Notes is set forth in Section 1.1.
<PAGE>
EXHIBITS DESCRIPTION
- ------------ -----------------------------------------------------------------
(c) Indenture with respect to the Trust's Senior Notes Due from One
Year to Ten Years from Date of Issue as filed as Exhibit 4(a) to
Registration Statement No. 33-19909 is hereby incorporated by
reference.
(d) First Supplemental Indenture with respect to the Trust's Senior
Notes due from One Year to Ten Years from Date of Issue as
filed as Exhibit T-3C to the Trust's Form T-3 Application for
Qualification of Indentures under the Trust Indenture Act of 1939
(File No. 22-20838) is hereby incorporated by reference.
(e) Indenture with respect to the Trust's Senior Notes due from One
Year to Ten Years from Date of Issue as filed as Exhibit 4(a) to
Registration Statement No. 33-9336 is hereby incorporated by
reference.
(f) Fourth Supplemental Indenture with respect to the Trust's Senior
Notes due from One Year to Ten Years from Date of Issue as filed
as Exhibit 4(a) to Registration Statement No. 2-95506 is hereby
incorporated by reference.
(g) Third Supplemental Indenture with respect to the Trust's Senior
Notes due from One Year to Ten Years from Date of Issue as filed
as Exhibit 4(a) to Registration Statement No. 2-91126 is hereby
incorporated by reference.
(h) Second Supplemental Indenture with respect to the Trust's Senior
Notes due from One Year to Ten Years from Date of Issue as filed
as Exhibit 4(a) to Registration Statement No. 2-80831 is hereby
incorporated by reference.
(i) Supplemental Indenture with respect to the Trust's Senior Notes
due from One Year to Ten Years from Date of Issue as filed as
Exhibit 4(a) to Registration Statement No. 2-68652 is hereby
incorporated by reference.
(j) Indenture with respect to the Trust's Senior Notes due from One
Year to Five Years from Date of Issue as filed as Exhibit T-3C to
the Trust's Form T-3 Application for Qualification of Indentures
under the Trust Indenture Act of 1939 (File No. 22-10206) is
hereby incorporated by reference.
(k) Indenture dated as of March 30, 1994 between the Trust and
Norwest Bank Minnesota, National Association, as Trustee, with
respect to the Trust's 11 5/8% Series B Senior Secured Notes due
2002, as filed as Exhibit 4(a) to Registration Statement
No. 33-52995 is hereby incorporated by reference.
*5. Opinion of Shaw, Pittman, Potts & Trowbridge with respect to
legality of the Notes.
10. (a) Advisory Contract with B.F. Saul Advisory Company effective
October 1, 1982 filed as Exhibit 10(a) to Registration Statement
No. 2-80831 is hereby incorporated by reference.
(b) Commercial Property Leasing and Management Agreement effective
October 1, 1982 between the Trust and Franklin Property Company
as filed as Exhibit 10(b) to Registration Statement No. 2-80831
is hereby incorporated by reference.
*(c) Tax Sharing Agreement dated June 28, 1990 among the Trust, Chevy
Chase Savings Bank F.S.B. and certain of their subsidiaries.
*(d) Agreement dated June 28, 1990 among the Trust, B.F. Saul Company,
Franklin Development Co., Inc., The Klingle Corporation and
Westminster Investing Corporation relating to the transfer of
certain shares of Chevy Chase Savings Bank, F.S.B. and certain
real property to the Trust in exchange for preferred shares of
beneficial interest of the Trust.
<PAGE>
EXHIBITS DESCRIPTION
- ------------ -----------------------------------------------------------------
(e) Regulatory Capital Maintenance/Dividend Agreement dated May 17,
1988 among B.F. Saul Company, the Trust and the Federal Savings
and Loan Insurance Corporation as filed as Exhibit 10(e) to the
Trust's Annual Report on Form 10-K (File No. 1-7184) for the
fiscal year ended September 30, 1991 is hereby incorporated by
reference.
* (f) Amendments to Commercial Property Leasing and Management
Agreement between the Trust and Franklin Property Company dated
as of December 31, 1992 (Amendment No. 5), July 1, 1989
(Amendment No. 4), October 1, 1986 (Amendment No. 3), January 1,
1985 (Amendment No. 2) and July 1, 1984 (Amendment No. 1).
* (g) Advisory Contract between B.F. Saul Advisory Company and Dearborn
Corporation dated as of December 31, 1992.
* (h) Commercial Property Leasing and Management Agreement between
Dearborn Corporation and Franklin Property Company dated as of
December 31, 1992.
(i) Registration Rights and Lock-Up Agreement dated August 26, 1993
by and among Saul Centers, Inc. and the Trust, Westminster
Investing Corporation, Van Ness Square Corporation, Dearborn
Corporation, Franklin Property Company and Avenel Executive
Park Phase II, Inc. as filed as Exhibit 10.6 to Registration
Statement No. 33-64562 is hereby incorporated by reference.
(j) Exclusivity and Right of First Refusal Agreement dated August 26,
1993 among Saul Centers, Inc., the Trust, B. F. Saul Company,
Westminster Investing Corporation, Franklin Property Company, Van
Ness Square Corporation, and Chevy Chase Savings Bank, F.S.B. as
filed as Exhibit 10.7 to Registration Statement No. 33-64562 is
hereby incorporated by reference.
(k) First Amended and Restated Reimbursement Agreement dated as of
August 1, 1994 by and among Saul Centers, Inc., Saul Holdings
Limited Partnership, Saul Subsidiary I Limited Partnership, Saul
Subsidiary II Limited Partnership, Avenel Executive Park
Phase II, Inc., Franklin Property Company, Westminster Investing
Corporation Van Ness Square Corporation, Dearborn Corporation and
the Trust as filed as Exhibit 10(l) to the Trust's Annual Report
on Form 10-K (File No. 1-7184) for the fiscal year ended
September 30, 1994 is hereby incorporated by reference.
(l) Registration Rights Agreement dated as of March 30, 1994 among
the Trust, Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner &
Smith Incorporated and Friedman, Billings, Ramsey & Co., Inc. as
filed as Exhibit 4(c) to Registration Statement No. 33-52995 is
hereby incorporated by reference.
(m) Bank Stock Registration Rights Agreement dated as of March 30,
1994 between the Trust and Norwest Bank Minnesota, National
Association, as Trustee. filed as Exhibit 4(c) to Registration
Statement No. 33-52995 is hereby incorporated by reference.
**12. Statement re: Computation of Ratio of Earnings to Fixed Charges.
**13. Annual Report to Security Holders for the fiscal year ended
September 30, 1997.
**23. (a) Consent of Arthur Andersen LLP.
*24. Power of Attorney.
*25. Statement of Eligibility on Form T-1 of First Trust of New York,
National Association.
- ---------------------------
* Previously filed.
** Filed herewith.
<PAGE>
ITEM 17. UNDERTAKINGS.
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or
the most recent post-effective amendment thereof) which,
individually or in the aggregate, represent a fundamental
change in the information set forth in the registration
statement;
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration
statement or any material change to such information in the
registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall
be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering
thereof.
(3) To remove from registration by means of a post-effective
amendment any of the securities being registered which remain
unsold at the termination of the offering.
The undersigned registrant hereby undertakes to deliver or cause to be
delivered with the prospectus, to each person to whom the prospectus is sent or
given, the latest annual report to security holders that is incorporated by
reference in the prospectus and furnished pursuant to and meeting the
requirements of Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of
1934; and, where interim financial information required to be presented by
Article 3 of Regulation S-X is not set forth in the prospectus, to deliver, or
cause to be delivered to each person to whom the prospectus is sent or given,
the latest quarterly report that is specifically incorporated by reference in
the prospectus to provide such interim financial information.
<PAGE>
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provision, or otherwise, the registrant has
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant certifies that it has duly caused this post-effective amendment to
be signed on its behalf by the undersigned, thereunto duly authorized, in
Chevy Chase, Maryland on this the 15th day of January 1998.
B.F. SAUL REAL ESTATE
INVESTMENT TRUST
By: B. FRANCIS SAUL II
----------------------
B. Francis Saul II
Chairman of the Board
(Principal Executive Officer)
Pursuant to the requirements of the Securities Act of 1933, this
post-effective amendment has been signed by the following persons in the
capacities indicated below on this 15th day of January 1998.
Signature Capacity
--------- --------
B. FRANCIS SAUL II Trustee, Chairman of the
-------------------------- Board and Principal
B. Francis Saul II Executive Officer
STEPHEN R. HALPIN, JR. Vice President and
-------------------------- Chief Financial Officer
Stephen R. Halpin Jr. (Principal Financial Officer)
ROSS E. HEASLEY Vice President
------------------------- (Principal Accounting
Ross E. Heasley Officer)
GARLAND J. BLOOM, JR.
------------------------- Trustee
Garland J. Bloom, Jr.
GILBERT M. GROSVENOR
------------------------- Trustee
Gilbert M. Grosvenor
GEORGE M. ROGERS, JR.
------------------------- Trustee
George M. Rogers, Jr.
B. FRANCIS SAUL III Trustee
--------------------------
B. Francis Saul III
JOHN R. WHITMORE
------------------------- Trustee
John R. Whitmore
<PAGE>
EXHIBIT INDEX
EXHIBITS DESCRIPTION
- ------------ -----------------------------------------------------------------
3. *(a) Amended and Restated Declaration of Trust filed with the
Maryland State Department of Assessments and Taxation on
June 22, 1990.
*(b) Amendment to Amended and Restated Declaration of Trust reflected
in Secretary Certificate filed with the Maryland State Department
of Assessments and Taxation on June 26, 1990.
(c) Amended and Restated By-Laws of the Trust dated as of
February 28, 1991 as filed as Exhibit T3B to the Trust's Form T-3
Application for Qualification of Indentures under the Trust
Indenture Act of 1939 (File No. 22-20838) is hereby incorporated
by reference.
4.* (a) Indenture dated as of September 1, 1992 with respect to the
Trust's Notes due from One to Ten Years from Date of Issue.
* (b) First Supplemental Indenture dated as of January 16, 1997 with
respect to the Trust's Notes due from One to Ten Years from
Date of Issue. The text of the Notes is set forth in Section 1.1.
(c) Indenture with respect to the Trust's Senior Notes Due from One
Year to Ten Years from Date of Issue as filed as Exhibit 4(a) to
Registration Statement No. 33-19909 is hereby incorporated by
reference.
(d) First Supplemental Indenture with respect to the Trust's Senior
Notes due from One Year to Ten Years from Date of Issue as
filed as Exhibit T-3C to the Trust's Form T-3 Application for
Qualification of Indentures under the Trust Indenture Act of 1939
(File No. 22-20838) is hereby incorporated by reference.
(e) Indenture with respect to the Trust's Senior Notes due from One
Year to Ten Years from Date of Issue as filed as Exhibit 4(a) to
Registration Statement No. 33-9336 is hereby incorporated by
reference.
(f) Fourth Supplemental Indenture with respect to the Trust's Senior
Notes due from One Year to Ten Years from Date of Issue as filed
as Exhibit 4(a) to Registration Statement No. 2-95506 is hereby
incorporated by reference.
(g) Third Supplemental Indenture with respect to the Trust's Senior
Notes due from One Year to Ten Years from Date of Issue as filed
as Exhibit 4(a) to Registration Statement No. 2-91126 is hereby
incorporated by reference.
(h) Second Supplemental Indenture with respect to the Trust's Senior
Notes due from One Year to Ten Years from Date of Issue as filed
as Exhibit 4(a) to Registration Statement No. 2-80831 is hereby
incorporated by reference.
(i) Supplemental Indenture with respect to the Trust's Senior Notes
due from One Year to Ten Years from Date of Issue as filed as
Exhibit 4(a) to Registration Statement No. 2-68652 is hereby
incorporated by reference.
(j) Indenture with respect to the Trust's Senior Notes due from One
Year to Five Years from Date of Issue as filed as Exhibit T-3C to
the Trust's Form T-3 Application for Qualification of Indentures
under the Trust Indenture Act of 1939 (File No. 22-10206) is
hereby incorporated by reference.
<PAGE>
EXHIBITS DESCRIPTION
- ------------ -----------------------------------------------------------------
(k) Indenture dated as of March 30, 1994 between the Trust and
Norwest Bank Minnesota, National Association, as Trustee, with
respect to the Trust's 11 5/8% Series B Senior Secured Notes due
2002, as filed as Exhibit 4(a) to Registration Statement
No. 33-52995 is hereby incorporated by reference.
*5. Opinion of Shaw, Pittman, Potts & Trowbridge with respect to
legality of the Notes.
10. (a) Advisory Contract with B.F. Saul Advisory Company effective
October 1, 1982 filed as Exhibit 10(a) to Registration Statement
No. 2-80831 is hereby incorporated by reference.
(b) Commercial Property Leasing and Management Agreement effective
October 1, 1982 between the Trust and Franklin Property Company
as filed as Exhibit 10(b) to Registration Statement No. 2-80831
is hereby incorporated by reference.
*(c) Tax Sharing Agreement dated June 28, 1990 among the Trust, Chevy
Chase Savings Bank F.S.B. and certain of their subsidiaries.
*(d) Agreement dated June 28, 1990 among the Trust, B.F. Saul Company,
Franklin Development Co., Inc., The Klingle Corporation and
Westminster Investing Corporation relating to the transfer of
certain shares of Chevy Chase Savings Bank, F.S.B. and certain
real property to the Trust in exchange for preferred shares of
beneficial interest of the Trust.
(e) Regulatory Capital Maintenance/Dividend Agreement dated May 17,
1988 among B.F. Saul Company, the Trust and the Federal Savings
and Loan Insurance Corporation as filed as Exhibit 10(e) to the
Trust's Annual Report on Form 10-K (File No. 1-7184) for the
fiscal year ended September 30, 1991 is hereby incorporated by
reference.
* (f) Amendments to Commercial Property Leasing and Management
Agreement between the Trust and Franklin Property Company dated
as of December 31, 1992 (Amendment No. 5), July 1, 1989
(Amendment No. 4), October 1, 1986 (Amendment No. 3), January 1,
1985 (Amendment No. 2) and July 1, 1984 (Amendment No. 1).
* (g) Advisory Contract between B.F. Saul Advisory Company and Dearborn
Corporation dated as of December 31, 1992.
* (h) Commercial Property Leasing and Management Agreement between
Dearborn Corporation and Franklin Property Company dated as of
December 31, 1992.
(i) Registration Rights and Lock-Up Agreement dated August 26, 1993
by and among Saul Centers, Inc. and the Trust, Westminster
Investing Corporation, Van Ness Square Corporation, Dearborn
Corporation, Franklin Property Company and Avenel Executive
Park Phase II, Inc. as filed as Exhibit 10.6 to Registration
Statement No. 33-64562 is hereby incorporated by reference.
(j) Exclusivity and Right of First Refusal Agreement dated August 26,
1993 among Saul Centers, Inc., the Trust, B. F. Saul Company,
Westminster Investing Corporation, Franklin Property Company, Van
Ness Square Corporation, and Chevy Chase Savings Bank, F.S.B. as
filed as Exhibit 10.7 to Registration Statement No. 33-64562 is
hereby incorporated by reference.
<PAGE>
EXHIBITS DESCRIPTION
- ------------ -----------------------------------------------------------------
(k) First Amended and Restated Reimbursement Agreement dated as of
August 1, 1994 by and among Saul Centers, Inc., Saul Holdings
Limited Partnership, Saul Subsidiary I Limited Partnership, Saul
Subsidiary II Limited Partnership, Avenel Executive Park
Phase II, Inc., Franklin Property Company, Westminster Investing
Corporation Van Ness Square Corporation, Dearborn Corporation and
the Trust as filed as Exhibit 10(l) to the Trust's Annual Report
on Form 10-K (File No. 1-7184) for the fiscal year ended
September 30, 1994 is hereby incorporated by reference.
(l) Registration Rights Agreement dated as of March 30, 1994 among
the Trust, Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner &
Smith Incorporated and Friedman, Billings, Ramsey & Co., Inc. as
filed as Exhibit 4(c) to Registration Statement No. 33-52995 is
hereby incorporated by reference.
(m) Bank Stock Registration Rights Agreement dated as of March 30,
1994 between the Trust and Norwest Bank Minnesota, National
Association, as Trustee. filed as Exhibit 4(c) to Registration
Statement No. 33-52995 is hereby incorporated by reference.
**12. Statement re: Computation of Ratio of Earnings to Fixed Charges.
**13. Annual Report to Security Holders for the fiscal year ended
September 30, 1997.
**23. (a) Consent of Arthur Andersen LLP.
*24. Power of Attorney.
*25. Statement of Eligibility on Form T-1 of First Trust of New York,
National Association.
- ---------------------------
* Previously filed.
** Filed herewith.
<TABLE>
EXHIBIT 12
STATEMENT RE COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - REAL ESTATE TRUST ONLY
- -----------------------------------------------------------------------------------------------------------------------------------
For the Twelve Months Ended September 30
----------------------------------------------------------------------------------
(Dollars in thousands) 1997 1996 1995 1994 1993
- ----------------------------------------------------------------- --------------- ---------------- --------------- ----------------
<S> <C> <C> <C> <C> <C>
FIXED CHARGES:
Interest and debt expense $ 40,819 $ 40,514 $ 41,040 $ 40,576 $ 53,499
Ground rent 101 101 109 115 506
---------------- --------------- ---------------- --------------- ----------------
Total fixed charges for ratio $ 40,920 $ 40,615 $ 41,149 $ 40,691 $ 54,005
================ =============== ================ =============== ================
EARNINGS:
Operating loss $ (18,987) $ (24,176) $ (27,341) $ (34,305) $ (44,495)
Total fixed charges for ratio 40,920 40,615 41,149 40,691 54,005
---------------- --------------- ---------------- --------------- ----------------
Total earnings for ratio $ 21,933 $ 16,439 $ 13,808 $ 6,386 $ 9,510
================ =============== ================ =============== ================
RATIO OF EARNINGS TO FIXED CHARGES Less than 1 Less than 1 Less than 1 Less than 1 Less than 1
================ =============== ================ =============== ================
Deficiency of available earnings to fixed charges $ (18,987) $ (24,176) $ (27,341) $ (34,305) $ (44,495)
================ =============== ================ =============== ================
</TABLE>
------------------------------
B. F. SAUL
REAL ESTATE INVESTMENT TRUST
ANNUAL REPORT 1997
------------------------------
<PAGE>
TABLE OF CONTENTS
BUSINESS ..............................................................
General ...........................................................
Real Estate ..................................................
Banking ......................................................
Properties ........................................................
Legal Proceedings .................................................
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ...................
MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS .......................................
SELECTED FINANCIAL DATA ...............................................
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS .....................
Financial Condition ...............................................
Real Estate ..................................................
Banking ......................................................
Liquidity and Capital Resources ...................................
Real Estate ..................................................
Banking ......................................................
Liquidity ...............................................
Capital .................................................
Results of Operations .............................................
Fiscal 1997 Compared to Fiscal 1996 ..........................
Real Estate .............................................
Banking .................................................
Fiscal 1996 Compared to Fiscal 1995 ..........................
Real Estate .............................................
Banking .................................................
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ...........................
Management's Statement on Responsibility ..........................
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE ...............................
<PAGE>
BUSINESS
GENERAL
B.F. Saul Real Estate Investment Trust (the "Trust") operates as a Maryland real
estate investment trust. The Trust began its operations in 1964 as an
unincorporated business trust organized under a Declaration of Trust governed by
District of Columbia law. The Trust terminated its status as a qualified real
estate investment trust for federal income tax purposes in 1978 and is now
taxable as a corporation. On October 24, 1988, the Trust amended its Declaration
of Trust to qualify the Trust as a statutory real estate investment trust under
Maryland law.
The principal business activity of the Trust and its real estate 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"), whose assets accounted for 95% of the Trust's consolidated assets
at September 30, 1997. The Trust is a thrift holding company by virtue of its
ownership of a majority interest in Chevy Chase. See "Real Estate - Holding
Company Regulation."
The Trust recorded net income of $18.9 million in the fiscal year ended
September 30, 1997, compared to a net loss of $78,000 in the fiscal year ended
September 30, 1996 and net income of $10.9 million in the fiscal year ended
September 30, 1995.
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 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 Chevy Chase and its
subsidiaries is identified by "Banking."
The principal offices of the Trust are located at 8401 Connecticut Avenue, Chevy
Chase, Maryland 20815, and the Trust's telephone number is (301) 986-6000.
Real Estate. The Real Estate Trust's long-term objectives are to increase cash
flow from operations and to maximize capital appreciation of its real estate.
The properties owned by the Real Estate Trust are located predominantly in the
Mid-Atlantic and Southeastern regions of the United States and consist
principally of hotels, office and industrial projects, and undeveloped land
parcels.
<PAGE>
Banking. Chevy Chase is a federally chartered and federally insured stock
savings bank which at September 30, 1997 was conducting business from 128
full-service offices and 614 automated teller machines ("ATMs") in Maryland,
Virginia and the District of Columbia. The Bank has its home office in McLean,
Virginia and its executive offices in Chevy Chase, Maryland, both suburban
communities of Washington, D.C. The Bank also maintains 18 mortgage loan
production offices in the mid-Atlantic region, 17 of which are operated by a
wholly-owned mortgage banking subsidiary, and 18 consumer loan production
offices, 10 of which are operated by a wholly-owned finance subsidiary of the
Bank. At September 30, 1997, the Bank had total assets of $6.1 billion and total
deposits of $4.9 billion. Based on total consolidated assets at September 30,
1997, Chevy Chase is the largest bank headquartered in the Washington, D.C.
metropolitan area.
Chevy Chase is a consumer oriented, full service banking institution principally
engaged in the business of attracting deposits from the public and using such
deposits, together with borrowings and other funds, to make loans secured by
real estate, primarily residential mortgage loans, and credit card and other
types of consumer loans. The Bank also has an active commercial lending program.
The Bank's principal deposit and lending markets are located in the Washington,
D.C. metropolitan area. As a complement to its basic deposit and lending
activities, the Bank provides a number of related financial services to its
customers, including securities brokerage and insurance products offered through
its subsidiaries. On November 12, 1997, the Bank acquired ASB Capital
Management, Inc. ("ASB"), one of the largest SEC-registered investment managers
headquartered in the Washington, D.C. metropolitan area, through which the Bank
will provide a variety of investment products and fiduciary services to a
primarily institutional customer base.
Chevy Chase recorded operating income of $80.2 million for the year ended
September 30, 1997, compared to operating income of $46.1 million for the year
ended September 30, 1996. At September 30, 1997, the Bank's tangible, core, tier
1 risk-based and total risk-based regulatory capital ratios were 6.96%, 6.96%,
7.24% and 13.50%, respectively. The Bank's capital ratios exceeded the
requirements under the Financial Institutions Reform, Recovery, and Enforcement
Act of 1989 ("FIRREA") as well as the standards established for "well
capitalized" institutions under the prompt corrective action regulations
established pursuant to the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA"). In addition, the Bank's capital levels immediately
following the acquisition of ASB discussed above, remained above the levels
established for well-capitalized institutions. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations Financial Condition -
Banking - Capital."
On December 3, 1996, the Bank sold $100.0 million of 9 1/4% Subordinated
Debentures due 2008 (the "1996 Debentures"), the principal amount of which is
includable in the Bank's supplementary capital. In addition, on December 3,
1996, a new real estate investment trust subsidiary of the Bank sold $150.0
million of its Noncumulative Exchangeable Preferred Stock, Series A (the "REIT
Preferred Stock"), which is eligible for inclusion as core capital of the Bank
in an amount up to 25% of the Bank's total core capital.
<PAGE>
Chevy Chase is subject to comprehensive regulation, examination and supervision
by the Office of Thrift Supervision (the "OTS") and, to a lesser extent, by the
Federal Deposit Insurance Corporation (the "FDIC"). The Bank's deposit accounts
are fully insured up to $100,000 per insured depositor by the Savings
Association Insurance Fund (the "SAIF"), which is administered by the FDIC.
REAL ESTATE
REAL ESTATE INVESTMENTS
The following tables set forth, at and for the periods indicated, certain
information regarding the properties in the Real Estate Trust's investment
portfolio at September 30, 1997.
<TABLE>
<CAPTION>
HOTELS
Average Occupancy (2) Average Room Rate
------------------------ ------------------------
Year Ended September 30, Year Ended September 30,
Available ------------------------ ------------------------
Location Name Rooms(1) 1997 1996 1995 1997 1996 1995
- ------------ -------------------------------- ---------- ------------------------ -------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
COLORADO
Pueblo Holiday Inn - Pueblo 193 74% 75% 81% $53.09 $54.84 $50.97
MARYLAND
Gaithersburg Holiday Inn - Gaithersburg 301 65% 61% 65% $70.10 $68.93 $61.76
MICHIGAN
Auburn Hills Holiday Inn - Auburn Hills (3) 190 74% 75% 77% $94.79 $86.52 $75.17
NEW YORK
Rochester Holiday Inn - Rochester Airport 280 71% 68% 73% $68.26 $66.51 $65.38
OHIO
Cincinnati Holiday Inn - Cincinnati 273 58% 49% 52% $63.21 $66.67 $62.37
VIRGINIA
Arlington Howard Johnsons - National Airport 279 66% 71% 66% $67.99 $66.37 $66.08
Herndon Holiday Inn Express 115 74% -- -- $64.70 -- --
McLean Holiday Inn - Tysons Corner 316 74% 73% 72% $87.52 $78.98 $72.23
Sterling Hampton Inn - Dulles Airport (4) 127 77% 77% 75% $71.70 $62.87 $58.06
Sterling Holiday Inn - Dulles Airport 296 75% 76% 71% $72.18 $63.86 $59.53
----- --- --- --- ------ ------ ------
Totals 2,370 70% 68% 69% $72.21 $68.79 $63.79
</TABLE>
- --------------------------------------------------------------------------------
(1) Available rooms as of September 30, 1997.
(2) Average occupancy is calculated by dividing the rooms occupied by the
rooms available.
(3) Acquired November 30, 1994.
(4) Acquired October 30, 1996.
(5) A Real Estate Trust subsidiary owns a 99% interest in this hotel.
<PAGE>
<TABLE>
<CAPTION>
OFFICE AND INDUSTRIAL
Expiring Leases (1)
-------------------
Leasing Percentages Year Ending
Gross ------------------------- -------------------
September 30, September 30,
Leasable ------------------------- -------------------
Location Name Area (1) 1997 1996 1995 1998 1999
- --------------- -------------------------- -------- ------------------------- -------------------
<S> <C> <C> <C> <C> <C> <C> <C>
FLORIDA
Fort Lauderdale Commerce Center - Phase II 60,959 97% 92% 83% 26,295 11,261
GEORGIA
Atlanta 900 Circle 75 Parkway 345,502 98% 95% 94% 106,510 43,837
Atlanta 100 Circle 75 Parkway 89,412 98% 100% 100% 10,084 9,426
Atlanta 1100 Circle 75 Parkway 268,779 99% 100% 100% 39,716 118,520
LOUISIANA
Metairie Metairie Tower 91,372 95% 99% 98% 34,052 10,658
VIRGINIA
Chantilly Dulles South (2) 38,502 100% 100% 74% 6,743 9,433
McLean 8201 Greensboro Drive 353,742 99% 85% 59% 36,573 32,778
Sterling Dulles North (3) 59,886 100% 81% 100% 16,943 42,943
--------- ---- ---- ---- ------- -------
Totals 1,308,154 99% 93% 85% 276,916 278,856
21.2% 21.3%
</TABLE>
- --------------------------------------------------------------------------------
(1) Square feet
(2) A Real Estate Trust subsidiary owns a 50% interest in this office building
(3) A Real Estate Trust subsidiary owns a 99% interest in this office building
<PAGE>
<TABLE>
<CAPTION>
LAND PARCELS
Location Name Acres Zoning
- ---------------- -------------------------------- -------- -----------------------------
<S> <C> <C> <C>
FLORIDA
Boca Raton Arvida Park of Commerce (1) 20 Mixed Use
Fort Lauderdale Commerce Center 14 Office & Warehouse
GEORGIA
Atlanta Circle 75 (2) 133 Office & Industrial
KANSAS
Overland Park Overland Park 162 Residential, Office & Retail
MARYLAND
Gaithersburg Avenel Business Park (3) 8 Commercial
Rockville Flagship Centre 8 Commercial
MICHIGAN
Auburn Hills Holiday Inn - Auburn Hills (4) 3 Commercial
NEW YORK
Rochester Holiday Inn - Rochester Airport 3 Commercial
VIRGINIA
Loudoun County Church Road 40 Office & Industrial
Loudoun County Sterling Boulevard (5) 48 Industrial
---
Total 439
</TABLE>
- ------------------------------------------------------------------------------
(1) A Real Estate Trust subsidiary owns a 50% interest in 11 acres of this
parcel.
(2) Includes land parcel formerly identified as Perimeter Way.
(3) The Real Estate Trust is currently developing a 46,000 square foot office/
research development building on 3.2 acres of this parcel.
(4) Acquired July 11, 1997.
(5) A Real Estate Trust subsidiary owns a 99% interest in this parcel.
<PAGE>
OTHER REAL ESTATE INVESTMENTS
Location Name
--------------- ------------------------------
PURCHASE - LEASEBACK PROPERTIES (1)
APARTMENTS
Number
of Units
--------
LOUISIANA
Metairie Chateau Dijon 336
TENNESSEE
Knoxville Country Club 232
---
Total 568
SHOPPING CENTERS
Gross
Leasable
Area (2)
--------
GEORGIA
Atlanta Old National 160,000
Warner Robbins Houston Mall 264,000
-------
Total 424,000
APARTMENT PROJECT
Number
of Units
TEXAS --------
Dallas San Simeon 124
MISCELLANEOUS PROPERTY (RETAIL)
Gross
Leasable
Area (2)
--------
MARYLAND
Oxon Hill Wheeler Road 24,000
- -----------------------------------------------------------------------------
(1) The Trust owns the ground under certain income-producing properties and
receives fixed ground rent, which is subject to periodic escalation, from
the owners of the improvements. In certain instances, the Real Estate Trust
also receives percentage rent based upon the income generated by the
properties.
(2) Square feet.
<PAGE>
The investment portfolio consists principally of seasoned operating properties.
The Real Estate Trust expects to hold its properties as long-term investments
and has no maximum period for retention of any investment. It may acquire
additional income-producing properties, expand and improve its properties, or
sell such properties, as and when circumstances warrant. The Real Estate Trust
also may participate with other entities in property ownership, through joint
ventures or other types of co-ownership.
INVESTMENT IN SAUL HOLDINGS LIMITED PARTNERSHIP
On August 26, 1993, the Real Estate Trust consummated a series of transactions
(together with related transactions, the "Formation Transactions") in which it
transferred its 22 shopping center properties and one of its office properties
(the "Transferred Properties"), together with the debt associated with such
properties, to a newly organized limited partnership, Saul Holdings Limited
Partnership ("Saul Holdings Partnership"), and one of two newly organized
subsidiary limited partnerships of Saul Holdings Partnership (the "Subsidiary
Partnerships" and, collectively with Saul Holdings Partnership, the
"Partnerships"). In exchange for the Transferred Properties, the Real Estate
Trust received securities representing a 21.5% limited partnership interest in
Saul Holdings Partnership. Entities under common control with the Trust (the
"Trust Affiliates") received limited partnership interests collectively
representing a 5.5% partnership interest in Saul Holdings Partnership in
exchange for the transfer of property management functions (the "Management
Functions") and certain other properties to the Partnerships. Saul Centers, Inc.
("Saul Centers"), a newly organized, publicly held real estate investment trust,
received a 73.0% general partnership interest in Saul Holdings Partnership in
exchange for the contribution of approximately $220.7 million to Saul Holdings
Partnership. The Trust Affiliates received certain cash distributions from Saul
Holdings Partnership and purchased 4.0% of the common stock of Saul Centers in a
private offering consummated concurrently with the initial public offering of
such common stock. B. Francis Saul II, the Chairman of the Board of Trustees and
Chief Executive Officer of the Trust, also serves as Chairman of the Board of
Directors and Chief Executive Officer of Saul Centers.
The Real Estate Trust and the Trust Affiliates own rights (the "Rights")
enabling them to convert their limited partnership interests in Saul Holdings
Partnership into shares of Saul Centers common stock on the basis of one share
of Saul Centers common stock for each partnership unit provided that they do not
own rights to the extent that they collectively would be treated as owning,
directly or indirectly, more than 24.9% of the value of the outstanding equity
securities of Saul Centers. The shares of Saul Centers common stock are listed
on the New York Stock Exchange (trading symbol "BFS").
<PAGE>
In July 1994, Saul Centers established Saul QRS, Inc. and SC Finance
Corporation, as wholly owned subsidiaries of Saul Centers. Saul QRS, Inc. was
established to succeed to the interest of Saul Centers as the sole general
partner of one of the Subsidiary Partnerships, Saul Subsidiary I Limited
Partnership, and SC Finance Corporation was established for the purpose of
issuing $128 million of collateralized floating rate mortgage notes (the
"Mortgage Notes"). In connection with these transactions, Saul Holdings
Partnership transferred ten shopping centers previously owned by it to Saul
Subsidiary I Limited Partnership as a capital contribution and the second
Subsidiary Partnership, Saul Subsidiary II Limited Partnership, transferred one
shopping center previously owned by it to Saul Subsidiary I Limited Partnership
as a capital contribution in return for a limited partnership interest in Saul
Subsidiary I Limited Partnership. As a consequence of these transfers, Saul
Subsidiary I Limited Partnership owned a total of 17 shopping centers (the
"Mortgaged Properties"). The Mortgaged Properties, which continued to be managed
by Saul Holdings Partnership, secured the mortgage purchased with the proceeds
of issuance of the Mortgage Notes.
On October 1, 1997 Saul Centers closed a $147 million mortgage loan secured on
nine of the company's retail properties. The loan term is 15 years and requires
payments based on a fixed rate of 7.67% and 25 year principal amortization. At
the same time Saul Centers closed a new three-year $60 million unsecured
revolving credit line which replaced a secured credit line. Proceeds from the
new loans were used to repay the $128 million of collateralized floating rate
debt mentioned above and the outstanding balance of other floating rate debt.
Saul Centers currently has fixed interest rates on approximately 95% of its
total outstanding debt which has a weighted remaining term of approximately 14
years.
As a consequence of the Formation Transactions and the later transactions
described above undertaken in connection with financings, Saul Centers serves as
the sole general partner of Saul Subsidiary II Limited Partnership, and Saul
QRS, Inc. serves as the sole general partner of Saul Subsidiary I Limited
Partnership. Each such general partner holds a 1% general partnership interest
in the applicable Subsidiary Partnership. The remaining 99% interests in Saul
Subsidiary I Limited Partnership and Saul Subsidiary II Limited Partnership are
held by Saul Holdings Partnership as the sole limited partner.
At September 30, 1997, Saul Holdings Partnership owned, directly or indirectly
through the Subsidiary Partnerships, 30 community and neighborhood shopping
centers (including the 22 shopping centers transferred by the Real Estate Trust)
located in seven states and the District of Columbia, one office property and
one office/retail property located in the District of Columbia and one research
park located in a Maryland suburb of Washington, D.C.(collectively, the
"Portfolio Properties).
Saul Centers. Saul Centers made an election to be treated as a real estate
investment trust ("REIT") for federal income tax purposes under Sections 856
through 860 of the Internal Revenue Code commencing with the year ended December
31, 1993. Under the Internal Revenue Code, REITs are subject to numerous
organizational and operational requirements. If Saul Centers continues to
qualify, it generally will not be subject to federal income tax, provided it
makes certain distributions to its stockholders and meets certain organizational
and other requirements. Saul Centers has announced that it intends to make
regular quarterly dividend distributions to its stockholders.
<PAGE>
Management of the Properties. The Partnerships manage the Portfolio Properties
and any subsequently acquired properties through the Management Functions, which
include personnel and such functions as property management, leasing, design,
renovation, development and accounting. The Management Functions provide the
Partnerships with a fully integrated property management capability through
approximately 150 professionals and staff personnel and with an extensive and
mature network of relationships with tenants and potential tenants as well as
with members of the brokerage and property owners' communities.
Saul Centers shares with the Trust Affiliates certain ancillary functions at
cost, such as computer and payroll services, benefit administration and in-house
legal services, and shares insurance expense on a pro rata basis. The Trust
Affiliates sublease office space to Saul Centers at their cost. The terms of all
sharing arrangements, including payments related thereto, are reviewed
periodically by the independent directors of Saul Centers, who constitute five
of the nine members of the board of directors.
Exclusivity Agreement and Right of First Refusal. The Real Estate Trust has
entered into an Exclusivity Agreement (the "Exclusivity Agreement") with, and
has granted a right of first refusal (the "Right of First Refusal") to, Saul
Centers and the Partnerships (collectively, the "Company"). The purpose of these
agreements is to minimize potential conflicts of interest between the Real
Estate Trust and the Company. The Exclusivity Agreement and Right of First
Refusal generally require the Real Estate Trust to conduct its shopping center
business exclusively through the Company and to grant the Company a right of
first refusal to purchase commercial properties and development sites that
become available to the Real Estate Trust in the District of Columbia or
adjacent suburban Maryland. Subject to the Exclusivity Agreement and Right of
First Refusal, the Real Estate Trust will continue to develop, acquire, own and
manage commercial properties and own land suitable for development as, among
other things, shopping centers and other commercial properties.
Allocations and Distributions of Saul Holdings Partnership. The net income or
net loss of Saul Holdings Partnership for tax purposes generally will be
allocated to Saul Centers and the limited partners in accordance with their
percentage interests, subject to compliance with the applicable provisions of
the Internal Revenue Code and the regulations promulgated thereunder. Net cash
flow after reserves of Saul Holdings Partnership and after reimbursement of
specified expenses will be distributed quarterly to the partners in proportion
to their respective partnership interests.
Reimbursement Agreement. Pursuant to a reimbursement agreement among the
partners of the Partnerships, the Real Estate Trust and two of its subsidiaries
that are partners in the Partnerships have agreed to reimburse Saul Centers and
the other partners in the event the Partnerships fail to make payments with
respect to certain portions of the Partnerships' debt obligations and Saul
Centers or any such other partners personally make payments with respect to such
debt obligations. The maximum potential obligations of the Real Estate Trust and
its subsidiaries under this agreement total $115.5 million. See Note 2 to the
Consolidated Financial Statements in this report. The Real Estate Trust believes
that the Partnerships will be able to make all payments due with respect to
their debt obligations.
<PAGE>
Tax Conflicts. The fair market value of each of the properties contributed to
the Partnerships by the Real Estate Trust and its subsidiaries at the date of
the Formation Transactions (the "FMV" of each such property) exceeded the tax
basis of such property (with respect to each property, such excess is referred
to as the "FMV-Tax Difference"). In the event Saul Centers or Saul QRS, Inc.,
acting as general partner of a Partnership, causes such Partnership to dispose
of, or there is an involuntary disposition of, one or more of such properties, a
disproportionately large share of the total gain for federal income tax purposes
would be allocated to the Real Estate Trust or its subsidiaries as a result of
the property disposition. In general, if the gain recognized by the Partnership
on such a property disposition is less than or equal to the FMV-Tax Difference
for such property (as previously reduced by the amounts of special tax
allocations of depreciation deductions to the partners), all such gain will be
allocated to the Real Estate Trust or its subsidiaries. To the extent the gain
recognized by the Partnerships on the property disposition exceeds the FMV-Tax
Difference (as adjusted), such excess generally will be allocated among all
partners in Saul Holdings based on their relative percentage interests. In
general, the amount of federal income tax liability in respect of gain allocated
to the Real Estate Trust or its subsidiaries in the event of such a property
disposition is likely to exceed, perhaps substantially, the amount of cash, if
any, distributable to the Real Estate Trust or its subsidiaries as a result of
the property disposition. In addition, future reductions in the level of the
Partnerships' debt, any release of the guarantees of such debt by the Real
Estate Trust or its subsidiaries (described above under "Reimbursement
Agreement") or any refinancings in which the Real Estate Trust or its
subsidiaries do not assume a comparable obligation to that contained in the
Reimbursement Agreement could cause the Real Estate Trust or its subsidiaries to
have taxable constructive distributions without the receipt of any corresponding
amounts of cash. See Note 2 to the Consolidated Financial Statements in this
report.
Registration Rights. Saul Centers has granted the Real Estate Trust and the
Trust Affiliates certain "demand" and "piggyback" registration rights
(collectively, the "Registration Rights") with respect to the shares of Saul
Centers common stock acquired in connection with the Formation Transactions or
as a consequence of exercise of the Rights (the "Registration Shares"). Subject
to certain limitations, the Registration Rights grant the holders of
Registration Shares the opportunity to cause Saul Centers to register all or any
portion of their respective Registration Shares once in each calendar year and
to have such Shares registered incidentally to any registration, by Saul
Centers, of shares of common stock or other securities substantially similar to
common stock. Except with respect to the Registration Rights incident to a
pledge of Registration Shares or Saul Holdings Partnership interests, the demand
Registration Rights may be exercised only prior to such time, if any, as the
holder is permitted to sell the Registration Shares pursuant to Rule 144 (k)
under the Securities Act of 1933. Saul Centers will bear expenses incident to
its registration obligations upon exercise of the Registration Rights, except
that it will not bear any underwriting discounts or commissions, Securities and
Exchange Commission or state Blue Sky registration fees, or transfer taxes
relating to registration of Registration Shares.
<PAGE>
COMPETITION
As an owner of, or investor in, commercial real estate properties, the Real
Estate Trust is subject to competition from a variety of other owners of similar
properties in connection with their sale, lease or other disposition and use.
Management believes that success in such competition is dependent upon the
geographic location of the property, the performance of property managers, the
amount of new construction in the area and the maintenance and appearance of the
property. Additional competitive factors with respect to commercial and
industrial properties are the ease of access to the property, the adequacy of
related facilities such as parking, and the ability to provide rent concessions
and additional tenant improvements without increasing rent. Management believes
that general economic circumstances and trends and new properties in the
vicinity of each of the Real Estate Trust's properties also will be competitive
factors.
ENVIRONMENTAL MATTERS
The Real Estate Trust's properties are subject to various laws and regulations
relating to environmental and pollution controls. The Real Estate Trust requires
an environmental study to be performed with respect to a property that may be
subject to possible environmental hazards prior to its acquisition to ascertain
that there are no material environmental hazards associated with such property.
Although the effect upon the Real Estate Trust of the application of
environmental and pollution laws and regulations cannot be predicted with
certainty, management believes that their application either prospectively or
retrospectively will not have a material adverse effect on the Real Estate
Trust's property operations.
RELATIONSHIPS WITH THE B. F. SAUL COMPANY
The Real Estate Trust has significant relationships with B. F. Saul Company (the
"Saul Company") and two of the Saul Company's wholly owned subsidiaries, B. F.
Saul Advisory Company (the "Advisor") and Franklin Property Company
("Franklin"). The Saul Company, founded in 1892, specializes in real estate
investment services, including acquisitions, financing, management and leasing,
and insurance. B. Francis Saul II, Chairman of the Board of Trustees and Chief
Executive Officer of the Trust, is Chairman of thr Board and President of the
Saul Company and the Advisor.
The Advisor acts as the Real Estate Trust's investment advisor and manages the
day-to-day financial, accounting, legal and administrative affairs of the Real
Estate Trust. Franklin acts as leasing and management agent for most of the
income-producing properties owned by the Real Estate Trust, and plans and
oversees the development of new properties and the expansion and renovation of
existing properties.
The Trustees, including the two independent Trustees, review the fees and
compensation arrangements between the Real Estate Trust and the Saul Company and
its related entities and affiliates and believe that such fees and compensation
arrangements are as favorable to the Real Estate Trust as would be obtainable
from unaffiliated sources. See "Certain Relationships and Related Transactions."
<PAGE>
HOLDING COMPANY REGULATION
The Trust and the Saul Company, by virtue of their direct and indirect control
of the Bank, and Chevy Chase Property Company ("CCPC") and CCPC's wholly-owned
subsidiary, Westminster Investing Corporation ("Westminster"), by virture of
Westminster's direct and indirect ownership of 24.9% of the common stock of the
Trust (collectively the "Holding Companies"), are "savings and loan holding
companies" subject to regulation, examination and supervision by the OTS. The
Bank is prohibited from making or guaranteeing loans or advances to or for the
benefit of the Holding Companies or other affiliates engaged in activities
beyond those permissible for bank holding companies and from investing in the
securities of the Holding Companies or other affiliates. Further, transactions
between the Bank and the Holding Companies must be on terms substantially the
same, or at least as favorable to the Bank , as those that would be available to
non-affiliates.
The Holding Companies must obtain the prior approval of the OTS before acquiring
by merger, consolidation or purchase of assets any federally insured savings
institution or any savings and loan holding company. As unitary savings and loan
holding companies, the Holding Companies are virtually unrestricted in the types
of business activities in which they may engage, provided the Bank continues to
meet the qualified thrift lender test. See "Banking - Regulation - Qualified
Thrift Lender ("QTL") Test." If the Holding Companies were to acquire one or
more federally insured institutions and operate them as separate subsidiaries
rather than merging them into the Bank, the Holding Companies would become
"multiple" savings and loan holding companies. As multiple savings and loan
holding companies, the Holding Companies would be subject to limitations on the
types of business activities in which they would be permitted to engage, unless
the additional thrifts were troubled institutions acquired pursuant to certain
emergency acquisition provisions and all subsidiary thrifts met the QTL test.
The Holding Companies may acquire and operate additional savings institution
subsidiaries outside of Maryland and Virginia only if the laws of the target
institution's state specifically permit such acquisitions or if the acquisitions
are made pursuant to emergency acquisition provisions.
The Trust and the Saul Company entered into an agreement with OTS's predecessor,
the Federal Savings and Loan Insurance Corporation, to maintain the Bank's
regulatory capital at the required levels, and, if necessary, to infuse
additional capital to enable the Bank to meet those requirements. Since the
execution of this agreement, the OTS has changed its policy and now accepts more
limited agreements from those acquiring thrift institutions. In addition, the
regulatory capital requirements applicable to the Bank have changed
significantly as a result of FIRREA. The OTS has stated that capital maintenance
agreements entered into prior to such modification of OTS policy and the
enactment of FIRREA were not affected by such changes. The Trust and the Saul
Company have not sought to modify the existing agreement. To the extent the Bank
is unable to meet regulatory capital requirements in the future, the OTS could
seek to enforce the obligations of the Trust and the Saul Company under the
agreement. The Bank's business plan does not contemplate any future capital
contributions from the Trust or the Saul Company.
<PAGE>
If the Bank were to become "undercapitalized" under the prompt corrective action
regulations, it would be required to file a capital restoration plan with the
OTS setting forth, among other things, the steps the Bank would take to become
"adequately capitalized." The OTS could not accept the plan unless the Holding
Companies guaranteed in writing the Bank's compliance with that plan. The
aggregate liability of the Holding Companies under such a commitment would be
limited to the lesser of (i) an amount equal to 5.0% of the Bank's total assets
at the time the Bank became "undercapitalized" and (ii) the amount necessary to
bring the Bank into compliance with all applicable capital standards as of the
time the Bank fails to comply with its capital plan. If the holding companies
refused to provide the guarantee, the Bank would be subject to the more
restrictive supervisory actions applicable to "significantly undercapitalized"
institutions.
FEDERAL TAXATION
The Trust terminated its status as a real estate investment trust for federal
income tax purposes in 1978 and is now taxable as a corporation. The Trust's
real estate operations have generated sizable depreciation, interest and other
deductions in excess of its total income and, as a result, the Trust has had
substantial net operating loss carryovers for federal income tax purposes
("NOLs"). The Trust and its subsidiaries join in the filing of a consolidated
federal income tax return using the accrual method of accounting on the basis of
a fiscal year ending September 30.
Since June 28, 1990 the Bank and its subsidiaries have joined in the
consolidated federal income tax returns filed by the Trust on a fiscal year
basis. Prior to June 28, 1990, the Bank and its subsidiaries filed a
consolidated federal income tax return on a calendar-year basis.
Savings institutions such as the Bank generally are taxed in the same manner as
other corporations. There are, however, several special rules that apply
principally to savings institutions (and, in some cases, other financial
institutions). Certain significant aspects of the federal income taxation of the
Bank are discussed below.
The Internal Revenue Service ("IRS") has concluded the audits of the federal
income tax returns of the Trust for the taxable years ended September 30, 1992
and September 30, 1993. The IRS audit adjustments did not have a significant
adverse effect on the Trust's reported earnings under Gaap.
Bad Debt Reserve. Savings institutions that satisfy certain requirements
(so-called "qualifying institutions" as defined by the Internal Revenue Code)
are permitted to establish reserves for bad debts and to deduct each year
reasonable additions to those reserves in lieu of taking a deduction for bad
debts actually sustained during the taxable year. To qualify for this treatment,
at least 60% of a savings institution's assets must be "qualifying assets,"
including cash, certain U.S. and state government securities, obligations of
certain deposit insurance corporations, loans secured by interests in
residential real property and loans made for the improvement of residential real
property.
<PAGE>
The Bank has calculated the bad debt deduction for tax purposes under the
experience method since calendar year 1988. The experience method is based on
the institution's actual loan loss experience over a prescribed period. If the
Bank were not treated as a qualifying institution for any taxable year, it would
be required to recapture its bad debt reserve (for 1997, approximately $111.8
million) into taxable income. In addition, the Bank would be allowed to deduct
only those bad debts that actually were sustained during the taxable year. If
the Bank were no longer permitted to use the reserve method, the change would
not have a significant adverse effect on the Bank's reported earnings under
generally accepted accounting principles.
Provisions that repealed the thrift bad debt provisions of the Internal Revenue
Code were included in the Small Business Act of 1996 and are effective for tax
years beginning after December 31, 1995. As a result, the Bank is no longer able
to use the "reserve method" for computing its bad debt deduction and is allowed
to deduct only those bad debts actually incurred during the taxable year. The
bad debt provisions of this legislation also require thrifts to recapture and
pay tax on bad debt reserves accumulated since 1987 over a six year period,
beginning with a thrift's taxable year starting after December 31, 1995 (or, if
the thrift meets a loan origination test, beginning up to two years later). Bad
debt reserves accumulated prior to 1988 do not have to be recaptured under this
legislation. The tax liability related to the recapture of the bad debt reserves
accumulated since 1987 has been reflected in the Bank's financial statements as
of September 30, 1997.
Consolidated Tax Returns; Tax Sharing Payments. In recent years, the operations
of the Trust have generated significant NOL's. The Bank's taxable income in the
current year was sufficient to fully utilize all NOL carryforwards and the
current year tax loss of the Trust. Under the terms of a tax sharing agreement
dated June 28, 1990 (the "Tax Sharing Agreement"), Chevy Chase is obligated to
make payments to the Trust based on its taxable income, as explained more fully
below. Under the terms of the Bank's board resolution, the Bank is permitted to
make tax sharing payments to the Trust of up to $15.0 million relating to any
fiscal year without OTS approval.
The Tax Sharing Agreement generally provides that each member of the Trust's
affiliated group is required to pay the Trust an amount equal to 100% of the tax
liability that the member would have been required to pay to the IRS if the
member had filed on a separate return basis. These amounts generally must be
paid even if the affiliated group has no tax liability or the group's tax
liability is less than the sum of such amounts. Under the Tax Sharing Agreement,
the Trust, in turn, is obligated to pay to the applicable tax authorities the
overall tax liability, if any, of the group. In addition, to the extent the net
operating losses or tax credits of a particular member reduce the overall tax
liability of the group, the Trust is required to reimburse such member on a
dollar-for-dollar basis, thereby compensating the member for the group's use of
its net operating losses or tax credits.
<PAGE>
The Bank made a tax sharing payment of $20.6 million in fiscal 1990, tax sharing
payments totaling $29.6 million in fiscal 1991 and a tax sharing payment of $5.0
million in fiscal 1993. OTS approval of the $5.0 million payment made in 1993
was conditioned on a pledge by the Trust of certain Trust assets to secure
certain of its obligations under the Tax Sharing Agreement. Following execution
of such a pledge, the OTS approved, and the Bank made during fiscal 1994, 1995,
1996, and 1997 additional tax sharing payments of $9.6, $20.5, $25.0, and
$9.8 million, respectively, to the Trust. At September 30, 1997, no tax sharing
payments were due from the Bank to the Trust. It is expected that the Bank will
have taxable income in future years and additional operating losses will be
utilized to reduce the overall tax liability of the group which would otherwise
arise from such taxable income of the Bank (or from the taxable income of other
members of the Trust's affiliated group).
In general, if the Bank has net operating losses or unused tax credits in any
taxable year, under the Tax Sharing Agreement the Trust is obligated to
reimburse the Bank in an amount generally equal to (i) the tax benefit to the
group of using such tax losses or unused tax credits in the group's consolidated
federal income tax return for such year, plus (ii) to the extent such losses or
credits are not used by the group in such year, the amount of the tax refunds
which the Bank would otherwise have been able to claim if it were not being
included in the consolidated federal income tax return of the group (but not in
excess of the net amount paid by the Bank to the Trust pursuant to the Tax
Sharing Agreement). There is no assurance that the Trust would be able to
fulfill this obligation. If the Trust did not make the reimbursement, the OTS
could attempt to characterize such nonpayment as an unsecured extension of
credit by the Bank to the Trust which, as described above under "Regulation
Holding Company Regulation," is prohibited under current law. The Tax Sharing
Agreement itself does not provide for any remedies upon a breach by any party of
its obligations under the Agreement. As noted above, at September 30, 1997, no
tax sharing payments were due from the Bank to the Trust.
STATE TAXATION
Maryland law does not allow the filing of consolidated income tax returns, and
thus the Trust and its subsidiaries, which includes the Bank, subject to
Maryland income tax are required to file separately in Maryland. The Trust and
its subsidiaries are also subject to income taxes in other states, some of which
allow or require combined or consolidated filing. The Commonwealth of Virginia
is currently conducting audits of the consolidated state income tax returns of
the Trust for the taxable years ended September 30, 1991, September 30, 1992 and
September 30, 1993.
<PAGE>
BANKING
REGULATION
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan
Bank (the "FHLB") of Atlanta. The 12 FHLBs are administered by the Federal
Housing Finance Board, an independent agency within the executive branch of the
federal government. The FHLBs serve as a central credit facility for their
members. Their primary credit mission is to enhance the availability of
residential mortgages. From time to time, the Bank obtains advances from the
FHLB. At September 30, 1997, the Bank had outstanding $188.5 million of advances
from the FHLB of Atlanta. See Note 19 to the Consolidated Financial Statements
in this report and "Deposits and Other Sources of Funds - Borrowings."
As a member of the FHLB of Atlanta, the Bank is required to acquire and hold
shares of capital stock in that bank in an amount equal to the greater of: (i)
1.0% of mortgage-related assets (i.e., home mortgage loans, home-purchase
contracts and similar obligations); (ii) 0.3% of total assets; (iii) $500; or
(iv) 5.0% of outstanding advances. Pursuant to this requirement, the Bank had an
investment of $33.2 million in FHLB stock at September 30, 1997. The Bank earned
dividends of $2.0 million and $2.3 million during the years ended September 30,
1997 and 1996, respectively.
Liquidity Requirements. The Bank is required to maintain a daily average balance
of liquid assets (including cash, federal funds, certain time deposits, certain
bankers' acceptances, certain corporate debt securities and commercial paper,
securities of certain mutual funds and specified U.S. Government, state
government and federal agency obligations) equal to a specified percentage of
its average daily balance of deposits (based upon the preceding month's average
balances), plus borrowings (or portions thereof) payable in one year or less.
Prior to November 24, 1997, this liquidity requirement was 5.0%. Federal
regulations also required that each institution maintain an average daily
balance of short-term liquid assets equal to at least 1.0% of its average daily
balance of deposits, plus borrowings payable in one year or less. If an
institution's liquid assets or short-term liquid assets at any time do not at
least equal (on an average daily basis for the month) the amount required by the
OTS, the institution could be subject to various monetary penalties imposed by
the OTS. At September 30, 1997, the Bank was in compliance with both
requirements, with both a liquid assets ratio and a short-term liquid assets
ratio of 11.1%.
Effective November 24, 1997, the OTS reduced the liquidity requirement from 5%
to 4% and eliminated the 1% short-term liquid asset requirement. In addition,
the OTS added flexibility in calculating the liquidity base, permitting an
institution to use either: (i) its liquidity base at the end of the preceding
quarter or (ii) the average daily balance of its liquidity base during the
preceding quarter. Finally, the OTS expanded the assets that qualify as liquid
assets to include long-term obligations of the United States government and
federal agencies, certain mortgage-related securities, and certain mortgage
loans.
Deposit Insurance Premiums. Under FDIC insurance regulations, the Bank is
required to pay premiums to the Savings Association Insurance Fund (the "SAIF")
for insurance of its accounts. The FDIC utilizes a risk-based premium system in
which an institution pays premiums for deposit insurance on its SAIF-insured
deposits based on supervisory evaluations and on the institution's capital
category under the OTS's prompt corrective action regulations. See "Prompt
Corrective Action."
<PAGE>
Although the FDIC insures commercial banks as well as thrifts, the insurance
reserve funds for commercial banks and thrifts have been segregated into the
Bank Insurance Fund (the "BIF") and the SAIF, respectively. The FDIC is required
to maintain the reserve levels of both the BIF and the SAIF at 1.25% of insured
deposits, which the BIF reached during fiscal 1995. Legislation was enacted on
September 30, 1996 that, among other things, imposed on thrift institutions a
one-time assessment of 65.7 cents for every $100 of SAIF-insured deposits to
recapitalize the SAIF to the 1.25% level. Pursuant to this legislation,
effective January 1, 1997, the FDIC lowered the risk-based schedule for SAIF
assessment rates so that the rates for SAIF members are identical to the rates
for BIF members. Beginning in 1997, commercial banks are required to share in
the payment of interest due on Financing Corporation ("FICO") bonds used to
provide liquidity to the savings and loan industry in the 1980s. Annualized FICO
assessments which were added to deposit insurance premiums equaled 6.49 basis
points for SAIF members and 1.298 basis points for BIF members for the first
semi-annual period of 1997 and 6.31 basis points for SAIF members and 1.262
basis points for BIF members for the second semi-annual period of 1997. This
differential is expected to remain in effect through December 31, 1999, after
which BIF and SAIF members will pay identical FICO assessments, which are
expected to be approximately 2.4 basis points. Thus, the Bank and other
institutions with SAIF-assessable deposits will continue to pay somewhat higher
deposit insurance premiums than institutions with BIF-assessable deposits, which
could lead to a competitive disadvantage in the pricing of loans and deposits.
SAIF insurance may be terminated by the FDIC, after notice and a 30-day
corrective period, upon a finding by the FDIC that the institution has engaged
in unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC. The 30-day period may be eliminated by the FDIC
with the approval of the OTS.
Regulatory Capital. Under OTS regulations implementing the capital requirements
imposed by FIRREA, savings institutions, such as the Bank, are subject to a
minimum tangible capital requirement, a minimum core (or leverage) capital
requirement, and a minimum total risk-based capital requirement. Each of these
requirements generally must be no less stringent than the capital standards for
national banks. At September 30, 1997, the Bank's tangible, core and total
risk-based regulatory capital ratios were 6.96%, 6.96% and 13.50%, respectively,
compared to the minimum requirements under FIRREA of 1.50%, 3.00% and 8.00%,
respectively, in effect at that date.
<PAGE>
Under FIRREA's minimum leverage ratio, Chevy Chase must maintain a ratio of
"core capital" to tangible assets of not less than 3.0%. However, under the OTS
"prompt corrective action" regulations, an institution that is not in the
highest supervisory category must maintain a minimum leverage ratio of 4.0% to
be considered an "adequately capitalized" institution. See "Prompt Corrective
Action." In October 1997, the OTS proposed amendments to its capital regulations
that would establish a minimum leverage ratio of 4.0% for institutions not in
the highest supervisory category. "Core capital" generally includes common
shareholders' equity, noncumulative perpetual preferred stock and minority
interests in consolidated subsidiaries, less investments in certain subsidiaries
and certain intangible assets, except that under interim guidance issued by the
OTS, servicing assets (both mortgage and non-mortgage) and purchased credit card
relationships ("PCCRs") may be included up to an aggregate amount of 50% of core
capital. PCCRs and non-mortgage servicing assets are also subject to a sublimit
of 25% of core capital. For these purposes, servicing assets and PCCRs are
valued at the lesser of 90% of fair market value or 100% of the current
unamortized book value. At September 30, 1997, the Bank had qualifying servicing
assets of $41.4 million, which constituted 9.8% of core capital at that date,
and had no PCCRs.
In August 1997, the OTS and the other federal bank regulatory agencies proposed
amendments to their regulatory capital requirements relating to servicing
assets. Under the proposal, the limitation on the amount of mortgage servicing
assets that can be included in Tier 1 capital would be increased from 50% to
100%. However, all non-mortgage servicing assets would be fully deducted from
core capital. The agencies also requested comment on whether to require
deduction from regulatory capital of amounts representing rights to future
interest income from serviced assets in excess of contractually specified
servicing fees ("interest-only strips") and whether the deduction for servicing
assets should be net of any associated deferred tax liability. The Bank is
unable to predict at this time whether and in what form any amendments will be
adopted. As of September 30, 1997, the Bank had $0.6 million in non-mortgage
servicing assets and $68.8 million in interest-only strips, net of any
associated deferred tax liability that, if the OTS ultimately requires deduction
of all non-mortgage servicing assets and interest-only strips and no
grandfathering is provided for existing transactions, would be required to be
deducted from core capital.
Deductions from capital apply for investments in, and loans to, subsidiaries
engaged in activities not permissible for national banks, for equity investments
that are not permissible for national banks and for the portion of land loans
and non-residential construction loans in excess of an 80% loan-to-value ratio.
The tangible capital requirement adopted by the OTS requires a savings
institution to maintain "tangible capital" in an amount not less than 1.5% of
tangible assets, which is the minimum ratio required by FIRREA. "Tangible
capital" is defined as core capital less investments in certain subsidiaries and
any intangible assets (including supervisory goodwill), plus qualifying
servicing assets valued at the amount includable in core capital.
The risk-based capital requirements issued by the OTS provide that the capital
ratio applicable to an asset is adjusted to reflect the degree of credit risk
associated with that asset and that the asset base for computing a savings
institution's capital requirement includes off-balance-sheet assets. Capital
must be maintained against assets sold with recourse despite the fact that the
assets are accounted for as having been sold. However, the amount of capital
required need not exceed the amount of recourse retained. The amount of recourse
retained in connection with the Bank's securitization activities typically
includes the full amount of any spread account or other asset posted as
collateral and interest-only strips recorded by the Bank.
<PAGE>
On November 5, 1997, the OTS and the other federal bank regulatory agencies
proposed revisions to their risk-based capital regulations to address the
regulatory capital treatment of recourse obligations and direct credit
substitutes involving exposure to credit risk. The proposal (i) would define
recourse to include, among other things, providing credit enhancement beyond any
contractual obligation to support assets sold and providing representations and
warranties other than those that relate to an existing state of facts that the
seller can either control or verify with reasonable due diligence at the time
the assets are sold; (ii) would treat direct credit substitutes and recourse
obligations consistently; and (iii) would use credit ratings and possibly
certain other alternative approaches to match the risk-based capital assessment
more closely to an institution's relative risk of loss in asset securitizations.
The agencies intend that any final rules adopted in connection with the proposal
that result in increased risk-based capital requirements for an institution will
apply only to transactions consummated after the effective date of any final
rules.
There are currently four categories of risk-weightings: 0% for cash and similar
assets, 20% for qualifying mortgage-backed securities, 50% for qualifying
residential permanent real estate loans and 100% for other assets, including
credit card loans, commercial real estate loans and loans more than 90 days past
due and for real estate acquired in settlement of loans. Savings institutions
generally are required to maintain risk-based capital equal to 8.0% of
risk-weighted assets, with at least half of that amount in the form of core
capital.
A savings institution's supplementary capital may be used to satisfy the
risk-based capital requirement only to the extent of the institution's core
capital. Supplementary capital includes cumulative perpetual preferred stock,
qualifying non-perpetual preferred stock, qualifying subordinated debt,
nonwithdrawable accounts and pledged deposits, and allowances for loan and lease
losses (up to a maximum of 1.25% of risk-weighted assets). At September 30,
1997, the Bank had $93.0 million in allowances for loan and lease losses, of
which $73.0 million was includable as supplementary capital.
Subordinated debt may be included in supplementary capital with OTS approval
subject to a phase-out based on its remaining term to maturity. The phase-out
established for such maturing capital instruments by the OTS permits an
institution to include such instruments in supplementary capital under one of
two phase-out options: (i) at the beginning of each of the last five years prior
to the maturity date of the instrument, the institution may reduce the amount
eligible to be included by 20% of the original amount or (ii) the institution
may include only the aggregate amount of maturing capital instruments that
mature in any one year during the seven years immediately prior to an
instrument's maturity that does not exceed 20% of the institution's capital.
Once an institution selects either the first or second option, it must continue
to select the same option for all subsequent issuances of maturing capital
instruments as long as there is any outstanding balance of such instruments for
which an option has been selected. At September 30, 1997, the Bank had $250.0
million in maturing subordinated capital instruments, all of which was
includable as supplementary capital. Of that amount, $150.0 million matures in
2005 and $100.0 million matures in 2008. See "Deposits and Other Sources of
Funds - Borrowings."
<PAGE>
The OTS has indefinitely delayed implementation of an interest-rate risk
component of its risk-based capital regulation pending the testing of an OTS
appeals process. Under that component, an institution that would experience a
change in "portfolio equity" in an amount in excess of 2.0% of the institution's
assets as a result of a 200 basis point increase or decrease in the general
level of interest rates would be required to maintain additional amounts of
risk-based capital based on the lowest interest rate exposure at the end of the
three previous quarters. At September 30, 1997, the Bank would not have been
required to maintain additional amounts of risk-based capital had the
interest-rate risk component of the capital regulations been in effect.
The OTS also considers concentration of credit risk and risks arising from
non-traditional activities, as well as a thrift's ability to manage these risks,
in evaluating whether the thrift should be subject to an individual minimum
capital requirement.
OTS regulations contain special rules affecting savings institutions with
certain kinds of subsidiaries. For purposes of determining compliance with each
of the capital standards, a savings institution's investments in, and extensions
of credit to, subsidiaries engaged in activities not permissible for a national
bank ("non-includable subsidiaries") are, with certain exceptions, deducted from
the savings institution's capital. At September 30, 1997, investments in
non-includable subsidiaries were fully deducted from all three FIRREA capital
requirements. All or a portion of the assets of each of a savings institution's
subsidiaries are generally consolidated with the assets of the savings
institution for regulatory capital purposes unless all of the savings
institution's investments in, and extensions of credit to, such subsidiary are
deducted from capital. Chevy Chase's real estate development subsidiaries are
its only subsidiaries engaged in activities not permissible for a national bank.
At September 30, 1997, the Bank's investments in, and extensions of credit to,
its non-includable subsidiaries totaled approximately $4.0 million, of which
$3.8 million constituted a deduction from tangible capital.
OTS capital regulations also require the 100% deduction from total capital of
all equity investments that are not permissible for national banks and the
portion of land loans and non-residential construction loans in excess of an 80%
loan-to-value ratio. The Bank's equity investments at September 30, 1997 were
certain properties classified as real estate held for sale which the Bank has
agreed to treat as equity investments for regulatory capital purposes. At
September 30, 1997, the book value of these properties after subsequent
valuation allowances, was $15.3 million, of which $14.5 million was required to
be deducted from total capital. The Bank had no land loans or non-residential
construction loans with loan-to-value ratios greater than 80% at September 30,
1997. The Bank has $1.0 million of general valuation allowances maintained
against its non-includable subsidiaries and equity investments which, pursuant
to OTS guidelines, are available as a "credit" against the deductions from
capital otherwise required.
<PAGE>
OTS capital regulations provide a five-year holding period (or such longer
period as may be approved by the OTS) for real estate acquired in settlement of
loans ("REO" or "real estate held for sale") to qualify for an exception from
treatment as an equity investment. If an REO property is considered an equity
investment, its then-current book value is deducted from total risk-based
capital. Accordingly, if the Bank is unable to dispose of any REO property
(through bulk sales or otherwise) prior to the end of its applicable five-year
holding period and is unable to obtain an extension of such five-year holding
period from the OTS, the Bank could be required to deduct the then-current book
value of such REO property from risk-based capital. In November 1996, the Bank
received from the OTS extensions through November 12, 1997 of the holding
periods for certain of its REO properties acquired through foreclosure in fiscal
1990, 1991 and 1992. The Bank has submitted to the OTS a request for a further
extension of the holding periods through fiscal 1998 for certain of its REO
properties. Based on its capital ratios at September 30, 1997, the Bank's
capital ratios would have remained above the levels required for
well-capitalized institutions even if the book value of REO properties for which
an extension has not yet been received had been deducted from total risk-based
capital as of that date. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Capital - Board
Resolution and Regulatory Requirements."
The Bank's ability to maintain capital compliance is dependent on a number of
factors, including, for example, general economic conditions and the condition
of local real estate markets. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition - Capital -
Board Resolution and Regulatory Requirements."
The OTS has the authority to require an institution to maintain capital at
levels above the minimum levels generally required, but has not taken any such
action with respect to the Bank.
Prompt Corrective Action. Pursuant to FDICIA, the OTS and the other federal
agencies regulating financial institutions have adopted regulations which apply
to every FDIC-insured commercial bank and thrift institution a system of
mandatory and discretionary supervisory actions which generally become more
severe as the capital levels of an individual institution decline. The
regulations establish five capital categories to which institutions are assigned
for purposes of determining their treatment under these prompt corrective action
provisions. An institution is categorized as "well capitalized" under the
regulations if (i) it has a leverage ratio of at least 5.0%, a tier 1 risk-based
capital ratio of at least 6.0% and a total risk-based capital ratio of at least
10.0%, and (ii) is not subject to any written agreement, order, capital
directive or prompt corrective action directive issued by the OTS to meet and
maintain a specific capital level. An institution is considered "adequately
capitalized" if such capital ratios are at least 4.0% (3.0% if rated in the
highest supervisory category), 4.0% and 8.0%, respectively. An institution with
a leverage ratio below 4.0% (3.0% if rated in the highest supervisory category),
a tier 1 risk-based capital ratio below 4.0% or a total risk-based capital ratio
below 8.0% is considered "undercapitalized" and an institution with ratios under
3.0%, 3.0% or 6.0%, respectively, is considered "significantly
undercapitalized." Finally, an institution is considered "critically
undercapitalized," and subject to provisions mandating appointment of a
conservator or receiver, if its ratio of "tangible equity" (generally defined by
the OTS as core capital plus cumulative perpetual preferred stock) to total
assets is 2.0% or less. An institution's classification category could be
downgraded if, after notice and an opportunity for a hearing, the OTS determined
that the institution is in an unsafe or unsound condition or has received and
has not corrected a less than satisfactory examination rating for asset quality,
management, earnings or liquidity.
<PAGE>
At September 30, 1997, the Bank's leverage, tier 1 risk-based and total
risk-based regulatory capital ratios were 6.96%, 7.24% and 13.50%, respectively,
which exceeded the minimum ratios established for "well capitalized"
institutions.
Board Resolution. At the request of the OTS, the Board of Directors of the Bank
adopted a resolution in March 1996 which, among other things, permits the Bank:
(i) to make tax sharing payments without OTS approval to the Trust, which owns
80% of the Bank's Common Stock, of up to $15.0 million relating to any single
fiscal year; and (ii) to declare dividends on its stock in any quarterly period
up to the lesser of (A) 50% of its after tax net income for the immediately
preceding quarter or (B) 50% of the average quarterly after tax net income for
the immediately preceding four quarter period, minus (in either case) dividends
declared on the Bank's preferred stock during that quarterly period. The
resolution also provides that the Bank will present a plan annually to the OTS
detailing anticipated consumer loan securitization activity.
Qualified Thrift Lender ("QTL") Test. Insured savings institutions like the Bank
must meet a QTL test to avoid imposition of certain restrictions. The QTL test
requires thrifts to maintain a "thrift investment percentage" equal to a minimum
of 65%. The numerator of such percentage is the thrift's "qualified thrift
investments" and the denominator is the thrift's "portfolio assets." "Portfolio
assets" is defined as total assets minus (i) the thrift's premises and equipment
used to conduct its business, (ii) liquid assets, as defined up to 20 percent of
total assets, and (iii) intangible assets, including goodwill. The QTL test must
be met on a monthly average basis in nine out of every 12 months.
The Bank had 86.8% of its assets invested in qualified thrift investments at
September 30, 1997, and met the QTL test in each of the previous 12 months.
A thrift's "qualified thrift investments" consist of residential housing loans
(including home equity loans and manufactured housing loans), mortgage-backed
securities, FHLB and Federal National Mortgage Association stock, small business
loans, credit card and educational loans. Portions of other assets are also
includable, provided that the total of these assets does not exceed 20% of
portfolio assets. Assets in this category include consumer loans (other than
credit card and educational loans), 50% of residential housing loans originated
and sold within 90 days, investments in real estate-oriented service
corporations, 200% of mortgage loans for residences, churches, schools, nursing
homes and small businesses in areas with unmet credit needs (low or moderate
income areas where credit demand exceeds supply). Intangible assets, including
goodwill, are specifically excluded from qualified thrift investments.
<PAGE>
An institution that fails to meet the QTL test is subject to significant
penalties. Immediately after an institution ceases to meet the QTL test, it (i)
may not make any new investment or engage directly or indirectly in any other
new activity unless the investment or activity would be permissible for a
national bank, (ii) may not establish any new branch office at any location at
which a national bank could not establish a branch office, (iii) may not obtain
new advances from the applicable FHLB and (iv) may not pay dividends beyond the
amounts permissible if it were a national bank. One year following an
institution's failure to meet the test, the institution's holding company parent
must register and be subject to supervision as a bank holding company. Three
years after failure to meet the QTL test, an institution may not retain any
investments or engage in any activities that would be impermissible for a
national bank, and must repay any outstanding FHLB advances as promptly as
possible consistent with the safe and sound operation of the institution.
Failure to meet the QTL test also could limit the Bank's ability to establish
and maintain branches outside of its home state of Virginia.
Because Chevy Chase is engaged in activities that are not currently permissible
for national banks, such as investing in subsidiaries that engage in real estate
development activities, failure to satisfy the QTL test would require Chevy
Chase to terminate these activities and divest itself of any prohibited assets
held at such time. Based on a review of the Bank's current activities,
management of the Bank believes that compliance with these restrictions would
not have a significant adverse effect on the Bank. In addition, because the
Trust is engaged in real estate ownership and development, which are activities
that are currently prohibited for bank holding companies, failure by Chevy Chase
to meet the QTL test, in the absence of a significant restructuring of the
Trust's operations, would, in effect, require the Trust to reduce its ownership
of Chevy Chase to a level at which it no longer would be deemed to control the
Bank.
The Bank has taken, and will continue to take, steps to meet the QTL test by
structuring its balance sheet to include the required percentage of qualified
thrift investments.
Dividends and Other Capital Distributions. Under OTS regulations, the ability of
thrift institutions such as the Bank to make "capital distributions" (defined to
include payment of dividends, stock repurchases, cash-out mergers and other
distributions charged against the capital accounts of an institution) varies
depending primarily on the institution's earnings and regulatory capital levels.
The regulations do not apply to interest or principal payments on debt,
including interest or principal payments on the Bank's outstanding subordinated
debentures.
Institutions are divided into two tiers for purposes of these regulations. Tier
1 institutions are those in compliance with their capital requirements and which
have not been notified by the OTS that they are "in need of more than normal
supervision." Tier 1 institutions may make capital distributions without
regulatory approval in amounts up to the greater of (i) 100% of net income for
the calendar year to date, plus up to one-half of the institution's surplus
capital (i.e., the excess of capital over the fully phased-in requirements) at
the beginning of the calendar year in which the distribution is made or (ii) 75%
of net income for the most recent four quarters. Tier 1 institutions that make
capital distributions under the foregoing rules must continue to meet the
applicable capital requirements on a pro forma basis after giving effect to such
distributions. Tier 1 institutions may seek OTS approval to pay dividends beyond
these amounts.
<PAGE>
The definition of Tier 2 institutions is no longer applicable because all
deductions from capital requirements have been fully phased-in as of July 1,
1996. All institutions are classified as either Tier 1 or Tier 3 institutions
since that date.
Tier 3 institutions have capital levels below their current required minimum
levels and may not make any capital distributions without the prior written
approval of the OTS.
At September 30, 1997, the Bank had sufficient levels of capital to be a Tier 1
institution for purposes of the capital distribution regulation. However, the
OTS retains discretion under its capital distribution regulation to treat an
institution that is in need of more than normal supervision (after written
notice) as a Tier 2 or Tier 3 institution.
In December 1994, the OTS proposed to amend its capital distribution regulation
to simplify it and to conform it to the system of "prompt corrective action"
established by FDICIA. The proposal would replace the current "tiered" approach
with one that, in accordance with the OTS's "prompt corrective action" rule,
would allow associations to make only those capital distributions that would not
cause capital to drop below the level required to remain adequately capitalized.
The proposal would delete from the OTS regulations the current numerical
restrictions on the amount of permissible capital distributions, but the OTS
indicated that it would continue to use them as general guidelines. The OTS has
since indicated that it intends to issue a revised proposal that would differ
from the previous proposal.
The OTS retains general discretion to prohibit any otherwise permitted capital
distributions on general safety and soundness grounds and must be given 30 days
advance notice of all capital distributions. The OTS has approved the payment of
dividends on the Bank's outstanding 13% Noncumulative Perpetual Preferred Stock,
Series A (the "13% Preferred Stock"), provided that (i) immediately after giving
effect to the dividend payment, the Bank's core and risk-based regulatory
capital ratios would not be less than 4.0% and 8.0%, respectively; (ii)
dividends are earned and payable in accordance with the OTS capital distribution
regulation; and (iii) the Bank continues to make progress in the disposition and
reduction of its non-performing loans and real estate owned.
Although the Bank believes that dividends paid on the REIT Preferred Stock
issued by Chevy Chase Preferred Capital Corporation (the "REIT Subsidiary")
should not be considered "capital distributions" for this purpose, there can be
no assurances that the OTS would agree with this position. Without addressing
the issue of whether dividends on the REIT Preferred Stock are "capital
distributions" subject to the regulations, the OTS has indicated that it would
not object to the REIT Subsidiary's payment of quarterly dividends on the REIT
Preferred Stock in an amount up to the amount of the REIT Subsidiary's net
income for that quarter. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Capital - Board
Resolution and Regulatory Requirements." The REIT Subsidiary currently expects
that its net income will be in excess of amounts needed to pay dividends on the
REIT Preferred Stock. However, dividends paid on the REIT Preferred Stock in
excess of the REIT Subsidiary's net income could be treated as "capital
distributions" by the OTS, in which case the REIT Subsidiary's payment of such
dividends would be subject to restrictions under the OTS capital distribution
regulations. Moreover, if dividends on the REIT Preferred Stock were treated as
"capital distributions," they would be included, together with dividends paid on
the 13% Preferred Stock and the common stock of the Bank, in calculating the
amount of "capital distributions" that could be paid by the Bank without
obtaining OTS approval.
<PAGE>
In May 1988, in connection with the merger of a Virginia thrift into the Bank,
the B.F. Saul Company (the "Saul Company") and the Trust entered into a capital
maintenance agreement in which they agreed not to cause the Bank without prior
written approval of its federal regulator to pay "dividends" in any fiscal year
in excess of 50% of the Bank's net income for that fiscal year, provided that
any dividends permitted under such limitation could be deferred and paid in a
subsequent year. However, under both the current and the proposed OTS capital
distribution rule, with the approval of the OTS, the Bank could substitute the
requirements of the OTS capital distribution rule for any more stringent
requirements imposed on it by a previous written agreement.
The Bank is subject to other limitations on its ability to pay dividends. The
indenture pursuant to which $150 million principal amount of the Bank's 9 1/4%
Subordinated Debentures due 2005 was issued in 1993 (the "1993 Indenture")
provides that the Bank may not pay dividends on its capital stock unless, after
giving effect to the dividend, no event of a continuing default shall have
occurred and the Bank is in compliance with its regulatory capital requirements.
In addition, the amount of the proposed dividend may not exceed the sum of (i)
$15 million, (ii) 66 2/3% of the Bank's consolidated net income (as defined)
accrued on a cumulative basis commencing on October 1, 1993 and (iii) the
aggregate net cash proceeds received by the Bank after October 1, 1993 from the
sale of qualified capital stock or certain debt securities, minus the aggregate
amount of any restricted payments made by the Bank. Notwithstanding these
restrictions on dividends, provided no event of default has occurred or is
continuing under the 1993 Indenture, the 1993 Indenture does not restrict the
payment of dividends on the 13% Preferred Stock or any payment-in-kind preferred
stock issued in lieu of cash dividends on the 13% Preferred Stock or the
redemption of any such payment-in-kind preferred stock. The indenture pursuant
to which $100 million principal amount of the Bank's 1996 Debentures was issued
provides that the proposed dividend may not exceed the sum of the restrictions
discussed above for the 1993 Indenture and the aggregate liquidation preference
of the Chevy Chase Bank, F.S.B. 10 3/8% Noncumulative Preferred Stock, Series B
(the "Series B Preferred Stock"), if issued in exchange for the outstanding REIT
Preferred Stock. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Capital - Board
Resolution and Regulatory Requirements" and "Security Ownership of Certain
Beneficial Owners and Management."
At the request of the OTS, the Board of Directors of the Bank adopted a
resolution which permits the Bank to declare dividends on its stock in any
quarterly period up to the lesser of (i) 50% of its after tax net income for the
immediately preceding quarter or (ii) 50% of the average quarterly after tax net
income for the immediately preceding four quarter period, minus (in either case)
dividends declared on the Bank's 13% Preferred Stock during that quarterly
period. In connection with the Bank's payment of common dividends, the OTS
advised the Bank that the dividends paid on the REIT Preferred Stock issued by
the new real estate investment trust subsidiary of the Bank also must be
deducted from net income for purposes of calculating the 50% limits under this
board resolution. The Bank disagrees with the OTS's position regarding the REIT
Preferred Stock and intends to seek clarification of this issue from the OTS.
The payment of any dividends on the Bank's common stock and preferred stock will
be determined by the Board of Directors based on the Bank's liquidity, asset
quality profile, capital adequacy and recent earnings history, as well as
economic conditions and other factors deemed relevant by the Board of Directors,
including applicable government regulations and policies. See "Deposits and
Other Sources of Funds - Borrowings."
<PAGE>
Lending Limits. With certain exceptions, the Bank is prohibited from lending to
one borrower (including certain related entities of the borrower) amounts in
excess of 15% of the institution's unimpaired capital and unimpaired surplus,
plus an additional 10% for loans fully secured by readily marketable collateral.
The Bank's loans-to-one-borrower limit was approximately $115.2 million at
September 30, 1997, and no group relationships exceeded this limit at that date.
Safety and Soundness Standards. The federal financial institution regulators
have developed standards to evaluate the operations of depository institutions,
as well as standards relating to asset quality, earnings and compensation. The
operational standards cover internal controls and audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth and
employee compensation. An institution that fails to meet a standard that is
imposed through regulation may be required to submit a plan for corrective
action within 30 days. If a savings association fails to submit or implement an
acceptable plan, the OTS must order it to correct the deficiency, and may
restrict its rate of asset growth, prohibit asset growth entirely, require the
institution to increase its ratio of tangible equity to assets, restrict the
interest rate paid on deposits to the prevailing rates of interest on deposits
of comparable amounts and maturities, or require the institution to take any
other action the OTS determines will better carry out the purpose of prompt
corrective action. Imposition of these sanctions is within the discretion of the
OTS in most cases, but is mandatory if the savings institution commenced
operations or experienced a change in control during the 24 months preceding the
institution's failure to meet these standards, or underwent extraordinary growth
during the preceding 18 months.
The asset quality standards require that an insured depository institution
establish and maintain a system to identify problem assets and prevent
deterioration in those assets. The earnings standards require that an insured
depository institution establish and maintain a system to evaluate and monitor
earnings and ensure that earnings are sufficient to maintain adequate capital
and reserves.
Regulatory Assessments. The OTS imposes the following fees to fund its
operations: (i) asset-based assessments for all savings institutions, (ii)
examination fees for certain affiliates of savings associations, (iii)
application fees, (iv) securities filing fees and (v) publication fees. Of these
fees, the semi-annual asset-based assessments (which for the Bank totaled
$431,000 for the six-month period ending December 31, 1997) are the most
significant.
Other Regulations and Legislation. Chevy Chase must obtain prior approval of the
OTS before merging with another institution or before increasing its insured
accounts through merger, consolidation, purchase of assets or assumption of
liabilities. Also, as a SAIF-insured institution, the Bank is subject to
limitations on its ability to buy or sell deposits from or to, or to combine
with, a BIF-insured institution. Despite these restrictions, SAIF-insured
thrifts may be acquired by banks or by bank holding companies under certain
circumstances.
The federal agencies regulating financial institutions possess broad enforcement
authority over the institutions they regulate, including the authority to impose
civil money penalties of up to $1 million per day for violations of laws and
regulations.
<PAGE>
Federally chartered thrifts like Chevy Chase generally are permitted to
establish new branches anywhere in the United States, provided that they meet
the QTL test and their regulatory capital requirements and have at least a
satisfactory rating under the Community Reinvestment Act ("CRA").
Amounts realized by the FDIC from the liquidation or other resolution of any
insured depository institution must be distributed to pay claims (other than
secured claims to the extent of any such security) in the following order of
priority: (i) administrative expenses of the receiver, (ii) any deposit
liability of the institution, (iii) any other general or senior liability of the
institution (which is not an obligation described in clause (iv) or (v)), (iv)
any obligation subordinated to depositors or general creditors (which is not an
obligation described in clause (v)) and (v) any obligation to stockholders
arising as a result of their status as stockholders.
The OTS and the other federal bank regulatory agencies have requested comment on
possible changes to the existing regulatory classification policies for retail
credit. Among the changes being considered are adoption of: (i) a uniform
charge-off policy for open-end and closed-end credit; (ii) a classification
policy for loans affected by bankruptcy, fraudulent activity, and/or death of a
borrower; (iii) a policy for treatment of partial payments; (iv) a prudent
reaging policy for past due accounts; and (v) a classification policy for
delinquent residential mortgage and home equity loans. After reviewing the
comments received, the agencies plan to issue a revised detailed policy
statement for further comment. The Bank is unable to predict at this time what,
if any, changes will be made to the existing policies.
PENDING LEGISLATION
Thrift Charter Legislation. Legislation passed in 1996 requires the merger of
the BIF and the SAIF into a single Deposit Insurance Fund on January 1, 1999,
but only if the thrift charter is eliminated by that date. Congress is
considering legislation in various forms that would require federal thrifts,
like the Bank, to convert their charters to national or state bank charters. The
House Banking Committee approved a version of such legislation on June 20, 1997
and the House Commerce Committee approved its version of the legislation on
October 30, 1997. The current session of Congress adjourned without further
action on the bills and leadership of the House has announced its intention to
resume consideration of the legislation when Congress returns for the second
session in January 1998. In the absence of appropriate "grandfather" provisions,
such legislation could have an adverse effect on the Bank and the Trust because,
among other things, the Trust engages in activities that are not permissible for
bank holding companies and the regulatory capital and accounting treatment for
banks and thrifts differs in certain significant respects. While the versions of
the bill approved by the House Banking and Commerce Committees both contain
grandfather provisions that address many of these issues, the Bank cannot
determine at this time whether, or in what form, such legislation may eventually
be enacted, and there can be no assurances that any such legislation that is
enacted will contain adequate grandfather rights for the Bank or the Trust.
<PAGE>
FEDERAL RESERVE SYSTEM
The Federal Reserve Board (the "FRB") requires depository institutions,
including federal savings banks, to maintain reserves against their transaction
accounts and certain non-personal deposit accounts. Because reserves generally
must be maintained in cash or non-interest-bearing accounts, the effect of the
reserve requirement is to decrease the Bank's earning asset base. FRB
regulations generally require that reserves be maintained against net
transaction accounts. Prior to December 30, 1997, the first $4.4 million of a
depository institution's transaction accounts were subject to a 0% reserve
requirement. The next $44.9 million in net transaction accounts were subject to
a 3.0% reserve requirement and any net transaction accounts over $49.3 million
were subject to a 10.0% reserve requirement. Effective December 30, 1997, the
FRB increased the amount of transaction accounts subject to a 0% reserve
requirement from $4.4 million to $4.7 million and decreased the "low reserve
tranche" from $44.9 million to $43.1 million. The Bank met its reserve
requirements for each period during the year ended September 30, 1997. The
balances maintained to meet the reserve requirements imposed by the FRB also may
be used to satisfy liquidity requirements which are imposed by the OTS.
Savings institutions may borrow from the FRB "discount window," although FRB
regulations require these institutions to exhaust all reasonable alternate
sources of funds, including FHLB sources, before borrowing from the FRB. FDICIA
imposes additional limitations on the ability of the FRB to lend to
undercapitalized institutions through the discount window.
COMMUNITY REINVESTMENT ACT
Under the CRA and the OTS's regulations, a savings association has a continuing
and affirmative obligation to help meet the credit needs of its local
communities, including low- and moderate-income neighborhoods, consistent with
the safe and sound operation of the institution. In connection with its
examination of a savings association, the OTS is required to assess the
institution's record in satisfying the intent of the CRA. In addition, the OTS
is required to take into account the institution's record of meeting the credit
needs of its community in determining whether to grant approval for certain
types of applications.
The Bank is committed to fulfilling its CRA obligation by providing access to a
full range of credit-related products and services to all segments of its
community. Based on an OTS examination covering the period from January 1994
through June 1997, the Bank received an "outstanding" CRA rating, the highest
rating given by the OTS.
Recent amendments to the CRA regulations, effective July 1, 1997, are designed
to focus the CRA examination process more on an institution's actual performance
in meeting the credit needs of low- and moderate-income neighborhoods and to
minimize consideration of its CRA related procedures. Institutions like the
Bank, with more than $250 million in assets, are evaluated primarily on the
basis of their lending and investment in, and provision of services, to low- and
moderate-income areas unless they request designation and receive approval as
wholesale or limited purpose institutions or have been approved for evaluation
under a strategic plan. Additionally, large retail banks, such as the Bank, are
required to collect and to report additional data concerning small business
loans.
<PAGE>
In August 1994, Chevy Chase and its subsidiary, B. F. Saul Mortgage Company
(together, the "Companies"), entered into an agreement with the United States
Department of Justice (the "Department") which committed them to continue the
types of lending practices, branching strategies and promotional programs that
are designed to increase the level of banking services available to
traditionally underserved areas of the Washington, D.C. metropolitan area.
Specifically, the Companies agreed to invest $11.0 million in the
African-American community of the Washington, D.C. metropolitan area over a
five-year period. This commitment obligated the Companies to (i) provide $7.0
million over the five-year period in subsidies for below-market mortgage loans
to residents of designated majority African-American neighborhoods in
Washington, D.C. and Prince George's County, Maryland; (ii) open two additional
mortgage offices in majority African-American neighborhoods in the metropolitan
Washington, D.C. area; and (iii) open one new deposit branch in the Anacostia
area of Washington, D.C. The Companies also agreed over the same five-year
period, among other things, to continue efforts to increase their promotional
efforts targeted to residents of African-American neighborhoods, to continue
efforts to recruit African-Americans for loan production positions, and to
continue various employee training programs. The Companies view these efforts as
continuations of their existing programs.
OTHER ASPECTS OF FEDERAL LAW
The Bank is also subject to federal statutory provisions covering other items,
including security procedures, currency transactions reporting, insider and
affiliated party transactions, management interlocks, truth-in-lending,
electronic funds transfers, funds availability and equal credit opportunity.
YEAR 2000 CONSIDERATIONS
Some of the Bank's computer systems are designed to process transactions using
two digits to describe the year (e.g., "97" for 1997) rather than four digits
and therefore such systems may have difficulty accurately processing
transactions and making calculations using dates later than December 31, 1999.
Management has implemented a program to upgrade or replace its computer systems
to address this problem and expects the upgrades and replacements, along with
related testing to be completed not later than December 1998. Management does
not expect that the cost of converting such systems will be material to its
financial condition or results of operations. Nevertheless, a failure on the
part of the Bank to ensure that its computer systems are year 2000 compliant
could have a material adverse affect on the Bank's operations. Moreover, if any
of the Bank's significant customers or service providers do not successfully and
timely achieve year 2000 compliance as to their computer systems, the Bank also
could be adversely affected.
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards ("SFAS") No. 129, "Disclosure of
Information about Capital Structure" ("SFAS 129") establishes standards for
disclosing information about an entity's capital structure. SFAS 129 supersedes
capital structure disclosure requirements found in previous accounting
pronouncements and consolidates them into one statement for ease of retrieval
and greater visibility for non-public entities. SFAS 129 is effective for
financial statements for periods ending after December 15, 1997. Because SFAS
129 addresses only disclosure related issues, its adoption will not have an
impact on the Bank's financial condition or its results of operations.
<PAGE>
SFAS No. 130, "Reporting Comprehensive Income" ("SFAS 130") was issued in June
1997 and establishes accounting standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS 130 requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. SFAS 130 also requires an enterprise to classify
items of other comprehensive income by their nature in a financial statement and
to display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of a
statement of financial position. SFAS 130 is effective for fiscal years
beginning after December 15, 1997.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"), was also issued in June 1997. SFAS 131 establishes
accounting standards for the way business enterprises report information about
operating segments in annual and interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS 131 requires
that a business enterprise report financial and descriptive information,
including profit or loss, certain specific revenue and expense items, and
segment assets, about its reportable operating segments. Operating segments are
defined as components of an enterprise about which separate financial
information is available that is evaluated regularly by management in deciding
how to allocate resources and in assessing performance.
SFAS 131 is effective for financial statements for periods beginning after
December 15, 1997. Because SFAS 131 addresses only disclosure related issues,
its adoption will not have an impact on the Bank's financial condition or its
results of operations.
MARKET AREA
The Bank's principal deposit and lending markets are located in the Washington,
D.C. metropolitan area. Service industries and federal, state and local
governments employ a significant portion of the Washington, D.C. area labor
force, while a substantial number of the nation's 500 largest corporations have
some presence in the area. The Washington, D.C. area's seasonally unadjusted
unemployment rate is generally below the national rate and was 3.5% in September
1997, compared to the national rate of 4.7%.
Chevy Chase historically has relied on retail deposits originated in its branch
network as its primary funding source. See "Deposits and Other Sources of
Funds." Chevy Chase's principal market for deposits consists of Montgomery and
Prince George's Counties in Maryland and Fairfax County in Virginia.
Approximately 19.4% of the Bank's deposits at September 30, 1997 were obtained
from depositors residing outside of Maryland and Northern Virginia. Chevy Chase
had the largest market share of deposits in Montgomery County and ranked third
in market share of deposits in Prince George's County at June 30, 1996,
according to the most recently published industry statistics. The per capita
income of each of Montgomery and Fairfax Counties ranks among the highest of
counties and equivalent jurisdictions nationally. These two counties are also
the Washington, D.C. area's largest suburban employment centers, with a
substantial portion of their labor force consisting of federal, state and local
government employees. Private employment is concentrated in services and retail
trade centers. Unemployment in Montgomery and Fairfax Counties in September 1997
(2.4% and 2.5%, respectively) was below the national rate (4.7%) and state rates
(4.7% for Maryland and 4.1% for Virginia) for the same month.
<PAGE>
The Bank historically has concentrated its lending activities in the Washington,
D.C. metropolitan area. See "Lending Activities."
INVESTMENT AND OTHER SECURITIES
The Bank is required by OTS regulations to maintain a specific minimum amount of
liquid assets and short-term liquid assets invested in certain qualifying types
of investments. See "Regulation - Liquidity Requirements." To meet these
requirements, the Bank maintains a portfolio of cash, federal funds and
mortgage-backed securities with final maturities of five years or less. The
balance of investments in excess of regulatory requirements reflects
management's objective of maintaining liquidity at a level sufficient to assure
adequate funds to meet expected and unexpected balance sheet fluctuations.
The Bank classifies its investment and mortgage-backed securities as either
"held-to-maturity", "available-for-sale" or "trading" at the time such
securities are acquired. At September 30, 1997 and 1996, all such securities are
classified as held-to-maturity.
Prior to fiscal 1995, the Bank classified all of its investment and
mortgage-backed securities as available-for-sale. During fiscal 1995, the Bank
transferred at fair value all of such securities to held-to-maturity. Net
unrealized holding losses, net of the related income tax effect, continue to be
reported as a separate component of stockholders' equity and are being amortized
to income over the remaining lives of the securities.
OTS guidelines require that investments in securities be accounted for in
accordance with generally accepted accounting principles ("GAAP"), summarize the
applicable accounting principles and provide guidance regarding the application
of GAAP in determining whether securities are properly classified as
held-to-maturity, available-for-sale or trading.
As part of its mortgage banking activities, the Bank exchanges loans held for
sale for mortgage-backed securities and then sells the mortgage- backed
securities, which are classified as trading securities, to third party investors
in the month of issuance. There were no mortgage securities classified as
trading securities at September 30, 1997.
At September 30, 1997, the Bank held one automobile loan-backed security which
was classified as trading. The security was issued in conjunction with an
automobile loan securitization transaction and represents a separate class of
certificates, all of which was retained by the Bank. See "Consumer Lending."
LENDING ACTIVITIES
Loan Portfolio Composition. At September 30, 1997, the Bank's loan portfolio
totaled $2.5 billion, which represented 41.6% of its total assets. (All
references in this report to the Bank's loan portfolio refer to loans, whether
they are held for sale and/or securitization or for investment, and exclude
mortgage-backed securities.) Loans collateralized by single-family residences
constituted 37.2% of the loan portfolio at that date.
The following table sets forth information concerning the Bank's loan portfolio
(net of unfunded commitments) for the periods indicated.
<PAGE>
<TABLE>
LOAN PORTFOLIO
(Dollars in thousands)
September 30,
-----------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------- ------------------- ------------------- -------------------- --------------------
% of % of % of % of % of
Balance Total Balance Total Balance Total Balance Total Balance Total
------------ ------ ------------ ------ ------------ ------ ------------ ------- ------------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>> <C> <C>
Single family
residential (1) $ 849,955 33.5% $ 1,601,483 47.4% $ 1,391,694 47.3% $ 1,369,571 53.7% $ 1,287,333 53.6%
Home equity (1) 94,088 3.7 32,052 0.9 29,024 1.0 34,708 1.4 60,549 2.5
Commercial real estate
and multifamily 53,551 2.1 78,866 2.3 85,781 2.9 84,210 3.3 94,079 3.9
Real estate construction
and ground 54,998 2.2 63,907 1.9 32,652 1.1 52,350 2.1 62,637 2.6
Commercial 98,346 3.9 57,023 1.7 13,986 0.5 3,950 0.2 4,116 0.2
Credit card (1) 1,077,149 42.6 1,118,271 33.1 1,012,548 34.4 650,199 25.5 754,520 31.4
Automobile (1) 217,111 8.6 297,560 8.8 239,217 8.1 289,346 11.4 106,725 4.4
Home improvement and
related loans (1) 49,551 2.0 94,316 2.8 112,705 3.8 37,526 1.5 8,255 0.3
Overdraft lines of
credit and other
consumer 36,029 1.4 37,954 1.1 26,206 0.9 25,375 0.9 25,677 1.1
------------ ------ ------------ ------ ------------ ------ ------------ ------- ------------ -------
2,530,778 100.0% 3,381,432 100.0% 2,943,813 100.0% 2,547,235 100.0% 2,403,891 100.0%
------------ ====== ------------ ====== ------------ ====== ------------ ======= ------------ =======
Less:
Unearned premiums
and discounts 449 836 1,103 1,438 1,543
Deferred loan
origination fees
(costs) (2,339) (13,958) (13,687) (10,604) (3,472)
Allowance for loan
losses 105,679 95,523 60,496 50,205 68,040
------------ ------------ ------------ ------------ ------------
103,789 82,401 47,912 41,039 66,111
------------ ------------ ------------ ------------ ------------
Total loans
receivable $ 2,426,989 $ 3,299,031 $ 2,895,901 $ 2,506,196 $ 2,337,780
============ ============ ============ ============ ============
- -------------------------------------------------------------------------------------------------------------------------------
(1) Includes loans held for sale and/or securitization, if any.
</TABLE>
<PAGE>
The Bank adjusts the composition of its loan portfolio in response to a variety
of factors, including regulatory requirements and asset and liability management
objectives. See "Regulation - Regulatory Capital," "- Qualified Thrift Lender
("QTL") Test" and "Federal Taxation - Bad Debt Reserve" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Condition - Asset and Liability Management."
Contractual Principal Repayments of Loans. The following table shows the
scheduled contractual principal repayments of the Bank's loans at September 30,
1997. The entire balance of loans held for sale and/or securitization is shown
in the year ending September 30, 1998, because such loans are expected to be
sold in less than one year.
<PAGE>
<TABLE>
CONTRACTUAL PRINCIPAL REPAYMENTS
(In thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
Principal
Balance Approximate Principal Repayments
Outstanding Due in Years Ending September 30,
at ---------------------------------------------------------------------------------------
September 30, 2013 and
1997 (1) 1998 1999 2000 2001-2002 2003-2007 2008-2012 Thereafter
------------- ----------- ----------- ------------ ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Single family residential $ 747,070 $ 13,703 $ 14,429 $ 18,431 $ 33,682 $ 76,366 $ 117,795 $ 472,664
Home equity 44,088 -- -- -- 3,028 2,289 8,633 30,138
Commercial real estate and
multifamily 53,551 4,493 -- 10,790 30,018 6,309 1,941 --
Real estate construction
and ground 54,998 15,594 10,641 1,296 6,640 20,827 -- --
Commercial 98,346 39,416 9,045 3,108 21,565 24,632 310 270
Credit card (2) 987,149 41,431 39,692 38,026 71,331 153,726 124,062 518,881
Automobile 137,111 22,039 25,465 29,493 60,114 -- -- --
Home improvement and related
loans 49,551 2,460 2,782 3,145 7,579 29,511 4,074 --
Overdraft lines of credit and
other consumer 36,029 2,840 3,318 3,887 9,944 16,040 -- --
Loans held for sale 102,885 102,885 -- -- -- -- -- --
Loans held for securitization
and sale 220,000 220,000 -- -- -- -- -- --
------------- ----------- ----------- ------------ ------------ ------------ ----------- ------------
Total loans receivable (3) $ 2,530,778 $ 464,861 $ 105,372 $ 108,176 $ 243,901 $ 329,700 $ 256,815 $ 1,021,953
============= =========== =========== ============ ============ ============ =========== ============
Fixed-rate loans $ 336,185 $ 36,766 $ 44,578 $ 47,578 $ 108,119 $ 72,152 $ 16,848 $ 10,144
Adjustable-rate loans 1,871,708 105,210 60,794 60,598 135,782 257,548 239,967 1,011,809
Loans held for sale 102,885 102,885 -- -- -- -- -- --
Loans held for securitization
andd sale 220,000 220,000 -- -- -- -- -- --
------------- ----------- ----------- ------------ ------------ ------------ ----------- ------------
Total loans receivable (3) $ 2,530,778 $ 464,861 $ 105,372 $ 108,176 $ 243,901 $ 329,700 $ 256,815 $ 1,021,953
============= =========== =========== ============ ============ ============ =========== ============
- -----------------------------------------------------------------------------------------------------------------------------------
(1) Of the total amount of loans outstanding at September 30, 1997 which were due after one year, an aggregate principal balance of
approximately $299.4 million had fixed interest rates and an aggregate principal balance of approximately $1.7 billion had
adjustable interest rates.
(2) Estimated repayments of credit card loans reflect the required minimum payments.
(3) Before deduction of allowance for loan losses, unearned discounts and deferred loan origination fees (costs).
</TABLE>
<PAGE>
Actual payments may not reflect scheduled contractual principal repayments due
to the effect of loan refinancings, prepayments and enforcement of due-on-sale
clauses, which give the Bank the right to declare a "conventional loan" -- one
that is neither insured by the Federal Housing Administration ("FHA") nor
partially guaranteed by the Veterans' Administration ("VA") -- immediately due
and payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid. Although the Bank's
single-family residential loans historically have had stated maturities of
generally 30 years, such loans normally have remained outstanding for
substantially shorter periods because of these factors. At September 30, 1997,
principal repayments of $142.0 million are contractually due within the next
year. Of this amount, $36.8 million is contractually due on fixed-rate loans and
$105.2 million is contractually due on adjustable-rate loans.
Origination, Purchase and Sale of Real Estate Loans. As a federally chartered
savings institution, the Bank has general authority to make loans secured by
real estate located throughout the United States. The following table shows
changes in the composition of the Bank's real estate loan portfolio and the net
change in mortgage-backed securities.
<PAGE>
<TABLE>
ORIGINATION, PURCHASE AND SALE OF REAL ESTATE LOANS
(In thousands)
For the Year Ended September 30,
----------------------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
Real estate loan originations and purchases: (1)
<S> <C> <C> <C>
Single family residential $ 1,392,341 $ 1,098,099 $ 522,846
Home equity 365,076 223,852 219,714
Commercial real estate and multifamily 29 345 4,023
Real estate construction and ground 64,430 72,655 37,510
--------------- --------------- ---------------
Total originations and purchases 1,821,876 1,394,951 784,093
--------------- --------------- ---------------
Principal repayments (444,375) (381,365) (245,376)
Sales (2) (529,545) (407,200) (374,414)
Loans transferred to real estate acquired
in settlement of loans (4,706) (5,972) (9,822)
--------------- --------------- ---------------
(978,626) (794,537) (629,612)
Transfers to mortgage-backed securities (3) (1,566,966) (363,257) (156,169)
--------------- --------------- ---------------
Increase (decrease) in real estate loans $ (723,716) $ 237,157 $ (1,688)
=============== =============== ===============
(1) Excludes unfunded commitments.
(2) Includes securitization and sale of home equity credit line receivables of $286.4 million, $96.5 million and $150.5 million
for the years ended September 30, 1997, 1996 and 1995, respectively.
(3) Represents real estate loans which were pooled and exchanged for Credit Suisse, First Boston, FHLMC and FNMA
mortgage-backed securities.
</TABLE>
<PAGE>
Single-Family Residential Real Estate Lending. The Bank originates a variety of
loans secured by single-family residential structures. At September 30, 1997,
$0.9 billion (or 37.2%) of the Bank's loan portfolio consisted of loans secured
by first or second mortgages on such properties, including $13.4 million of
FHA-insured or VA-guaranteed loans. Approximately 77.0% of the Bank's
single-family residential real estate loans at September 30, 1997 by principal
balance were secured by properties located in Maryland, Virginia or the District
of Columbia.
The Bank originates VA, FHA and a wide variety of conventional residential
mortgage loans through its wholly-owned mortgage banking subsidiary, B.F. Saul
Mortgage Company, and through Chevy Chase Mortgage, a division of the Bank.
Chevy Chase currently offers fixed-rate loans with maturities of 15 to 30 years
and adjustable-rate residential mortgage loans ("ARMs"), principally with
maturities of 30 years.
The Bank maintains a wholesale network of correspondents, including loan brokers
and financial institutions, in order to supplement its direct origination of
single-family residential mortgage loans. The Bank determines the specific loan
products and rates under which the correspondents originate the loans, and
subjects the loans to the Bank's underwriting criteria and review. During the
year ended September 30, 1997, approximately $754.5 million of loans settled
under the correspondent program.
At September 30, 1997, 79.8% of the Bank's residential mortgage loans consisted
of ARMs scheduled to have interest rate adjustments within five years. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Asset and Liability Management." Interest
rates on the majority of the Bank's ARMs are adjusted based on changes in yields
on U.S. Treasury securities of varying maturities. The interest rate adjustment
provisions of the Bank's ARMs contain limitations on the frequency and maximum
amount of interest rate adjustments, although such limitations are not required
by law. These limitations are determined by a variety of factors, including
mortgage loan competition in the Bank's markets. The ARMs currently offered by
the Bank are generally subject to a limitation on the annual increase in the
interest rate of 2.0% and a limitation on the increase in the interest rate over
the term of the loan ranging from 6.0% to 9.0%.
During the current fiscal year, the Bank continued to fulfill its $1.0 billion
five-year mortgage loan commitment made in 1994 to meet the credit needs of low-
and moderate-income borrowers in the various communities which it serves. As
part of this commitment, the Community Development Fund is providing $140.0
million of mortgage financing over a five-year period, with $7.0 million in
subsidies for below-market mortgage loans, to families in minority neighborhoods
in the District of Columbia and Prince George's County, Maryland.
<PAGE>
Loan sales provide the Bank with liquidity and additional funds for lending,
enabling the Bank to increase the volume of loans originated and thereby
increase loan interest and fee income, and in recent periods have produced
additional non-interest income in the form of gains on sales of loans. In fiscal
1997, sales of mortgage loans originated or purchased for sale by the Bank
totaled $243.1 million. The marketability of loans, loan participations and
mortgage-backed securities depends on purchasers' investment limitations,
general market and competitive conditions, mortgage loan demand and other
factors. The Bank originates fixed-rate, single-family loans on terms which
conform to Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National
Mortgage Association ("FNMA") guidelines in order to ensure the salability of
the loan in the public secondary mortgage market. In order to manage its
interest-rate exposure, the Bank hedges its fixed-rate mortgage loan pipeline by
entering into whole loan and mortgage-backed security forward sale commitments.
Sales of residential mortgage loans are generally made without recourse to the
Bank. At September 30, 1997, the Bank had $102.7 million of single-family
residential loans held for sale to investors.
From time to time, as part of its capital and liquidity management plans, the
Bank may consider exchanging loans held in its portfolio for lower risk-weighted
mortgage-backed securities and retaining those securities in its portfolio
rather than selling them in the secondary mortgage market. In September 1997,
the Bank exchanged $1.1 billion of single-family residential loans held in its
portfolio for mortgage-backed securities which the Bank retained for its own
portfolio.
When the Bank sells a residential whole loan or loan participation and retains
servicing, or purchases mortgage servicing assets from third parties, it
continues to collect and remit loan payments, inspect the properties, make
certain insurance and tax payments on behalf of borrowers and otherwise service
the loans. The servicing fee, generally ranging from 0.25% to 0.50% of the
outstanding loan principal amount per annum, is recognized as income over the
life of the loans. The Bank also typically derives income from temporary
investment for its own account of loan collections pending remittance to the
participation or whole loan purchaser. At September 30, 1997, the Bank was
servicing residential permanent loans totaling $3.9 billion for other investors.
See "Loan Servicing."
Sales of Mortgage-Backed Securities. A significant portion of the Bank's sales
of mortgage-backed securities involve sales pursuant to the Bank's normal
mortgage banking operations. Generally, the Bank's policy is to sell its
fixed-rate mortgage production which, in the case of most conforming fixed-rate
loans, is accomplished by first pooling such loans into mortgage-backed
securities. The mortgage-backed securities sold as part of the Bank's mortgage
banking operations are generally issued in the same month as the sale of such
securities. The securities are formed from conforming fixed-rate loans
originated for sale or from conforming fixed-rate loans resulting from the
borrower's election to convert from a variable-rate loan to a fixed-rate loan.
Mortgage-backed securities held for sale in conjunction with mortgage banking
activities are classified as trading securities. As a result of the sale of
trading securities in the month such securities are formed, the Consolidated
Statements of Cash Flows in this report reflect significant proceeds from the
sales of trading securities, even though there are no balances of such
securities at September 30, 1997. Fixed-rate loans are designated as held for
sale in the Consolidated Balance Sheets in this report.
<PAGE>
Home Equity Lending. The Bank's home equity credit line loan provides revolving
credit secured principally by a second mortgage on the borrower's home. Such
loans are originated directly by the Bank. Home equity credit line loans bear
interest at a variable rate that adjusts monthly based on changes in the
applicable interest rate index and generally are subject to a maximum annual
interest rate of between 18.0% and 24.0%. Except for any amortization of
principal that may occur as a result of monthly payments, there are no required
payments of principal until maturity. In order to promote its home equity credit
line loan program, the Bank currently offers prospective borrowers a
below-market interest rate for an introductory period and settlement without
closing costs.
In December 1996, the Bank purchased $119.2 million of home equity credit line
loans at a premium. The Bank may make additional purchases of such loans in the
future as a way to supplement its direct origination of such loans.
Securitizations of home equity credit line receivables have been an important
element of the Bank's strategies to enhance liquidity and to maintain compliance
with regulatory capital requirements. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Financial Condition." The
Bank transferred $286.4 million, $96.5 million and $150.5 million of home equity
credit line receivables in fiscal 1997, fiscal 1996 and fiscal 1995,
respectively, to trusts for securitization and sale to investors. Gains of $11.7
million, $4.7 million and $7.6 million were recognized by the Bank as a result
of these transactions. The Bank continues to service the underlying accounts.
Commercial Real Estate and Construction Lending. Commercial, real estate
construction and ground loans are originated directly by the Bank. Aggregate
balances of residential construction, commercial construction, ground and
commercial real estate and multifamily loans decreased 24.0% in fiscal 1997 to
$108.5 million at September 30, 1997, from $142.8 million at September 30, 1996.
The Bank provides financing, generally at market rates, to certain purchasers of
its REO. Additionally, the Bank finances the construction of residential real
estate, principally single-family detached homes and townhouses, but generally
only when a home is under contract for sale by the builder to a consumer.
Commercial Lending. In July 1994, the Bank began developing an active commercial
lending program. Commercial loans are defined as any loans made to a business
entity for commercial purposes. Such purposes may include the financing of
working capital, the acquisition of machinery and equipment or other assets, and
the financing of cash flow needs. Loans for acquisition, construction or
permanent financing of real estate used in the borrower's business are
considered commercial loans. All commercial loans are underwritten, originated
and managed by the Bank's Business Banking Group. A wide variety of products is
offered, including revolving lines of credit for working capital or seasonal
needs; term loans for the financing of fixed assets; letters of credit;
corporate credit cards; cash management services; and other deposit and
investment products. Business development efforts have been concentrated in the
major industry groups in the metropolitan Washington, D.C. area, as well as a
broad base of small businesses and community service organizations. Commercial
loans increased $41.3 million during fiscal 1997 to $98.3 million at September
30, 1997 and are expected to continue to grow as the Bank continues to expand
this aspect of its business. The recent acquisition of ASB Capital Management,
Inc., should enhance the operations of the Business Banking Group by allowing
the Bank to offer a broader variety of investment products and fiduciary
services to institutional customers.
<PAGE>
Under legislation signed into law on September 30, 1996, the authority of
federal thrifts, like Chevy Chase, to make commercial loans was increased from
10% to 20% of assets, provided that the additional 10% consists of small
business loans.
Credit Card Lending. Chevy Chase provides consumer credit through its credit
card program, which offers VISA(R) and MasterCard(R) credit cards and includes
Platinum, Gold and Classic cards. Chevy Chase issues the credit cards and
receives interest income on credit extended, a fee based on a percentage of
credit sales paid by merchants accepting card purchases, and generally, an
annual membership fee for use of the cards, as well as certain other fees. Chevy
Chase's credit card loan portfolio accounted for 42.6% of Chevy Chase's total
loans at September 30, 1997. According to statistics published in the American
Banker, Chevy Chase is the third largest issuer of credit cards among thrift
institutions, based on managed credit card loans outstanding at June 30, 1997.
At September 30, 1997, credit card loans outstanding totaled $1.1 billion and
managed credit card receivables, including receivables owned by the Bank and
receivables securitized, sold and serviced by the Bank, totaled $5.1 billion.
The Bank emphasizes credit card lending because the shorter term and normally
higher interest rates on such loans help it maintain a profitable spread between
the average loan yield and the cost of funds. In addition, credit card accounts
typically may be sold at a premium over their receivables balances, thus further
enhancing their potential value to the Bank. Chevy Chase also believes its
credit card program contributes to market share growth in its local markets by
attracting new depositors, promoting a high degree of customer loyalty and
providing opportunities to cross-market other products of the Bank.
Chevy Chase's internal data processing systems are capable of handling a broad
range of credit card program operations, including processing of credit
applications and collection functions. Certain data processing and
administrative functions associated with the servicing of the credit card
accounts are performed on behalf of the Bank by First Data Resources
Incorporated from its facilities in Omaha, Nebraska.
Changes in credit card use and payment patterns by cardholders, including
increased defaults, may result from a variety of social, legal and economic
factors. Chevy Chase currently offers introductory and promotional periodic
interest rates, which are generally fixed for varying initial and promotional
periods and, which at the conclusion of such periods, revert to a variable
interest rate. If account holders choose to utilize competing sources of credit,
the rate at which new receivables are generated may be reduced and certain
purchase and payment patterns with respect to the receivables may be affected.
Economic factors affecting credit card use include the rate of inflation and
relative interest rates offered for various types of loans. Adverse changes in
economic conditions could have a direct impact on the timing and amount of
payments by borrowers. During times of economic recession, default rates on
credit card loans generally may be expected to exceed default rates on
residential mortgage loans. During 1996 and 1997, the Bank, as well as other
credit card issuers, experienced an increase in the level of individuals
declaring bankruptcy. Although the Bank cannot predict with certainty the level
of bankruptcies that may occur among cardholders, management has implemented
more stringent underwriting and other lending policies and has become more
proactive in managing its accounts and in monitoring its portfolio in an attempt
to mitigate losses incurred as a result of a cardholder declaring bankruptcy.
The Bank can make no assurances as to the level of bankruptcies that may occur
among cardholders in the future. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition - Asset
Quality - Delinquent Loans" and "- Allowances for Losses."
<PAGE>
Certain issuers of credit cards have adjusted their pricing to provide for the
different credit risks among customers based upon card usage, repayment habits
and other criteria. The Bank has implemented such risk-based pricing by
increasing the interest rates charged to high-risk customers and by continuing
to allow low-risk customers a more favorable rate. Periodically, the Bank
offers promotional discounts to certain customers to encourage increased usage
of the Bank's credit cards.
Certain jurisdictions and their residents may attempt to require out-of-state
credit card issuers to comply with such jurisdictions' consumer protection laws
that impose requirements on the making, enforcement and collection of consumer
loans. For example, in recent years, a number of lawsuits and administrative
actions have been filed in several states against out-of-state credit card
issuers (including both federally and state chartered insured institutions)
challenging various fees and charges (such as late fees, over-the-limit fees,
returned check fees and annual membership fees) assessed against residents of
the states in which such lawsuits were filed, based on restrictions or
prohibitions under the laws of such states. The Supreme Court recently ruled
that national banks may export late fees on credit cards as interest regardless
of states' usury laws, however the law is not settled with respect to all types
of fees and charges. If it were determined that out-of-state credit card issuers
must comply with a jurisdiction's laws limiting the charges imposed by credit
card issuers, such action could have an adverse impact on the Bank's credit card
results.
Securitizations of credit card receivables has been an integral element of the
Bank's strategy to enhance liquidity, to further asset and liability management
objectives and to maintain compliance with regulatory capital requirements. The
Bank transferred $1.1 billion, $919.0 million, $1.6 billion, $1.4 billion and
$350.0 million of credit card receivables in fiscal 1997, fiscal 1996, fiscal
1995, fiscal 1994 and fiscal 1993, respectively, to trusts for securitization
and sale to investors. Prior to January 1, 1997, no gain or loss was recognized
by the Bank as a result of these transactions as retained cash flows were
recognized over the lives of the transactions when earned. Subsequent to January
1, 1997, as a result of the adoption of SFAS 125, the Bank recognized gains of
$33.1 million. The Bank continues to service the underlying loans in each of
trusts. See Note C to the Consolidated Financial Statements in this report.
Chevy Chase plans to securitize an additional $615.0 million of credit card
receivables during the first and second quarters of fiscal 1998. Certain of
these receivables at September 30, 1997 were classified as loans held for
securitization and sale in the Consolidated Balance Sheets in this report.
Credit card loans are not subject to those provisions of federal laws and
regulations that limit to 35% of an institution's total assets the amount of
consumer loans that a federally chartered savings institution may make.
<PAGE>
Other Consumer Lending. Chevy Chase currently offers a variety of consumer loans
other than credit card loans, including automobile loans, overdraft lines of
credit, home improvement loans and other unsecured loans for traditional
consumer purchases and needs. In addition, through a wholly-owned subsidiary,
the Bank offers "non-prime" automobile loans. "Non-prime" refers to a category
of loans made to applicants who have experienced certain adverse credit events,
but who meet certain other creditworthiness tests. See "Other Consumer Loan
Underwriting." The Bank's portfolio of automobile loans, home improvement and
related loans and other consumer loans totaled $217.1 million, $49.6 million and
$36.0 million, respectively, at September 30, 1997, which accounted for a
combined 12.0% of total loans at that date. The largest areas of recent growth
have been in automobile loans and home improvement loans. During fiscal 1997,
the Bank purchased or originated $890.0 million and $138.5 million of automobile
loans and home improvement loans, respectively, which was more than offset by
the transfers of $938.9 million and $224.0 million, respectively, of receivables
to trusts for securitization and sale to investors.
Federal laws and regulations permit a federally chartered savings institution to
make secured and unsecured consumer loans up to 35% of the institution's total
assets. In addition, a federally chartered savings institution has lending
authority above the 35% limit for certain consumer loans which include, in
addition to credit card loans, home improvement, secured deposit account and
educational loans.
Real Estate Loan Underwriting. In the loan approval process, Chevy Chase
assesses both the borrower's ability to repay the loan and, in appropriate
cases, the adequacy of the proposed security. Credit approval is vested with the
Board of Directors and delegated to the Executive Loan Committee and certain
senior officers in accordance with the credit authorizations approved by the
Board of Directors. Generally, all construction and commercial real estate loans
are reviewed and approved by the Executive Loan Committee. Any significant loan
not conforming to the Bank's approved policies must be approved by the Executive
Loan Committee or the Chief Executive Officer. All loans of $15 million or more
are presented to the Board of Directors for final approval.
The approval process for all types of real estate loans includes appraisals or
evaluations of the properties securing such loans and a review of the
applicant's financial statements and credit, payment and banking history,
financial statements of any guarantors, and tax returns of guarantors of
construction and commercial real estate loans.
In an effort to minimize the increased risk of loss associated with construction
and development loans, Chevy Chase considers the reputation of the borrower and
the contractor, reviews pre-construction sale and leasing information, and
requires an independent inspecting engineer or architect to review the progress
of multifamily and commercial real estate projects. In addition, the Bank
generally requires personal guarantees of developers for all development loans
and, if a general contractor is used by the developer, may require the posting
of a performance bond.
<PAGE>
The Bank generally lends up to 95% of the appraised value of single-family
residential dwellings to be owner-occupied. The Bank also lends up to 85% of the
appraised value of the completed project to finance the construction of such
dwellings, and, on a case-by-case basis, the Bank occasionally may lend up to
90% of such appraised value when such financing is limited to pre-sold units.
The loan-to-value ratio generally applied by the Bank to commercial real estate
loans and multifamily residential loans has been 80% of the appraised value of
the completed project. Currently, the Bank generally does not originate a second
mortgage loan (excluding home equity credit line loans) if the aggregate
loan-to-value ratio of the second loan and the related first mortgage loan
exceeds 80% of the appraised value of the property. In some circumstances, the
Bank originates a first and second mortgage loan simultaneously where the total
loan value does not exceed 90% of the appraised value of the property.
Currently, the Bank offers home equity credit line loans up to a 125% maximum
loan-to-value ratio. Private mortgage insurance is generally obtained for the
amount over 80% of the value of the underlying property. Loan-to-value ratios
are determined at the time a loan is originated. Consequently, subsequent
declines in the value of the loans' collateral could expose the Bank to losses.
OTS regulations require institutions to adopt internal real estate lending
policies, including loan-to-value limitations conforming to specific guidelines
established by the OTS. The Bank's current lending policies conform to these
regulations.
On all loans secured by real estate (other than certain home equity credit line
loans), Chevy Chase requires title insurance policies protecting the priority of
the Bank's liens. The Bank requires fire and casualty insurance for permanent
loans (including home equity credit line loans) and fire, casualty and builders'
risk insurance for construction loans. The borrower selects the insurance
carrier, subject to Chevy Chase's approval. Generally, for any residential loan
(including home equity credit line loans) in an amount exceeding 80% of the
appraised value of the security property, Chevy Chase currently requires
mortgage insurance from an independent mortgage insurance company. The majority
of the Bank's mortgage insurance is placed with four carriers.
Substantially all fixed-rate mortgage loans originated by the Bank contain a
"due on sale" clause providing that the Bank may declare a loan immediately due
and payable in the event, among other things, that the borrower sells the
property securing the loan without the consent of the Bank. The Bank's ARMs
generally are assumable.
Commercial Loan Underwriting. All commercial loan requests are underwritten and
approved under authorities granted to specified committees and individuals as
outlined in the Bank's credit policies. The scope and depth of the underwriting
for a particular request are generally dictated by the size of the proposed
transaction. All commercial loans greater than $100,000 are assigned a risk
rating at inception, utilizing a risk-rating system as defined in the Bank's
credit policies.
Credit Card Loan Underwriting. The Bank generates new credit card accounts
through various methods, including telemarketing, direct mail and other
distribution channels. The Bank identifies potential cardholders for
solicitation by supplying a list of credit criteria to a credit bureau, which
generates a list of individuals who meet such criteria. An individual receiving
a solicitation provides all the necessary application information to the Bank
which then obtains a credit report (on such individual) from an
independent credit reporting agency. The credit limit and terms of the account
are subject to certain post-screening underwriting reviews performed by the
Bank.
<PAGE>
The Bank's underwriting approach to account approval supplements a computerized
credit scoring system with an individual evaluation of each complete application
for creditworthiness. Cardholder credit limits are adjusted from time to time
based on the Bank's continuing evaluation of the cardholder's repayment ability
as evidenced by the cardholder's payment history and other factors. The Bank
also may increase the credit limit at the cardholder's request after completion
of an evaluation comparable to that performed during the initial underwriting.
Management reviews credit losses on a monthly basis and adjusts the Bank's
underwriting standards as appropriate.
Other Consumer Loan Underwriting. Other consumer loans (which include automobile
loans and home improvement loans) are originated or purchased by the Bank after
a review by the Bank in accordance with its established underwriting procedures.
The underwriting procedures are designed to provide a basis for assessing the
borrower's ability and willingness to repay the loan. In conducting this
assessment, the Bank considers the borrower's ratio of debt to income and
evaluates the borrower's credit history through a review of a written credit
report compiled by a recognized consumer credit reporting bureau. The borrower's
equity in the collateral and the terms of the loan are also considered. The
Bank's guidelines are intended only to provide a basis for lending decisions,
and exceptions to such guidelines may, within certain limits, be made based upon
the credit judgment of the Bank's lending officer. The Bank periodically
conducts quality audits to ensure compliance with its established policies and
procedures.
The Bank also makes automobile loans through one of its operating subsidiaries.
The underwriting guidelines for this subsidiary apply to a category of lending
in which loans may be made to applicants who have experienced certain adverse
credit events (and therefore would not necessarily meet all of the Bank's
guidelines for its traditional loan program), but who meet certain other
creditworthiness tests. Such loans may experience higher rates of delinquencies,
repossessions and losses, especially under adverse economic conditions, compared
with loans originated pursuant to the Bank's traditional lending program. See
"Subsidiaries - Operating Subsidiaries."
Loan Servicing. In addition to interest earned on loans, the Bank receives
income through servicing of loans and fees in connection with loan origination,
loan modification, late payments, changes of property ownership and
miscellaneous services related to its loans. Loan servicing income, principally
servicing income earned on single-family residential mortgage loans owned by
third parties and the Bank's securitized credit card, home equity credit line,
automobile and home loan receivables portfolios, has been a source of
substantial earnings for the Bank in recent periods. Income from these
activities varies with the volume and type of loans originated and sold.
The following table sets forth certain information relating to the Bank's
servicing income as of or for the years indicated.
<PAGE>
As of or For the Year Ended September 30,
-------------------------------------------
1997 1996 1995
----------- ----------- -----------
(In thousands)
Residential $ 3,930,371 $ 3,045,650 $ 1,350,423
Credit Card 4,015,172 3,889,704 3,226,316
Home Equity 459,130 416,365 455,791
Automobile 1,083,026 505,638 218,287
Home Loans 244,140 141,106 --
----------- ----------- -----------
Total amount of loans
serviced for others (1) $ 9,731,839 $ 7,998,463 $ 5,250,817
=========== =========== ===========
Loan servicing fee
income (2) $ 227,817 $ 264,139 $ 184,275
=========== =========== ===========
- ---------------------
(1) The Bank's basis in its servicing assets and interest-only strips at
September 30, 1997, 1996 and 1995 was $147.4 million, $75.4 million and
$54.2 million, respectively.
(2) In each of the years ended September 30, 1997, 1996 and 1995, loan
servicing fee income as a percentage of net interest income before
provision for loan losses was 108.2%, 132.9% and 104.6%, respectively.
The Bank earns fees in connection with the servicing of home equity credit line
loans, credit card loans, home loans, automobile loans and single-family
residential mortgage loans. The Bank's level of servicing fee income varies
based in large part on the amount of the Bank's securitization activities with
respect to these loan types. As the Bank securitizes and sells assets, acquires
servicing assets either through purchase or origination, or sells mortgage loans
and retains the servicing rights on those loans, the level of servicing fee
income generally increases. During fiscal 1997, the Bank securitized and sold
$1.1 billion of credit card receivables, $286.4 million of home equity credit
line receivables, $938.9 million of automobile loan receivables and $224.0
million of home loan receivables. Although the Bank's securitization activity
increased during fiscal 1997, loan servicing fee income decreased from the level
achieved in fiscal 1996 principally because of an increase in charge-offs on
securitized credit card receivables. See "Management's Discussion and Analysis -
Financial Condition - Allowance for Losses." The Bank's level of servicing fee
income also declines upon repayment of assets previously securitized and sold
and repayment of mortgage loans serviced for others.
<PAGE>
The Bank's investment in loan servicing assets (including servicing assets and
interest-only strips), and the amortization of such assets, are periodically
evaluated for impairment. Interest-only strips are evaluated quarterly based on
the discounted value of estimated future net cash flows to be generated by the
underlying loans. The difference between the book value of these assets and the
discounted value is recorded as a valuation adjustment and recognized as an
unrealized gain or loss in the period in which the change occurs. Several
estimates are used when determining the discounted value, the most significant
of which is the estimated rate of repayment of the underlying loans. The Bank
evaluates its servicing assets for impairment based on fair value. To measure
fair value of its servicing assets, the Bank uses either quoted market prices or
discounted cash flow analyses using appropriate assumptions for servicing fee
income, servicing costs, prepayment rates and discount rates. Additionally, the
Bank stratifies its capitalized servicing assets for purposes of evaluating
impairment by taking into consideration relevant risk characteristics, including
loan type, note rate and date of acquisition. See Note C to the Consolidated
Financial Statements in this report.
The Bank prices its single-family mortgage loans to achieve a competitive yield.
Loan origination and commitment fees, and the related costs associated with
making the loans, are deferred. For fully amortizing loans originated for the
Bank's portfolio, the net deferred fees are accreted to interest income over the
estimated life of the loans using the level-yield method. Fees deferred on
revolving credit lines or loans which have no scheduled amortization originated
for the Bank's portfolio are accreted to income over the estimated lives of the
underlying loans using the straight-line method. Fees deferred on loans
originated and held for sale are not accreted to income but instead are used in
determining the gain or loss on the sale of the loans.
DELINQUENCIES, FORECLOSURES AND ALLOWANCES FOR LOSSES
Delinquencies and Foreclosures. When a borrower fails to make a required payment
on a mortgage loan, the loan is considered delinquent and, after expiration of
the applicable cure period, the borrower is charged a late fee. The Bank follows
practices customary in the banking industry in attempting to cure delinquencies
and in pursuing remedies upon default. Generally, if the borrower does not cure
the delinquency within 90 days, the Bank initiates foreclosure action. If the
loan is not reinstated, paid in full or refinanced, the security property is
sold. In some instances, the Bank may be the purchaser. Thereafter, such
acquired property is listed in the Bank's account for real estate acquired in
settlement of loans until the property is sold. Deficiency judgments generally
may be enforced against borrowers in Maryland, Virginia and the District of
Columbia, but may not be available or may be subject to limitations in other
jurisdictions in which loans are originated by the Bank.
The total outstanding balance of a credit card loan (the largest category of the
Bank's consumer loans) is considered contractually delinquent if the minimum
payment indicated on the cardholder's statement is not received by the due date
indicated on such statement. Efforts to collect contractually delinquent credit
card receivables currently are made by the Bank's service center personnel or
the Bank's designees. Collection activities include statement messages, formal
collection letters and telephone calls. The Bank may, at its option, enter into
arrangements with cardholders to extend or otherwise change payment schedules.
Delinquency levels are monitored by collection managers, and information is
reported regularly to senior management. Accounts are charged off when they
become 180 days contractually delinquent, although the Bank continues to attempt
to collect balances due and, in some cases, may refer the accounts to outside
collection agencies.
<PAGE>
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Asset Quality - Delinquent Loans" for a
discussion of the Bank's delinquent loan portfolio at September 30, 1997.
Allowances for Losses. It is the Bank's policy to maintain adequate allowances
for estimated losses on loans and real estate. Generally, the allowances are
based on, among other things, historical loan loss experience, evaluation of
economic conditions in general and in various sectors of the Bank's customer
base, and periodic reviews of loan portfolio quality by Bank personnel.
Allowances for losses on loans and real estate are based on current events or
facts that may ultimately lead to future losses. The Bank's actual losses may
vary from management's current estimates. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Financial Condition
- - Asset Quality - Allowances for Losses."
The Bank's specific methods for establishing the appropriate levels of
allowances vary depending upon the assets involved. The Bank's allowance on
credit card loans is based on a number of factors, including historical
charge-off and repayment experience and the age of the portfolio. The Bank has
developed a roll rate model to extrapolate its allowance needs based on an
analysis of the characteristics of the portfolio and trends at any particular
time. In this regard, the Bank considers various historical information relative
to origination date, borrower profiles, age of accounts, geographic
concentration, creditworthiness of recent applicants, delinquencies,
bankruptcies and other factors. Although industry standards are considered, they
are given comparatively less weight due to management's belief that comparisons
among different institutions' portfolios are potentially misleading because of
significant differences in underwriting standards, curing and re-aging
procedures and charge-off policies. Chevy Chase's policy is to charge off credit
card receivables at the earlier of when they become 180 days contractually
delinquent or during the month following receipt of notice of the death or
bankruptcy filing of the borrower. The Bank's actual charge-off experience for
credit card loans may vary from the levels forecasted by the Bank's roll rate
model because credit card loans typically are more sensitive to general economic
conditions than certain other types of loans. For example, an unforeseen decline
in economic activity may result in increased bankruptcy losses which the model
is unable to forecast. Nevertheless, because the Bank's model utilities a
rolling 6-month and 12-month base, such unforeseen losses are incorporated into
the model as they occur and allowances are adjusted accordingly. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Asset Quality - Allowances for Losses."
The Bank's methods for determining the allowance on loans secured by real estate
vary depending on whether the loans are secured by residential homes or by other
real estate. For residential mortgage loans, management computes the allowance
by stratifying residential permanent loans on a state by state and ownership
(i.e., investor or homeowner) basis. After the residential permanent portfolio
has been stratified by state, historical loss ratios (as adjusted for
predictable or quantifiable trends, if known) for the specific states are
applied to delinquent loans. The sum of these calculations is the component
assigned to residential permanent loans. In the Bank's experience, this approach
has resulted in timely recognition of necessary allowances, which has been
generally supported by the Bank's favorable results on the ultimate disposition
of the underlying collateral.
<PAGE>
The Bank assesses the adequacy of its general valuation allowances on
non-residential (i.e., other than single-family residential) mortgage loans, REO
and real estate held for investment based primarily on an ongoing evaluation of
individual assets. This evaluation takes into consideration a variety of
factors, including cash flow analyses, independent appraisals, market studies,
economic trends and management's knowledge of the market and experience with
particular borrowers. The Bank obtains current appraisals when properties are
classified as REO. The Bank periodically reviews appraisals and orders new
appraisals as appropriate based on a number of factors, including the date of
the previous appraisal, changes in market conditions and regulatory
requirements.
The Bank regularly reviews its overall loan portfolio consisting of performing
non-classified assets and, based on such review, establishes additional
allowances for losses.
In addition to the general valuation allowances described above, valuation
allowances are provided for individual loans where the ultimate collection is
considered questionable by management after reviewing the current status of
loans which are contractually past due and considering the net realizable value
of the collateral or guarantees, if applicable.
Beginning October 1, 1994, the Bank has been providing additional general
valuation allowances, which are equal to, or exceed, the net earnings generated
by the development and sale of land in the Communities. See "Managements'
Discussion and Analyses of Financial Condition and Results of Operations -
Financial Condition - Asset Quality - Allowances for Losses."
REO is carried at the lower of cost or fair value, less selling costs. To date,
sales of REO, non-residential mortgage loans and loans classified as investments
in real estate have resulted in no material additional aggregate loss to the
Bank above the amounts already reserved. However, these results do not
necessarily assure that the Bank will not suffer losses in the future beyond its
level of allowances.
The Bank's individualized asset review takes place within its Asset Review
Committee and the Asset Classification Committee (the "Committee"). The Asset
Review Committee accumulates and analyzes data relating to classified and
potential problem assets of $5.0 million or more and makes appropriate
recommendations regarding asset classifications to the Committee. The Committee
meets on a regular basis to discuss classifications of such assets and to review
the allowances for losses. The Committee generally reviews the status of various
projects, including, for example, data on recent lot sales for residential
development projects. Actual progress is compared to projections made when the
related loan was underwritten. Local economic conditions and known trends are
also reviewed. The Committee also considers steps being taken by borrowers to
address problems, and reviews financial information relating to borrowers and
guarantors as well as reports by loan officers who are responsible for
continually evaluating the projects. The actions of the Committee are reported
to the Board of Directors.
The Federal Financial Institution Examination Council, which is composed of the
OTS and the other federal banking agencies, has issued guidelines regarding the
appropriate levels of general valuation allowances that should be maintained by
insured institutions. The Bank believes that its levels of general valuation
allowances at September 30, 1997 comply with the guidelines.
The Bank's assets are subject to review and classification by the OTS and the
FDIC upon examination. Based on such examinations, the Bank could be required to
establish additional valuation allowances or incur additional charge-offs.
<PAGE>
DEPOSITS AND OTHER SOURCES OF FUNDS
General. Deposits are the primary source of the Bank's funds for use in lending
and for other general business purposes. In addition to deposits, Chevy Chase
receives funds from loan repayments and loan sales. Loan repayments are a
relatively stable source of funds, while deposit inflows and outflows are
influenced by general interest rates and money-market conditions. Borrowings may
be used to compensate for reductions in normal sources of funds, such as deposit
inflows at less than projected levels or deposit outflows, or to support the
Bank's operating or investing activities.
Deposits. Chevy Chase currently offers a variety of deposit accounts with a
range of interest rates and maturities designed to attract both long-term and
short-term deposits. Deposit programs include Super Statement Savings, Super
NOW, Insured Money Fund, Checking, Simple Statement Savings, Young Savers,
Certificate, and special programs for Individual Retirement and Keogh
self-employed retirement accounts. All jumbo certificates of deposit are sold
directly by the Bank to depositors, either through its branches or through its
money desk operation.
Chevy Chase attracts deposits through its branch network and advertisements, and
offers depositors access to their accounts through 614 ATMs, including 189 ATMs
located in grocery stores. The Bank also has the right to install ATMs in
certain additional grocery stores in the greater Washington,
D.C./Baltimore/Richmond area which do not currently have ATM service. These ATMs
and installation rights significantly enhance the Bank's position as a leading
provider of convenient ATM service in its primary market area. The Bank is a
member of the regional "HONOR"(R) ATM network which offers over 250,000
locations worldwide. The Bank is also a member of the "PLUS"(R) ATM network,
which offers over 368,000 locations worldwide.
The Bank obtains deposits primarily from customers residing in Montgomery and
Prince George's Counties in Maryland and Northern Virginia. Approximately 33.9%
of the Bank's deposits at September 30, 1997 were obtained from depositors
residing outside of Maryland, with approximately 14.5% of the Bank's deposits
being obtained from depositors residing in Northern Virginia.
The following table shows the amounts of Chevy Chase's deposits by type of
account at the dates indicated.
<PAGE>
<TABLE>
DEPOSIT ANALYSIS
(Dollars in thousands)
September 30,
------------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------------------- -------------------- -------------------- -------------------- --------------------
% of % of % of % of % of
Balance Total Balance Total Balance Total Balance Total Balance Total
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Demand and NOW
accounts $ 1,120,375 22.9% $ 1,007,902 24.2% $ 950,118 22.8% $ 918,227 22.9% $ 835,084 21.6%
Money market deposit
accounts 983,016 20.1 1,002,688 24.1 984,257 23.7 1,104,730 27.6 1,196,690 30.9
Statement savings
accounts 907,141 18.5 881,285 21.2 872,366 21.0 1,201,141 30.0 941,289 24.3
Jumbo certificate
accounts 358,737 7.3 125,847 3.0 219,304 5.3 85,110 2.1 56,218 1.5
Other certificate
accounts 1,445,416 29.6 1,077,828 25.9 1,072,196 25.8 641,857 16.0 790,465 20.4
Other deposit
accounts 79,071 1.6 68,487 1.6 61,011 1.4 57,696 1.4 50,277 1.3
------------- ------ ------------- ------ ------------- ------ ------------- ------ --------------------
Total deposits $ 4,893,756 100.0% $ 4,164,037 100.0% $ 4,159,252 100.0% $ 4,008,761 100.0% $ 3,870,023 100.0%
============= ====== ============= ====== ============= ====== ============= ====== ============= ======
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
AVERAGE COST OF DEPOSITS
Year Ended September 30,
----------------------------------------------------------------
1997 1996 1995
-------------------- -------------------- --------------------
<S> <C> <C> <C>
Demand and NOW
accounts 2.47% 2.73% 2.86%
Money market accounts 3.90% 3.87% 3.96%
Statement savings and
other deposit
accounts 3.39% 3.38% 3.35%
Certificate accounts 5.29% 5.48% 5.17%
Total deposit accounts 3.95% 4.02% 3.88%
======== ======== ========
</TABLE>
<PAGE>
The range of deposit account products offered by the Bank through its extensive
branch and ATM network allows the Bank to be competitive in obtaining funds from
its local retail deposit market. At the same time, however, as customers have
become increasingly responsive to changes in interest rates, the Bank has
experienced some fluctuations in deposit flows. Chevy Chase's ability to attract
and maintain deposits and its cost of funds will continue to be significantly
affected by market conditions and its pricing strategy. At September 30, 1997,
the Bank had $378.8 million in brokered deposits which the Bank began accepting
in fiscal 1997 as a way to diversify the Bank's funding sources. However, the
Bank does not currently anticipate significant reliance on brokered deposits as
a key source of funding. Under FDIC regulations, the Bank is permitted to accept
brokered deposits as long as it meets the capital standards established for
"well-capitalized" institutions or with a waiver from the FDIC,
"adequately-capitalized" institutions, under the prompt corrective action
regulations.
<PAGE>
The following table sets forth Chevy Chase's deposit flows during the periods
indicated.
Deposit Flows
Year Ended September 30,
----------------------------------------------
(In thousands)
1997 1996 1995
------------ ------------ ------------
Deposits $ 18,915,801 $ 15,312,125 $ 14,086,575
Withdrawals from accounts (18,348,494) (15,475,215) (14,089,444)
------------ ------------ ------------
Net cash to (from)
accounts 567,307 (163,090) (2,869)
Interest credited to
accounts 162,412 167,875 153,360
------------ ------------ ------------
Net increase in
deposit balances $ 729,719 $ 4,785 $ 150,491
============ ============ ============
Deposit growth may be moderated by the Bank from time to time either to take
advantage of lower cost funding alternatives or in response to more modest
expectations for loan and other asset growth.
The following table sets forth, by weighted average interest rates, the types
and amounts of deposits as of September 30, 1997 which will mature during the
fiscal years indicated.
<PAGE>
<TABLE>
WEIGHTED AVERAGE INTEREST RATES OF DEPOSITS
As of September 30, 1997
(Dollars in thousands)
Demand, NOW
and Money Market Statement Passbook and Other Certificate
Deposit Accounts Savings Accounts Core Accounts Accounts Total
--------------------- --------------------- --------------------- --------------------- ---------------------
Maturing During Weighted Weighted Weighted Weighted Weighted
Year Ending Average Average Average Average Average
September 30, Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
- -------------- ----------- --------- ----------- --------- ----------- --------- ------------ -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1998 $ 2,103,391 2.90% $ 907,141 3.48% $ 79,071 2.97% $ 1,514,252 5.53% $ 4,603,855 3.88%
1999 - - - - - - 139,458 5.28 139,458 5.28
2000 - - - - - - 104,298 6.51 104,298 6.51
2001 - - - - - - 19,459 5.52 19,459 5.52
2002 - - - - - - 26,686 5.81 26,686 5.81
----------- ----------- ----------- ------------ -----------
Total $ 2,103,391 2.90% $ 907,141 3.48% $ 79,071 2.97% $ 1,804,153 5.57% $ 4,893,756 3.99%
=========== =========== =========== ============ ===========
</TABLE>
<PAGE>
The following table summarizes maturities of certificate accounts in amounts of
$100,000 or greater as of September 30, 1997.
Year Ending Weighted
September 30, Amount Average Rate
- -------------- ----------- ------------
1998 $ 620,291 5.88%
1999 9,676 5.57%
2000 12,984 6.72%
2001 1,573 5.50%
2002 2,905 5.70%
-----------
Total $ 647,429 5.69%
=========== =====
The following table represents the amounts of deposits by various interest rate
categories as of September 30, 1997 maturing during the fiscal years indicated.
<PAGE>
<TABLE>
MATURITIES OF DEPOSITS BY INTEREST RATES
As of September 30, 1997
(In thousands)
Accounts Maturing During Year Ending September 30,
-----------------------------------------------------------------------------------------------------------
Interest Rate 1998 1999 2000 2001 2002 Total
- -------------------- --------------- --------------- -------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Demand deposits (0%) $ 215,678 $ - $ - $ - $ - $ 215,678
0.01% to 1.99% 260 - - - - 260
2.00% to 2.99% 936,652 - - - - 936,652
3.00% to 3.99% 1,242,652 - - - - 1,242,652
4.00% to 4.99% 839,225 21,385 1,250 429 - 862,289
5.00% to 5.99% 1,076,537 109,836 16,753 19,006 12,644 1,234,776
6.00% to 7.99% 292,817 8,237 86,295 24 14,042 401,415
8.00% to 9.99% 34 - - - 34
--------------- --------------- -------------- -------------- -------------- ---------------
Total $ 4,603,855 $ 139,458 $ 104,298 $ 19,459 $ 26,686 $ 4,893,756
=============== =============== ============== ============== ============== ===============
</TABLE>
<PAGE>
Borrowings. The FHLB system functions as a central reserve bank providing credit
for member institutions. As a member of the FHLB of Atlanta, Chevy Chase is
required to own capital stock in the FHLB of Atlanta and is authorized to apply
for advances on the security of such stock and certain of its mortgages and
other assets (principally securities which are obligations of, or guaranteed by,
the United States or its agencies), provided certain standards related to
creditworthiness have been met.
Under the credit policies of the FHLB of Atlanta, credit may be extended to
creditworthy institutions based upon the financial condition, and the adequacy
of collateral pledged to secure the extension of credit. Such extensions of
credit or borrowings may be obtained pursuant to several different credit
programs, each of which has its own rate and range of maturities. Advances from
the FHLB of Atlanta must be secured by certain types of collateral with a value,
as determined by the FHLB of Atlanta, at least equal to 100% of the borrower's
outstanding advances. The Bank had outstanding FHLB advances of $188.5 million
at September 30, 1997.
From time to time, the Bank enters into repurchase agreements, which are treated
as financings. The Bank sells securities (usually mortgage-backed securities) to
a dealer and agrees to buy back the same securities at a specified time
(generally within seven to 90 days). The Bank pays a stated interest rate for
the use of the funds for the specified time period to the dealer. The obligation
to repurchase the securities sold is reflected as a liability and the securities
underlying the agreements are included in assets in the Consolidated Balance
Sheets in this report. These arrangements are, in effect, borrowings by the Bank
secured by the securities sold. The Bank had outstanding repurchase agreements
of $2.6 million at September 30, 1997.
The following table sets forth a summary of the repurchase agreements of the
Bank as of the dates and for the years indicated.
September 30,
---------------------------
1997 1996
-------- --------
(Dollars in thousands)
Securities sold under repurchase agreements:
Balance at year-end $ 2,606 $576,823
Average amount outstanding at any
month-end 483,076 59,687
Maximum amount outstanding at any
month-end 946,090 576,823
Weighted average interest rate during
the year 5.48% 5.50%
Weighted average interest rate on
year-end balances 5.35% 5.41%
<PAGE>
In December 1986, the Bank issued an unsecured ten-year subordinated capital
note in the original principal amount of $10.0 million to BACOB Bank, s.c., a
foreign private savings bank. On November 15, 1996, the Bank redeemed this note
at par.
On November 23, 1993, the Bank sold $150 million principal amount of its 9 1/4%
Subordinated Debentures due 2005 (the "1993 Debentures"). Interest on the 1993
Debentures is payable semiannually on December 1 and June 1 of each year. The
OTS approved the inclusion of the principal amount of the 1993 Debentures in the
Bank's supplementary capital for regulatory capital purposes. On or after
December 1, 1998, the 1993 Debentures will be redeemable, in whole or in part,
at any time at the option of the Bank.
On December 3, 1996, the Bank sold $100 million principal amount of its 9 1/4%
Subordinated Debentures due 2008. Interest on the 1996 Debentures is payable
semiannually on December 1 and June 1 of each year. The OTS approved the
inclusion of the principal amount of the 1996 Debentures in the Bank's
supplementary capital for regulatory capital purposes. On or after December 1,
2001, the 1996 Debentures will be redeemable, in whole or in part, at any time
at the option of the Bank.
Under the OTS capital regulations, redemption of the 1993 Debentures or the 1996
Debentures prior to their stated maturity would be subject to prior approval of
the OTS unless the debentures are redeemed with the proceeds of, or replaced by,
a like amount of "a similar or higher quality" capital instrument.
SUBSIDIARIES
OTS regulations generally permit the Bank to make investments in service
corporation subsidiaries in an amount not to exceed 3.0% of the Bank's assets,
provided that any investment in excess of 2.0% of assets serves primarily
community, inner city or community development purposes. Such regulations also
permit the Bank to make "conforming loans" to such subsidiaries and joint
ventures in an amount not to exceed 50% of the Bank's regulatory capital. At
September 30, 1997, 2.0% and 3.0% of the Bank's assets was equal to $121.9
million and $182.9 million, respectively, and the Bank had $9.3 million invested
in its service corporation subsidiaries, $5.0 million of which was in the form
of conforming loans.
The Bank is required to provide 30 days advance notice to the OTS and to the
FDIC before establishing a new subsidiary or conducting a new activity in an
existing subsidiary. With prior written approval from the OTS, the Bank may also
establish operating subsidiaries to engage in any activities in which the Bank
may engage directly. The Bank engages in a variety of other activities through
its subsidiaries, including those described below.
Real Estate Development Activities. Manor Investment Company ("Manor") was
engaged in certain real estate development activities commenced prior to the
enactment of FIRREA and continues to manage the two remaining properties it
holds. As a result of the stringent capital requirements that FIRREA applies to
investments in subsidiaries, such as Manor, that engage in activities
impermissible for national banks, Manor has not entered, and does not intend to
enter, into any new real estate development arrangements. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations
Financial Condition - Asset Quality."
<PAGE>
Securities Brokerage Services. Chevy Chase Securities, Inc., is a subsidiary of
Chevy Chase Financial Services Corporation ("CCFS"), a wholly-owned subsidiary
of Chevy Chase. Chevy Chase Securities, Inc. is a licensed broker-dealer,
selling securities on a retail basis to the general public, including customers
and depositors of the Bank.
Insurance Services. Chevy Chase Insurance Agency, Inc., a subsidiary of CCFS, is
a licensed insurance broker offering a variety of "personal line" insurance
programs in the property and casualty field (primarily homeowner and automobile
insurance) and in the life insurance field (primarily mortgage and credit card
life and disability programs).
Special Purpose Subsidiaries. At September 30, 1997, Chevy Chase Real Estate
Corporation ("CCRC"), a subsidiary of Chevy Chase, held 100% of the common stock
of 25 subsidiaries (14 of which are active) that were formed for the sole
purpose of acquiring title to various real estate projects pursuant to
foreclosure or deed-in-lieu of foreclosure. The Bank's investment in the
subsidiaries was $131.8 million at September 30, 1997. The Bank's investment in
CCRC is not subject to the 3.0% service corporation investment limit discussed
above.
Operating Subsidiaries. Chevy Chase engages in significant mortgage lending
activities through B.F. Saul Mortgage Company ("BFSMC"). See "Lending
Activities". CCB Holding Corporation ("CCBH") is a Delaware corporation created
by the Bank as an operating subsidiary in September 1994 in connection with its
asset securitization activities. CCBH owns certain certificates issued by two
credit card trusts formed by the Bank and certain other related assets. Consumer
Finance Corporation was formed as an operating subsidiary in December 1994 to
engage in automobile lending. Chevy Chase Preferred Capital Corporation was
formed as an operating subsidiary to issue the REIT Preferred Stock.
On November 12, 1997, a newly formed operating subsidiary of the Bank acquired
ASB Capital Management, Inc. through which the Bank will offer investment,
management and fiduciary services to primarily institutional customers.
EMPLOYEES
The Bank and its subsidiaries had 3,424 full-time and 776 part-time employees at
September 30, 1997. The Bank provides its employees with a comprehensive range
of employee benefit programs, including group health benefits, life insurance,
disability insurance, paid sick leave and an employee loan program. The Bank
offers home mortgage and credit card loans to employees at prevailing market
rates, but waives up to one point of any loan origination fees on home mortgage
loans and the annual fee on credit card loans, and provides a yearly rebate
equal to 0.5% of the outstanding loan balance of home mortgage loans at calendar
year-end. The Bank also offers employees a one percent discount on the interest
rate on overdraft lines of credit. See "Executive Compensation" for a discussion
of certain compensation programs available to the Bank's executive officers.
None of the Bank's employees is represented by a collective bargaining agent.
The Bank believes that its employee relations are good.
<PAGE>
COMPETITION
Chevy Chase encounters strong competition both in attracting deposits and making
real estate and other loans in its markets. The Bank's most direct competition
for deposits has come from other thrift institutions, commercial banks and
credit unions, as well as from money market funds and corporate and government
securities. In addition to offering competitive interest rates, Chevy Chase
offers a variety of services, convenient ATM locations and convenient office
locations and hours to attract deposits. Competition for real estate and other
loans comes principally from other thrifts, banks, mortgage banking companies,
insurance companies and other institutional lenders. Chevy Chase competes for
loans through interest rates, loan fees and the variety and quality of services
provided to borrowers and brokers.
The Bank's major competition historically has come from local depository
institutions, but deregulation of the financial services industry and changing
market demands in recent years have eroded distinctions between providers of
financial services. In addition, both depository and non-depository institutions
have greater nationwide access to attractive markets, such as the Washington,
D.C. area, than they have had in past years. Chevy Chase now competes with
regional financial institutions and national providers of investment
alternatives, as well as with a number of large money center and regional banks
that have acquired institutions in the area.
The Bank estimates that it competes principally with approximately eight
depository institutions in its deposit-taking activities in the Washington, DC
metropolitan area. The Bank also competes with such institutions in the
origination of single-family residential mortgage loans and home equity credit
line loans. According to the most recently published industry statistics, Chevy
Chase had the largest market share (approximately 20.9%) of deposits in
Montgomery County, Maryland, and ranked third in market share of deposits in
Prince George's County, Maryland at June 30, 1996. Based on publicly available
information, Chevy Chase estimates that, in the Washington, DC metropolitan
area, it maintains the leading market share of single-family residential
mortgage and home equity credit line loans.
The credit card industry is highly competitive and characterized by increasing
use of advertising, target marketing, pricing competition in interest rates and
annual membership fees, and other features (such as buyer protection plans), as
both established and new credit card issuers seek to expand or to enter the
market. Management anticipates that competitive pressures will continue to
require adjustments, from time to time, to the pricing of the Bank's credit card
products.
Interstate banking laws enacted by Congress and various states have intensified
the competition faced by the Bank in attracting deposits and making loans. A
number of large out-of-state financial institutions have established or acquired
banking operations in Maryland, Virginia and the District of Columbia pursuant
to these provisions.
<PAGE>
PROPERTIES
REAL ESTATE
A list of the investment properties of the Real Estate Trust is set forth under
"Business - Real- Estate - Real Estate Investments."
The Trust conducts its principal business from its executive offices at 8401
Connecticut Avenue, Chevy Chase, Maryland. The Trust sells its unsecured notes
due one year to ten years from date of issue from a sales office located at 7200
Wisconsin Avenue, Suite 903, Bethesda, Maryland. The Saul Company leases both
office facilities on behalf of the Trust.
BANKING
At September 30, 1997, the Bank conducted its business from its home office at
7926 Jones Branch Drive, McLean, Virginia and its executive offices at 8401
Connecticut Avenue, Chevy Chase, Maryland; its operations centers at 6151 and
6200 Chevy Chase Drive, Laurel, Maryland, and 5202 President's Court, Frederick,
Maryland; its office facilities at 7700 Old Georgetown Road, Bethesda, Maryland;
and 128 full-service offices located in Maryland, Virginia and the District of
Columbia. On that date, the Bank owned the building and land for 24 of its
branch offices and leased its remaining 104 branch offices. Chevy Chase leases
the office facilities at 8401 Connecticut Avenue, 6200 Chevy Chase Drive and the
land at 7700 Old Georgetown Road. Chevy Chase owns the building at 7700 Old
Georgetown Road. In addition, the Bank leases office space in which its
subsidiaries are housed. The office facility leases have various terms expiring
from 1998 to 2019 and the ground leases have terms expiring from 2029 to 2080.
See Note 16 to the Consolidated Financial Statements in this report for lease
expense and commitments. As of November, 1997, the Bank has received OTS
approval to open four branches and is awaiting OTS approval to open another two
branches. The branches, two in Virginia, two in Maryland and two in the District
of Columbia, are scheduled to open during fiscal 1998.
As of November 1997, the Bank has received OTS approval to open four branches
and is awaiting OTS approval to open another two branches. The branches, two
in Virginia, two in Maryland and two in the District of Columbia, are
scheduled to open during fiscal 1998.
The following table sets forth the location of the Bank's 128 full-service
offices at September 30, 1997.
1 Catoctin Circle 14245-R Centreville Square
Leesburg, VA 22075 Centreville, VA 20121
8201 Greensboro Drive 1100 W. Broad Street
McLean, VA 22102 Falls Church, VA 22046
234 Maple Avenue East 3941 Pickett Road
McLean, VA 22180 Fairfax, VA 22031
8436 Old Keene Mill Road 1439 Chain Bridge Road
Springfield, VA 22152 McLean, VA 22101
75 West Lee Highway 8120 Sudley Road
Warrenton, VA 22186 Manassas, VA 22110
6367 Seven Corners Center 1100 S. Hayes Street
Falls Church, VA 22044 Arlington, VA 22202
11800 Sunrise Valley 13344-A Franklin Farms
Drive Road
Reston, VA 22091 Herndon, VA 22071
2952-H Chain Bridge Road 20970 Southbanks Street
Oakton, VA 22124 Sterling, VA 20165
6756 Richmond Highway 21800 Towncenter Plaza
Alexandria, VA 22306 Sterling, VA 20164
5613 Stone Road 7030 Little River Turnpike
Centreville, VA 22020 Annandale, VA 22003
44151 Ashburn Village Way 3095 Nutley Street
Ashburn, VA 22011 Fairfax, VA 22031
<PAGE>
3690-A King Street 4700 Lee Highway
Alexandria, VA 22302 Arlington, VA 22207
6609 Springfield Mall 5851 Crossroads Center Way
Springfield, VA 22150 Falls Church, VA 22041
500 South Washington
Street 7340 Westlake Terrace
Alexandria, VA 22314 Bethesda, MD 20817
3499 S. Jefferson Street 11261 New Hampshire Avenue
Baileys Crossroads, VA Silver Spring, MD 20904
22041
6025-A Burke Town Center
Parkway 1327 Lamberton Drive
Burke, VA 22015 Silver Spring, MD 20902
3046 Gatehouse Plaza 1609-B Rockville Pike
Falls Church, VA 22042 Rockville, MD 20852
7935 L Tysons Corner
Center 2215 Bel Pre Road
McLean, VA 22102 Wheaton, MD 20906
1621 B Crystal Square 2807 University Boulevard
Arcade West
Arlington, VA 22202 Kensington, MD 20895
1100 Wilson Boulevard 11301 Rockville Pike
Arlington, VA 22209 Kensington, MD 20895
5230-A Port Royal Road 7500 Old Georgetown Road
Springfield, VA 22151 Bethesda, MD 20814
4299 Merchant Plaza 26001 Ridge Road
Woodbridge, VA 22192 Damascus, MD 20872
8628 Richmond Highway 5370 Westbard Avenue
Alexandria, VA 22309 Bethesda, MD 20816
11874 Spectrum Center 3601 St. Barnabas Road
Reston, VA 20190 Silver Hill, MD 20746
46160 Potomac Run Plaza 17831 Georgia Avenue
Sterling, VA 20164 Olney, MD 20832
8401 Connecticut Avenue 6107 Greenbelt Road
Chevy Chase, MD 20815 Berwyn Heights, MD 20740
5424 Western Avenue 4 Bureau Drive
Chevy Chase, MD 20815 Gaithersburg, MD 20878
<PAGE>
13641 Connecticut Avenue 19610 Club House Road
Wheaton, MD 20906 Gaithersburg, MD 20879
8315 Georgia Avenue 812 Muddy Branch Road
Silver Spring, MD 20910 Gaithersburg, MD 20878
4701 Sangamore Road 10211 River Road
Bethesda, MD 20816 Potomac, MD 20854
Landover Mall 12331-C Georgia Avenue
Landover, MD 20785 Wheaton, MD 20906
11325 Seven Locks Road 14113 Baltimore Avenue
Potomac, MD 20854 Laurel, MD 20707
6200 Annapolis Road 7290-A Cradlerock Way
Landover Hills, MD 20784 Columbia, MD 21045
33 West Franklin Street 1151 Maryland Route 3 North
Hagerstown, MD 21740 Gambrills, MD 21054
6400 Belcrest Road 12228 Viers Mill Road
Hyattsville, MD 20782 Silver Spring, MD 20906
8740 Arliss Street 317 Kentlands Boulevard
Silver Spring, MD 20901 Gaithersburg, MD 20878
2409 Wootton Parkway 215 N. Washington Street
Rockville, MD 20850 Rockville, MD 20850
8889 Woodyard Road 1336 Crain Highway South
Clinton, MD 20735 Mitchellville, MD 20716
1181 University Boulevard 543 Ritchie Highway
Langley Park, MD 20783 Severna Park, MD 21146
12921 Wisteria Drive 4745 Dorsey Hall Drive
Germantown, MD 20874 Ellicott City, MD 21042
1009 West Patrick Street 1130 Smallwood Drive
Frederick, MD 21701 Waldorf, MD 20603
7937 Ritchie Highway 10800 Baltimore Avenue
Glen Burnie, MD 21061 Beltsville, MD 20705
19781-83 Frederick Road 1040 Largo Center Drive
Germantown, MD 20876 Landover, MD 20785
16827 Crabbs Branch Way 6335 Marlboro Pike
Rockville, MD 20855 District Heights, MD 20747
2331-A Forest Drive 7530 Annapolis Road
Annapolis, MD 21401 Lanham, MD 20784
<PAGE>
15460 Annapolis Road 11241 Georgia Avenue
Bowie, MD 20715 Wheaton, MD 20902
20000 Goshen Road 13484 New Hampshire Avenue
Gaithersburg, MD 20879 Silver Spring, MD 20904
12097 Rockville Pike 2401 Cleanleigh Drive
Rockville, MD 20852 Baltimore, MD 21234
10159 New Hampshire
Avenue 7101 Democracy Boulevard
Hillandale, MD 20903 Bethesda, MD 20814
6264 Central Avenue 4825 Cordell Avenue
Seat Pleasant, MD 20743 Bethesda, MD 20814
7700 Old Georgetown Road 7515 Greenbelt Road
Bethesda, MD 20814 Greenbelt, MD 20770
15777 Columbia Pike 2722 N. Salisbury Boulevard
Burtonsville, MD 20866 Salisbury, MD 21801
18104 Town Center Drive 509 N. Frederick Avenue
Olney, MD 20832 Gaithersburg, MD 20877
6197 Oxon Hill Road 504 Ridgeville Boulevard
Oxon Hill, MD 20745 Mt. Airy, MD 21771
10821 Connecticut Avenue 5823 Eastern Avenue
Kensington, MD 20895 Chillum, MD 20782
18006 Mateny Road 3355 Corridor Market Place
Germantown, MD 20874 Laurel, MD 20724
7406 Baltimore Avenue 4860 Massachusetts Avenue, NW
College Park, MD 20740 Washington, DC 20016
10400 Old Georgetown Road 4000 Wisconsin Avenue, NW
Bethesda, MD 20814 Washington, DC 20016
980 E. Swan Creek Road 210 Michigan Avenue, NE
Fort Washington, MD 20744 Washington, DC 20017
115 University Boulevard West 4455 Connecticut Avenue, NW
Silver Spring, MD 20901 Washington, DC 20008
<PAGE>
3828 International Drive 2831 Alabama Avenue, SE
Silver Spring, MD 20906 Washington, DC 20020
9707 Old Georgetown Road 1800 M Street, NW
Bethesda, MD 20814 Washington, DC 20036
3400 Crain Highway 1545 Wisconsin Avenue, NW
Bowie, MD 20716 Washington, DC 20007
5714 Connecticut Avenue, NW 1717 Pennsylvania Avenue, NW
Washington, DC 20015 Washington, DC 20006
At September 30, 1997, the net book value of the Bank's office facilities
(including leasehold improvements) was $193.9 million. See Note 15 to the
Consolidated Financial Statements in this report.
During fiscal 1997, the Bank completed the construction of a facility in
Frederick, Maryland and consolidated the Bank's employees and operations in that
area. At September 30, 1997, the Bank had invested $4.0 million in the land and
$27.4 million for capital expenditures relating to this facility.
During fiscal 1995, the Bank transferred an office building, which was
previously classified as real estate held for investment, to property and
equipment and the Bank began to occupy a portion of the building during fiscal
1996 in order to satisfy its need for additional office space.
In fiscal 1991, the Bank purchased an office building and the underlying land in
downtown Washington, D.C. with plans to establish a deposit branch office and a
trust office in the building. Although the Bank has no current plans to
establish a trust office there, it is currently seeking OTS approval to
establish a branch in the building during fiscal 1998.
The Bank owns additional assets, including furniture and data processing
equipment. At September 30, 1997, these other assets had a net book value of
$79.6 million. The Bank also has operating leases, primarily for certain data
processing equipment and software. Such leases have month-to-month or
year-to-year terms.
<PAGE>
LEGAL PROCEEDINGS
In the normal course of business, the Trust is involved in certain litigation,
including litigation arising out of the collection of loans, the enforcement or
defense of the priority of its security interests, the continued development and
marketing of certain of its real estate properties, and certain employment
claims. In the opinion of management, litigation which is currently pending will
not have a material adverse impact on the financial condition or future
operations of the Trust.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended September 30, 1997.
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED TOCKHOLDER MATTERS
There currently is no established public trading market for the Trust's Common
Shares of Beneficial Interest (the "Common Shares"). At December 5, 1997, there
were nine corporate or individual holders of record of Common Shares. All
holders of Common Shares at such date were affiliated with the Trust. See
"Security Ownership of Certain Beneficial Owners and Management."
SELECTED FINANCIAL DATA
The selected financial data of the Trust herein have been derived from the
Consolidated Financial Statements of the Trust. The data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements included
elsewhere in this report.
<PAGE>
<TABLE>
SELECTED FINANCIAL DATA
===================================================================================================================================
Year Ended September 30
------------------------------------------------------------------------
(In thousands, except per share amounts and other data) 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Real Estate:
Revenues $ 84,569 $ 76,839 $ 77,285 $ 66,044 $ 93,245
Operating expenses 108,601 104,321 109,971 102,087 137,256
Equity in earnings (losses) of partnership investments 4,150 3,374 3,681 1,738 (668)
Gain (loss) on sales of property 895 (68) 1,664 -- 184
------------------------------------------------------------------------
Real estate operating loss (18,987) (24,176) (27,341) (34,305) (44,495)
------------------------------------------------------------------------
Banking:
Interest income 450,480 387,511 365,315 334,464 348,814
Interest expense 239,815 188,836 189,114 165,544 167,518
------------------------------------------------------------------------
Net interest income 210,665 198,675 176,201 168,920 181,296
Provision for loan losses (125,115) (115,740) (54,979) (29,222) (60,372)
------------------------------------------------------------------------
Net interest income after provision for loan losses 85,550 82,935 121,222 139,698 120,924
------------------------------------------------------------------------
Other income:
Credit card, loan servicing and deposit service fees 327,091 324,804 218,572 111,279 91,216
Earnings (loss) on real estate held for investment or
sale, net (18,688) (24,413) (5,549) 835 (12,722)
Gain on sales of assets 75,025 24,400 12,282 32,217 40,270
Net unrealized gain on valuation of interest-only
strips 6,976 -- -- -- --
Other 22,573 19,713 7,320 15,718 11,989
------------------------------------------------------------------------
Total other income 412,977 344,504 232,625 160,049 130,753
------------------------------------------------------------------------
Operating expenses 418,346 381,328 298,164 246,560 187,828
------------------------------------------------------------------------
Banking operating income 80,181 46,111 55,683 53,187 63,849
------------------------------------------------------------------------
Total Company:
Operating income before income taxes, 61,194 21,935 28,342 18,882 19,354
extraordinary items, cumulative effect of change in
accounting principle, and minority interest
Provision for income taxes 12,810 8,301 2,021 7,025 11,703
------------------------------------------------------------------------
Income before extraordinary items, cumulative
effect of change in accounting principle and
minority interest 48,384 13,634 26,321 11,857 7,651
Extraordinary items:
Adjustment for tax benefit of operating loss
carryovers -- -- -- -- 7,738
Loss on early extinguishment of debt, net of taxes -- -- -- (11,315) --
------------------------------------------------------------------------
Income before cumulative effect of change in
accounting principle and minority interest 48,384 13,634 26,321 542 15,389
Cumulative effect of change in accounting principle -- -- -- 36,260 --
------------------------------------------------------------------------
Income before minority interest 48,384 13,634 26,321 36,802 15,389
Minority interest held by affiliates (6,848) (3,962) (5,721) (3,963) (6,582)
Minority interest -- other (22,676) (9,750) (9,750) (9,750) (4,334)
------------------------------------------------------------------------
Total company net income (loss) $ 18,860 $ (78) $ 10,850 $ 23,089 $ 4,473
========================================================================
Net income (loss) available to common shareholders $ 13,442 $ (5,498) $ 5,430 $ 17,669 $ (947)
Net income (loss) per common share:
Income before extraordinary items, cumulative
effect of change in accounting principle and
minority interest $ 8.90 $ 1.70 $ 4.33 $ 1.33 $ 0.46
Extraordinary items:
Adjustment for tax benefit of operating loss
carryovers -- -- -- -- 1.60
Loss on early extinguishment of debt, net of taxes -- -- -- (2.34) --
------------------------------------------------------------------------
Income (loss) before cumulative effect of change in
accounting principle and minority interest 8.90 1.70 4.33 (1.01) 2.06
Cumulative effect of change in accounting principle -- -- -- 7.51 --
------------------------------------------------------------------------
Income before minority interest 10.03 1.70 4.33 6.50 2.06
Minority interest held by affiliates (1.42) (0.82) (1.19) (0.82) (1.36)
Minority interest -- other (4.70) (2.02) (2.02) (2.02) (0.90)
------------------------------------------------------------------------
Total company net income (loss) $ 2.78 $ (1.14) $ 1.12 $ 3.66 $ (0.20)
========================================================================
- -----------------------------------------------------------------------------------------------------------------------------------
Continued on following page.
</TABLE>
<PAGE>
<TABLE>
SELECTED FINANCIAL DATA
(Continued)
==================================================================================================================================
Year Ended September 30
------------------------------------------------------------------------
(In thousands, except per share amounts and other data) 1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Assets:
Real estate assets $ 300,573 $ 294,503 $ 313,412 $ 327,739 $ 220,556
Income-producing properties, net 156,535 156,115 163,787 159,529 162,356
Land parcels 42,160 41,580 38,458 38,455 38,411
Banking assets 6,057,413 5,693,074 4,911,536 4,666,298 4,872,771
Total company assets 6,357,986 5,987,577 5,224,948 4,994,037 5,093,327
Liabilities:
Real estate liabilities 590,910 578,092 555,814 558,109 450,153
Mortgage notes payable 180,204 173,345 184,502 185,730 264,776
Notes payable - secured 175,000 177,500 175,500 175,000 --
Notes payable - unsecured 46,633 42,367 41,057 40,288 38,661
Banking liabilities 5,582,167 5,388,444 4,619,451 4,413,832 4,634,001
Minority interest held by affiliates 51,388 46,065 43,556 35,632 34,495
Minority interest - other 218,306 74,307 74,307 74,307 74,307
Total company liabilities 6,442,771 6,086,908 5,293,128 5,081,880 5,192,956
Shareholders' deficit (84,785) (99,331) (68,180) (87,843) (99,629)
- ----------------------------------------------------------------------------------------------------------------------------------
CASH FLOW DATA:
Net cash flows provided by (used in) operating activities:
Real estate $ 6,911 $ 9,032 $ 4,324 $ (10,859) $ (3,149)
Banking 2,358,691 1,739,505 2,088,022 2,218,262 1,137,686
------------------------------------------------------------------------
Total Company 2,365,602 1,748,537 2,092,346 2,207,403 1,134,537
------------------------------------------------------------------------
Net cash flows provided by (used in) investing activities:
Real estate (11,664) (4,907) (17,143) (29,118) (2,999)
Banking (2,266,569) (2,559,381) (2,261,803) (1,777,281) (879,178)
------------------------------------------------------------------------
Total Company (2,278,233) (2,564,288) (2,278,946) (1,806,399) (882,177)
------------------------------------------------------------------------
Net cash flows provided by (used in) financing activities:
Real estate 7,485 (5,964) (271) 75,723 3,230
Banking 293,344 727,019 160,966 (260,094) (190,850)
------------------------------------------------------------------------
Total Company 300,829 721,055 160,695 (184,371) (187,620)
------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 388,198 (94,696) (25,905) 216,633 64,740
- ----------------------------------------------------------------------------------------------------------------------------------
OTHER DATA:
Hotels:
Number of hotels 10 9 10 9 9
Number of guest rooms 2,370 2,261 2,608 2,415 2,356
Average occupancy 70% 68% 67% 62% 68%
Average room rate $72.21 $68.79 $60.82 $57.57 $54.02
Shopping centers:
Number of properties N/A N/A N/A N/A 23
Leasable area (square feet) N/A N/A N/A N/A 4,408,000
Average occupancy N/A N/A N/A N/A 95%
Office properties:
Number of properties (1) 8 8 9 9 10
Leasable area (square feet) (1) 1,308,000 1,308,000 1,368,000 1,363,000 1,537,000
Leasing percentages (1) 99% 93% 84% 93% 85%
Land parcels:
Number of parcels 10 9 10 10 12
Total acreage 439 446 433 433 1,496
(1) Includes Dulles South Office Building which is owned
by a subsidiary in which the Trust has a 50% interest.
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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
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 Real Estate Trust's investment portfolio at September 30, 1997 consisted
primarily of hotels, office and industrial projects, and land parcels. See
"Business - Real Estate - Real Estate Investments." In the first quarter of
fiscal 1997, the Real Estate Trust purchased a 115-room Holiday Inn Express in
Herndon, Virginia. In the last quarter of fiscal 1997, the Real Estate Trust
sold its purchase-leaseback property in Casper, Wyoming.
Office space in the Real Estate Trust's office property portfolio was 99% leased
at September 30, 1997, compared to a leasing rate of 93% at September 30, 1996.
At September 30, 1997, the Real Estate Trust's office property portfolio had a
total gross leasable area of approximately 1.3 million square feet, of which
277,000 square feet (21.2%) and 279,000 square feet (21.3%) are subject to
leases whose terms expire in fiscal 1998 and fiscal 1999, respectively.
Overall, the hotel portfolio experienced an average occupancy rate of 70% and
average room rate of $72.21 during the year ended September 30, 1997. For the
eight hotels owned by the Real Estate Trust throughout fiscal 1997 and fiscal
1996, the average occupancy rates were 69% and 68%, respectively, and the
average room rates were $70.41 and $66.98, respectively. Five of these hotels
registered improved occupancies and six registered higher average room rates in
the current fiscal year.
BANKING
General. The Bank recorded operating income of $80.2 million during fiscal 1997,
compared to operating income of $46.1 million in fiscal 1996. The increase in
income for fiscal 1997 was primarily attributable to a $68.5 million increase in
other (non-interest) income and an $11.9 million increase in net interest income
before provision for loan losses, the effect of which was partially offset by a
$9.4 million increase in the provision for loan losses and a $37.0 million
increase in operating (non-interest) expense. See "Results of Operations."
<PAGE>
Gain on sales of loans of $73.8 million, which increased 217.6% over fiscal
1996, was a large component of the Bank's non-interest income during the current
year and resulted primarily from the Bank's securitization activity. During
fiscal 1997, the Bank securitized and sold $2.4 billion of receivables, of which
$1.1 billion, $286.4 million, $938.9 million and $224.1 million, related to
securitizations and sales of credit card, home equity, automobile and home loan
receivables, respectively, and recognized gains of $33.1 million, $11.8 million,
$26.9 million and $10.0 million, respectively. In addition, the Bank 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 Note C and Note 14 to the Consolidated Financial Statements
in this report. See "Liquidity."
Real estate owned, net of valuation allowances, declined 24.4% during fiscal
1997 to $90.7 million at September 30, 1997, from $119.9 million at September
30, 1996. This reduction was primarily due to sales in the Communities and other
residential properties and additional valuation allowances. See "REO."
During fiscal 1997, the Bank experienced a decline in the performance of its
credit card portfolio which resulted in increased delinquent amounts and net
charge-offs recorded for the year and reflects the trends that are affecting the
credit card industry as a whole. See "Business - Lending Activities - Credit
Card Lending" and "Asset Quality - Allowances for Losses."
At September 30, 1997, the Bank's tangible, core, tier 1 risk-based and total
risk-based regulatory capital ratios were 6.96%, 6.96%, 7.24% and 13.50%,
respectively. The Bank's capital ratios exceeded the requirements under FIRREA
as well as the standards established for "well-capitalized" institutions under
the prompt corrective action regulations issued pursuant to FDICIA. See
"Capital."
On December 3, 1996, the Bank sold $100 million principal amount of its 9 1/4%
Subordinated Debentures due 2008, the principal amount of which is includable in
the Bank's supplementary capital. In addition, on December 3, 1996, the REIT
Subsidiary sold $150 million of REIT Preferred Stock, which is eligible for
inclusion as core capital of the Bank in an amount up to 25% of the Bank's total
core capital. Minority interest in the amount of $12.9 million was recorded
during fiscal 1997 as a reduction to net income.
On November 12, 1997 the Bank purchased 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, through which the Bank will provide a variety of investment
products and fiduciary services to a primarily institutional customer base. The
Bank anticipates that the acquisition will provide an additional source of
fee-based revenues. Although the acquisition generated additional goodwill which
reduced the Bank's regulatory capital levels, the Bank's capital levels
immediately following the acquisition remained above the levels established for
well-capitalized institutions.
During fiscal 1997, the Bank declared and paid, out of the retained earnings of
the Bank, cash dividends on its Common Stock in the amount of $900 per share.
The Bank's assets are subject to review and classification by the OTS upon
examination. The OTS concluded its most recent annual examination of the Bank in
June 1997.
<PAGE>
Asset Quality. Non-Performing Assets. The Bank's level of non-performing assets
continued to decline during fiscal 1997. 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 AND PAST DUE CREDIT CARD LOANS
(Dollars in thousands)
September 30,
-------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Non-performing assets:
Non-accrual loans:
Residential $ 9,617 $ 8,200 $ 8,593 $ 8,306 $ 9,108
Commercial real estate and multifamily -- -- 194 -- --
------------ ------------ ------------- ------------ ------------
Total non-accrual real estate loans 9,617 8,200 8,787 8,306 9,108
Credit card (1) -- 25,350 18,569 16,229 20,557
Consumer and other 4,226 1,239 595 498 314
------------ ------------ ------------- ------------ ------------
Total non-accrual loans (2) 13,843 34,789 27,951 25,033 29,979
------------ ------------ ------------- ------------ ------------
Non-accrual real estate held for investment (2) -- -- -- 8,915 8,898
------------ ------------ ------------- ------------ ------------
Real estate acquired in settlement of loans 231,407 246,380 354,277 387,024 434,616
Allowance for losses on real estate acquired in
settlement of loans (140,738) (126,519) (135,043) (109,074) (101,462)
------------ ------------ ------------- ------------ ------------
Real estate acquired in settlement of loans, net 90,669 119,861 219,234 277,950 333,154
------------ ------------ ------------- ------------ ------------
Total non-performing assets $ 104,512 $ 154,650 $ 247,185 $ 311,898 $ 372,031
============ ============ ============= ============ ============
Accruing credit card loans past due 90 days (3) $ 25,700 -- -- -- --
============ ============ ============= ============ ============
Total non-performing assets and accruing credit card
loans past due 90 days $ 130,212 $ 154,650 $ 247,185 $ 311,898 $ 372,031
============ ============ ============= ============ ============
Allowance for losses on loans $ 105,679 $ 95,523 $ 60,496 $ 50,205 $ 68,040
Allowance for losses on real estate held for investment 198 191 193 9,899 10,182
Allowance for losses on real estate acquired in settlement
of loans 140,738 126,519 135,043 109,074 101,462
------------ ------------ ------------- ------------ ------------
Total allowances for losses $ 246,615 $ 222,233 $ 195,732 $ 169,178 $ 179,684
============ ============ ============= ============ ============
- -----------------------------------------------------------------------------------------------------------------------------------
(1) Effective June 30, 1997, the Bank no longer places credit card loans on non-accrual status.
(2) Before deduction of allowances for losses.
(3) Loans which are both past due 90 days or more and not deemed nonaccrual due to an assessment of collectibility are specifically
excluded from the definition of non-performing.
</TABLE>
<PAGE>
<TABLE>
NON-PERFORMING ASSETS AND PAST DUE CREDIT CARD LOANS (CONTINUED)
September 30,
-------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Ratios:
Non-performing assets and credit card loans past due 90 days,
net to total assets (1) (2) 0.40% 1.04% 3.80% 5.40% 5.97%
Allowance for losses on real estate loans to non-accrual
real estate loans (3) 103.60% 134.44% 123.82% 169.58% 219.29%
Allowance for losses on consumer and other loans to
non-accrual consumer and other loans (3) 148.37% 388.86% 553.11% 319.28% 376.11%
Allowance for losses on loans to non-accrual loans (1) (3) 763.41% 274.58% 216.44% 200.56% 226.96%
Allowance for losses on loans to total loans receivable (4) 4.17% 2.81% 2.05% 1.97% 2.83%
- -----------------------------------------------------------------------------------------------------------------------------------
(1) Prior to 1997, non-performing asset ratios do not include loans more than 90
days past due and still accruing.
(2) Non-performing assets is presented after all allowances for losses on loans
and real estate held for investment or sale.
(3) Before deduction of allowances for losses.
(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), non-accrual real estate held for
investment ("non-accrual REI"), and REO, acquired either through foreclosure or
deed-in-lieu of foreclosure, or pursuant to in-substance foreclosure (prior to
the adoption of SFAS No. 114, "Accounting by Creditors for Impairment of a
Loan," in fiscal 1994).
Effective June 30, 1997, the Bank conformed its reporting practices for credit
card loans to that of most credit card issuers and excluded credit card loans
from non-accrual loans and non-performing assets. Credit card loans are not
placed on non-accrual status, but continue to accrue interest until the loan is
either paid-off or charged-off.
Non-performing assets totaled $104.5 million, after valuation allowances on REO
of $140.7 million, at September 30, 1997, compared to $154.7 million, after
valuation allowances on REO of $126.5 million, at September 30, 1996. In
addition to the valuation allowances on REO, the Bank maintained $1.4 million
and $26.1 million of valuation allowances on its non-accrual loans at September
30, 1997, and September 30, 1996, respectively. The $50.2 million decrease in
non-performing assets was comprised of a net decrease in REO of $29.2 million
and a decrease in non-accrual loans of $21.0 million resulting from the change
in the Bank's reporting practices.
Non-accrual Loans. The Bank's non-accrual loans totaled $13.8 million at
September 30, 1997, compared to $34.8 million at September 30, 1996. At
September 30, 1997, non-accrual loans consisted primarily of $9.6 million of
non-accrual real estate loans and $4.2 million of non-accrual consumer and other
loans. The $21.0 million decrease in non-accrual loans, from fiscal 1996 was
primarily due to the change in reporting practices for credit card loans
discussed above. Non-accrual credit card loans were $25.4 million at September
30, 1996.
At September 30, 1997, the Bank had $61.3 million of credit card loans
classified for regulatory purposes as substandard, of which $47.8 million
related to loans 90 days or more past due. The remainder ($13.5 million) related
to accounts for which the customers have agreed to modified payment terms, but
which were 30-89 days past due. All delinquent amounts are included in the table
of delinquent loans under "Delinquent Loans."
REO. At September 30, 1997, the Bank's REO totaled $90.7 million, after
valuation allowances on such assets of $140.7 million as set forth in the
following table.
<PAGE>
Balance Balance
Number Before All After Percent
of Valuation Valuation Valuation of
Properties Allowances Allowances Allowances Total
---------- ---------- ---------- ---------- ------
(Dollars in thousands)
Communities 5 $200,505 $132,907 $ 67,598 74.5%
Residential ground 3 6,993 1,039 5,954 6.6%
Commercial ground 7 20,999 6,792 14,207 15.7%
Single-family
residential
properties 19 2,910 -- 2,910 3.2%
-- -------- -------- -------- ------
Total REO 34 $231,407 $140,738 $ 90,669 100.0%
== ======== ======== ======== ======
<PAGE>
During fiscal 1997, REO decreased $29.2 million, which was attributable to $15.0
million of sales in the Communities and other residential properties, partially
offset by additional capitalized costs, and $14.2 million of additional
valuation allowances.
During fiscal 1997, the Bank received revenues of $36.3 million from
dispositions of 245 residential lots or units in the Communities ($14.6
million), approximately 38 acres of commercial land in two of the Communities
and one residential ground property ($15.5 million), a portion of commercial
and residential ground properties ($0.6 million) and various single-family
residential properties ($5.6 million).
At September 30, 1997, the Bank had executed contracts to sell two of the
commercial ground properties and one of the residential ground properties at
their aggregate book value of $6.1 million at that date.
The Bank's objective with respect to its REO is to sell such properties as
expeditiously as possible and in a manner which will best preserve the value of
the Bank's assets. In accordance with this objective, management of the Bank
continues to pursue several strategies. First, the Bank has focused its efforts
on marketing residential building lots directly to homebuilders, and is
proceeding with lot development to meet the requirements of existing and new
contracts with builders. Second, the Bank continues to seek and negotiate with
potential purchasers of remaining retail and commercial ground. Third, the Bank
continues to seek potential investors concerning the possibility of larger scale
or bulk purchases of remaining ground at the Communities. The Bank's ability to
achieve this objective will depend on a number of factors, some of which are
beyond its control, such as the general economic conditions in the Washington,
D.C. metropolitan area.
The principal component of REO consists of the five Communities, four of which
are under active development. At September 30, 1997, two of the active
Communities had 2,330 remaining residential lots, of which 438 lots (18.8%) were
under contract and pending settlement. Four of the active Communities had
approximately 259 remaining acres of land designated for commercial use, of
which 27.4 acres (10.6%) were under contract and pending settlement. In
addition, at September 30, 1997, the Bank was engaged in discussions with
potential purchasers regarding the sale of additional residential units and
retail land.
<PAGE>
In addition to the four active Communities, REO includes a fifth Community,
consisting of approximately 2,400 acres, in Loudoun County, Virginia, which is
in the pre-development stage and was to be developed into approximately 6,200
residential units. At September 30, 1997, this property had a book value of
$12.0 million, after valuation allowances.
The Bank has continued to make financing available to homebuilders, purchasers
of retail ground and home purchasers in an attempt to facilitate sales of lots
in the Communities. The following table presents, at the periods indicated, the
outstanding balances of loans provided by the Bank (subsequent to its
acquisition of title to the properties) to facilitate sales of lots in such
Communities.
Year Ended September 30,
------------------------------------
1997 1996 1995
----------- ---------- ---------
(In thousands)
Construction loans $ 36,504 $ 49,623 $12,615
Single-family permanent loans (1) 20,598 43,297 50,096
----------- ---------- ---------
Total $ 57,102 $ 92,920 $62,711
=========== ========== =========
- --------------------------
(1) Includes $4.0 million, $1.2 million and $2.3 million of loans classified
as held for sale at September 30, 1997, September 30, 1996 and September
30, 1995, respectively.
The Bank anticipates that it will provide construction financing for a portion
of the remaining unsold lot inventory in the Communities. The Bank also expects
that it will provide permanent financing for a portion of the homes to be sold
in the Communities. The Bank's current policy is to sell all such single-family
loans for which it provides permanent financing. At September 30, 1997, $4.0
million of such loans are classified as held for sale and generally are expected
to be sold in the first quarter of fiscal 1998.
In furtherance of its objective of facilitating sales, the Bank has continued
development efforts in the Communities. The following table presents the net
decrease in the balances of the five Communities for the periods indicated.
<PAGE>
Year Ended September 30,
-------------------------------------
1997 1996 1995
----------- ---------- ----------
(In thousands)
Sales proceeds $ 34,318 $ 71,023 $ 65,211
Development costs 23,462 17,931 32,626
---------- ---------- ---------
Net cash flow 10,856 53,092 32,585
Increase in reserves and
other non-cash items
16,656 13,870 16,884
---------- ---------- ---------
Net decrease in balances of the
Communities $ 27,512 $ 66,962 $ 49,469
========== ========== =========
The Bank currently anticipates that sales proceeds will continue to exceed
development costs in future periods. In the event development costs exceed sales
proceeds in future periods, the Bank believes that adequate funds will be
available from its primary liquidity sources to fund such costs. See
"Liquidity."
The Bank capitalizes costs relating to development and improvement of REO.
Interest costs are capitalized on real estate properties under development.
During fiscal 1997, the Bank capitalized interest in the amount of $2.2 million
relating to its four active Communities.
In accordance with the OTS extensions of the holding periods for certain of its
REO, the Bank is required to submit a quarterly status report on its large REO
properties. See "Capital - Regulatory Action and Requirements."
The Bank will continue to monitor closely its major non-performing and potential
problem assets in light of current and anticipated market conditions. The Bank's
asset workout group focuses its efforts in resolving these problem assets as
expeditiously as possible. The Bank does not anticipate any significant
increases in non-performing and potential problem assets.
Potential Problem Assets. Although not considered non-performing assets,
primarily because the loans are not 90 or more days past due and the borrowers
have not abandoned control of the properties, potential problem assets are
experiencing problems sufficient to cause management to have serious doubts as
to the ability of the borrowers to comply with present repayment terms.
At September 30, 1997, none of the Bank's assets were deemed by management to be
potential problem assets. At September 30, 1996, potential problem assets
totaled $5.9 million, before valuation allowances of $1.1 million. The decline
in potential problem assets was primarily attributable to the improved status of
one residential construction loan with a principal balance of $2.3 million
following lot sales which reduced the principal balance of the loan.
<PAGE>
Delinquent Loans. At September 30, 1997, delinquent loans totaled $84.6 million
(or 3.5% of loans) compared to $51.6 million (or 1.6% of loans) at September 30,
1996. The following table sets forth information regarding the Bank's delinquent
loans at September 30, 1997.
Principal Balance Total
------------------------------------ as a
Non- Percentage
Mortgage Mortgage of
Loans Loans Total Loans(1)
------- ------- ------- ----------
(Dollars in thousands)
Loans delinquent for:
30-59 days $ 6,095 $32,288 $38,383 1.6%
60-89 days 2,378 18,091 20,469 0.8%
90 days or more and
still accruing -- 25,700 25,700 1.1%
------- ------- ------- ----
Total $ 8,473 $76,079 $84,552 3.5%
======= ======= ======= ====
- ------------------------
(1) Includes loans held for sale and/or securitization, before deduction of
valuation allowances.
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 increased to $8.5 million at September
30, 1997, from $5.9 million at September 30, 1996.
Non-mortgage loans (principally credit card loans) delinquent 30-89 days
increased to $50.4 million at September 30, 1997 from $45.7 million at September
30, 1996, and increased as a percentage of total non-mortgage loans outstanding
to 3.6% at September 30, 1997 from 2.9% at September 30, 1996. The increased
percentage of delinquent non-mortgage loans to total non-mortgage loans
outstanding resulted primarily from the increase in delinquent credit card
loans, which reflects the industry-wide decline in the performance of such loans
in recent periods.
Non-mortgage loans delinquent 90 days or more and still accruing consists
entirely of credit card loans. Effective 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. A troubled debt restructuring occurs when the Bank
agrees to modify significant terms of a loan in favor of the borrower when the
borrower is experiencing financial difficulties. In aggregate, troubled debt
restructurings were $11.9 million and $13.6 million at September 30, 1997 and
1996, respectively.
At September 30, 1997, loans accounted for as troubled debt restructurings
included one commercial permanent loan with a principal balance of $11.7 million
and one commercial collateralized loan with a principal balance of $0.2 million.
The $1.8 million decrease in loans accounted for as troubled debt restructurings
from September 30, 1996, was a result of net principal reductions. At September
30, 1997, the Bank had commitments to lend $0.1 million of additional funds on
loans that have been restructured.
<PAGE>
Real Estate Held for Investment. At September 30, 1997 and 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 years indicated and may include
charge-offs taken against assets which the Bank disposed of during such years.
<PAGE>
<TABLE>
ANALYSIS OF ALLOWANCE FOR AND CHARGE-OFFS OF LOANS
(Dollars in thousands)
Year Ended September 30,
---------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $ 95,523 $ 60,496 $ 50,205 $ 68,040 $ 78,818
------------ ------------ ------------- ------------ ------------
Provision for loan losses 125,115 115,740 54,979 29,222 60,372
------------ ------------ ------------- ------------ ------------
Increase due to acquisition of loans 118 -- -- -- --
------------ ------------ ------------- ------------ ------------
Charge-offs:
Residential 1,014 867 1,174 1,641 45
Commercial real estate and multifamily -- -- -- 112 766
Real estate construction and ground -- -- 1,768 2,474 4,274
Credit card 115,835 84,805 50,172 55,754 76,141
Consumer and other 9,657 6,375 3,463 1,058 3,664
------------ ------------ ------------- ------------ ------------
Total charge-offs 126,506 92,047 56,577 61,039 84,890
------------ ------------ ------------- ------------ ------------
Recoveries:
Residential 34 32 20 -- --
Credit card 10,365 10,720 11,219 13,525 13,438
Consumer and other 1,030 582 650 457 302
------------ ------------ ------------- ------------ ------------
Total recoveries 11,429 11,334 11,889 13,982 13,740
------------ ------------ ------------- ------------ ------------
Charge-offs, net of recoveries 115,077 80,713 44,688 47,057 71,150
------------ ------------ ------------- ------------ ------------
Balance at end of year $ 105,679 $ 95,523 $ 60,496 $ 50,205 $ 68,040
============ ============ ============= ============ ============
Provision for loan losses to average loans (1) 3.50% 3.94% 1.85% 1.08% 2.83%
Net loan charge-offs to average loans (1) 3.22% 2.75% 1.51% 1.74% 3.33%
Ending allowance for losses on loans to total
loans (1) (2) 4.17% 2.81% 2.05% 1.97% 2.83%
- ---------------------------------------------------------------------------------------------------------------------------
(1) Includes loans held for sale and/or securitization.
(2) Before deduction of allowances.
</TABLE>
<PAGE>
<TABLE>
COMPONENTS OF ALLOWANCE FOR LOSSES ON LOANS BY TYPE
(Dollars in thousands)
September 30,
------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------------------- --------------------- ------------------ -------------------- -------------------
Percent Percent Percent Percent Percent
of of of of of
Loans Loans Loans Loans Loans
to to to to to
Total Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------------ ------- ------------ ------- ----------- ------ ------------ ------- ------------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at end of year
allocated to:
Single family residential $ 661 33.5% $ 925 47.4% $ 929 47.3% $ 1,384 53.7% $ 4,235 53.6%
Home equity 683 3.7 446 0.9 164 1.0 133 1.4 250 2.5
Commercial real estate
and multifamily 7,705 2.1 8,398 2.3 8,523 2.9 8,506 3.3 9,606 3.9
Real estate construction
and ground 550 2.2 1,255 1.9 1,264 1.1 4,062 2.1 5,882 2.6
Commercial 364 3.9 223 1.7 65 0.5 505 0.2 0.2
Credit card 89,446 42.6 79,681 33.1 46,325 34.4 34,530 25.5 46,886 31.4
Automobile 3,080 8.6 3,965 8.8 3,226 8.1 1,085 11.4 1,181 4.4
Home improvement and
related loans 2,415 2.0 229 2.8 -- 3.8 -- 1.5 -- 0.3
Overdraft lines of credit
and other consumer 775 1.4 401 1.1 -- 0.9 -- 0.9 -- 1.1
------------ ------------ ----------- ------------ ------------
Total $ 105,679 $ 95,523 $ 60,496 $ 50,205 $ 68,040
============ ============ =========== ============ ============
</TABLE>
<PAGE>
<TABLE>
ANALYSIS OF ALLOWANCE FOR AND CHARGE-OFFS OF
REAL ESTATE HELD FOR INVESTMENT OR SALE
(In thousands)
Year ended September 30,
--------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year:
Real estate held for investment $ 191 $ 193 $ 9,899 $ 10,182 $ 14,919
Real estate held for sale 126,519 135,043 109,074 101,462 94,125
------------ ------------ ------------ ------------ ------------
Total 126,710 135,236 118,973 111,644 109,044
------------ ------------ ------------ ------------ ------------
Provision for real estate losses:
Real estate held for investment 7 (2) (6,974) (283) 1,470
Real estate held for sale 19,616 26,343 33,295 14,335 28,945
------------ ------------ ------------ ------------ ------------
Total 19,623 26,341 26,321 14,052 30,415
------------ ------------ ------------ ------------ ------------
Charge-offs:
Real estate held for investment:
Commercial ground -- -- 2,732 -- --
Commercial construction -- -- -- -- 6,207
------------ ------------ ------------ ------------ ------------
Total -- -- 2,732 -- 6,207
------------ ------------ ------------ ------------ ------------
Real estate held for sale:
Residential construction -- -- 1,924 911 79
Residential ground 5,397 34,867 103 -- 259
Commercial ground -- -- 2,827 -- 1,353
Commercial permanent -- -- -- 5,812 761
Commercial construction -- -- 2,472 -- 19,156
------------ ------------ ------------ ------------ ------------
Total 5,397 34,867 7,326 6,723 21,608
------------ ------------ ------------ ------------ ------------
Total charge-offs on real estate
held for investment or sale 5,397 34,867 10,058 6,723 27,815
------------ ------------ ------------ ------------ ------------
Balance at end of year:
Real estate held for investment 198 191 193 9,899 10,182
Real estate held for sale 140,738 126,519 135,043 109,074 101,462
------------ ------------ ------------ ------------ ------------
Total $ 140,936 $ 126,710 $ 135,236 $ 118,973 $ 111,644
============ ============ ============ ============ ============
</TABLE>
<PAGE>
<TABLE>
COMPONENTS OF ALLOWANCE FOR LOSSES
ON REAL ESTATE HELD FOR INVESTMENT OR SALE
(In thousands)
September 30,
--------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Allowance for losses on real estate
held for investment:
Commercial real estate and multifamily $ -- $ -- $ -- $ 7,793 $ 7,945
Ground -- -- -- 1,975 1,972
Other 198 191 193 131 265
------------ ------------ ------------ ------------ ------------
Total 198 191 193 9,899 10,182
------------ ------------ ------------ ------------ ------------
Allowance for losses on real estate
held for sale:
Single family residential -- 112 184 66 102
Home equity -- 8 2 4 53
Commercial real estate and multifamily -- -- -- 142 4,678
Residential construction -- -- -- 1,942 2,924
Commercial construction -- -- -- 1,216 1,387
Ground 140,738 126,399 134,857 105,704 92,318
------------ ------------ ------------ ------------ ------------
Total 140,738 126,519 135,043 109,074 101,462
------------ ------------ ------------ ------------ ------------
Total allowance for losses on real
estate held for investment or sale $ 140,936 $ 126,710 $ 135,236 $ 118,973 $ 111,644
============ ============ ============ ============ ============
</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 $24.4 million from the level at
September 30, 1996, to $246.6 million at September 30, 1997. The $24.4 million
increase was primarily attributable to increased valuation allowances on credit
card loans and the Communities.
The following table shows valuation allowances for losses on performing and
non-performing assets at the dates indicated.
September 30, 1997
---------------------------------------------
Performing Non-performing Total
------------ --------------- -----------
(In thousands)
Allowances for losses on:
Loans:
Real estate $ 8,626 $ 972 $ 9,599
Credit card 89,446 -- 89,446
Consumer and other 6,212 423 6,634
------------ --------------- -----------
Total allowance for losses
and loans 104,284 1,395 105,679
------------ --------------- -----------
Real estate held for
investment 198 -- 198
Real estate held for sale -- 140,738 140,738
------------ --------------- -----------
Total allowance for losses
on real estate held for
investment for sale
198 140,738 140,936
------------ --------------- -----------
Total allowance for losses $ 104,482 $ 142,133 $ 246,615
============ =============== ===========
<PAGE>
September 30, 1996
-----------------------------------------
Performing Non-performing Total
----------- -------------- ----------
(In thousands)
Allowances for losses on:
Loans:
Real estate $ 10,293 $ 731 $ 11,024
Credit card 54,331 25,350 79,681
Consumer and other 4,802 16 4,818
----------- -------------- ----------
Total allowance for losses and
loans
69,426 26,097 95,523
----------- -------------- ----------
Real estate held for investment 191 -- 191
Real estate held for sale -- 126,519 126,519
----------- -------------- ----------
Total allowance for losses on
real estate held for investment
for sale 191 126,519 126,710
----------- -------------- ----------
Total allowance for losses $ 69,617 $ 152,616 $ 222,233
=========== ============== ==========
The allowance for losses on loans secured by real estate and real estate held
for investment or sale totaled $150.5 million at September 30, 1997, which
constituted 62.5% of total non-performing real estate assets, before valuation
allowances. This amount represented a $12.8 million increase from the September
30, 1996 level of $137.7 million, or 54.1% of total non-performing real estate
assets, before valuation allowances at that date.
During fiscal 1997, the Bank provided an additional $3.1 million of general
valuation allowances pursuant to its policy of providing additional general
valuation allowances which are equal to, or exceed, the amount of the net
earnings generated by the development and sale of land in the Communities.
When real estate collateral securing an extension of credit is initially
recorded as REO, it is recorded at the lower of cost or fair value, less
estimated selling costs, on the basis of an appraisal. As circumstances change,
it may be necessary to provide additional valuation allowances based on new
information. The allowance for losses on real estate held for sale at September
30, 1997 is in addition to approximately $50.5 million of cumulative charge-offs
previously taken against assets remaining in the Bank's portfolio at September
30, 1997.
The Bank from time to time obtains updated appraisals on its real estate
acquired in settlement of loans. As a result of such updated appraisals, the
Bank could be required to increase its valuation allowances.
<PAGE>
Net charge-offs of credit card loans for fiscal 1997 were $105.5 million,
compared to $74.1 million for fiscal 1996. The increase in net charge-offs
generally reflects the trends that are affecting the credit card industry as a
whole. Management has implemented more stringent underwriting and other lending
policies designed to reduce such losses in future periods. The allowance at any
balance sheet date relates only to receivable balances that exist as of that
date. Because of the nature of a revolving credit card account, the cardholder
may enter into transactions (such as retail purchases and cash advances)
subsequent to a balance sheet date which increase the outstanding balance of the
account. Accordingly, charge-offs in any fiscal period relate both to balances
and conditions or events that existed at the beginning of the period and to
balances created during the period, and may therefore exceed the levels of
valuation allowances established at the beginning of the fiscal period.
The allowance for losses on credit card loans increased to $89.4 million at
September 30, 1997 from $79.7 million at September 30, 1996, primarily because
of a $7.8 million increase in the provision for losses on such loans. The
increase in the provision was primarily attributable to an unallocated allowance
established by the Bank due to general uncertainties about future bankruptcies.
Also contributing to the increase was the reclassification of allowances
maintained for delinquent interest that were previously presented net of the
credit card loan balance in the accompanying Consolidated Statement of Financial
Condition, substantially all of which related to prior periods. The ratio of the
allowance for such losses to outstanding credit card loans increased to 8.3%, at
September 30, 1997, from 7.1% at September 30, 1996.
The allowance for losses on consumer and other loans (automobile, home
improvement, overdraft lines of credit and other consumer loans) increased to
$6.3 million at September 30, 1997 from $4.6 million at September 30, 1996,
primarily because of the increased volume of consumer and other loans. The
ratios of the allowances for losses on consumer and other loans to
non-performing consumer and other loans and to outstanding consumer and other
loans were 157.0% and 1.7%, respectively, at September 30, 1997 compared to
388.9% and 1.0%, respectively, at September 30, 1996.
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 mix, volume and maturity to stabilize the net
interest spread is referred to as asset and liability management. The objective
of asset and liability management is to maximize the net interest yield within
the constraints imposed by prudent lending and investing practices, liquidity
needs and capital planning.
The Bank's assets and liabilities are inherently sensitive to changes in
interest rates. These movements can result in variations to the overall level of
income and market value of equity. Based on the characteristics of a specific
asset or liability (including maturity, repricing frequency and interest caps) a
change in interest rates can significantly affect the contribution to net income
and market value for the instrument. If, in the aggregate, the Bank's assets
mature or reprice more quickly or to a greater extent than its liabilities, the
Bank is termed "asset sensitive" and will tend to experience increased income
and market value during periods of rising interest rates and declining income
and value during periods of falling interest rates. Conversely, if the Bank's
liabilities mature or reprice more quickly or to a greater extent than its
assets, the Bank is termed "liability sensitive" and will tend to experience
decreased income and market value during periods of rising interest rates and
increased income and value during periods of falling interest rates.
<PAGE>
The Bank is pursuing an asset-liability management strategy to control risk from
changes in market interest rates principally by originating interest-sensitive
loans for its portfolio. In furtherance of this strategy, the Bank emphasizes
the origination and retention of ARMs, adjustable-rate home equity credit line
loans and adjustable-rate credit card loans. At September 30, 1997,
adjustable-rate loans accounted for 79.5% of total loans, of which 75.7% will
adjust in one year or less.
In recent periods, the Bank's policy has generally been to sell all of its
long-term fixed-rate mortgage production, thereby reducing its exposure to
market interest rate fluctuations typically associated with long-term fixed-rate
lending.
A traditional measure of interest-rate risk within the banking industry is the
interest sensitivity "gap," which is the sum of all interest-earning assets
minus all interest-bearing liabilities subject to repricing within the same
period. Gap analysis is a tool used by management to evaluate interest-rate risk
which results from the difference between repricing and maturity characteristics
of the Bank's assets and those of the liabilities that fund them. By analyzing
these differences, management can attempt to estimate how changes in interest
rates affect the Bank's future net interest income.
The Bank views control over interest rate sensitivity as a key element in its
financial planning process and monitors interest rate sensitivity through its
forecasting system. The Bank manages interest rate exposure and will narrow or
widen its gap, depending on its perception of interest rate movements and the
composition of its balance sheet. For the reasons discussed above, the Bank
might take action to narrow its gap if it believes that market interest rates
will experience a significant prolonged increase, and might widen its gap if it
believes that market interest rates will decline or remain relatively stable.
A number of asset and liability management strategies are available to the Bank
in structuring its balance sheet. These include selling or retaining certain
portions of the Bank's current residential mortgage loan production; altering
the Bank's pricing on certain deposit products to emphasize or de-emphasize
particular maturity categories; altering the type and maturity of securities
acquired for the Bank's investment portfolio when replacing securities following
normal portfolio maturation and turnover; lengthening or shortening the maturity
or repricing terms for any current period asset securitizations; and altering
the maturity or interest rate reset profile of borrowed funds, if any, including
funds borrowed from the FHLB of Atlanta.
The following table presents the interest rate sensitivity of the Bank's
interest-earning assets and interest-bearing liabilities at September 30, 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 prepayment rates are assumed for the Bank's loans
based on recent actual experience. Statement savings and passbook accounts with
balances under $20,000 are classified based upon management's assumed attrition
rate of 17.5%, and those with balances of $20,000 or more, as well as all NOW
accounts, are assumed to be subject to repricing within six months or less.
<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 September 30, 1997 Real estate loans:
Adjustable-rate $ 356,409 $ 344,822 $ 83,716 $ 1,614 $ 156 $ 786,717
Fixed-rate 8,307 2,843 15,354 16,875 12,452 55,831
Loans held for sale 102,749 -- -- -- -- 102,749
Home equity credit lines and second
mortgages 52,688 801 2,787 2,222 8,190 66,688
Credit card and other 1,087,804 35,795 93,842 60,085 23,157 1,300,683
Loans held for securitization and sale 220,000 -- -- -- -- 220,000
Mortgage-backed securities 745,171 689,014 223,036 124,444 204,042 1,985,707
Trading securities 7,899 -- -- -- -- 7,899
Other investments 573,498 -- 4,998 -- -- 578,496
------------ ------------ ------------- ------------ ------------ -------------
Total interest-earning assets 3,154,525 1,073,275 423,733 205,240 247,997 5,104,770
Total non-interest earning assets -- -- -- -- 952,643 952,643
------------ ------------ ------------- ------------ ------------ -------------
Total assets $ 3,154,525 $ 1,073,275 $ 423,733 $ 205,240 $ 1,200,640 $ 6,057,413
============ ============ ============= ============ ============ =============
Deposits:
Fixed maturity deposits $ 1,098,963 $ 415,345 $ 243,699 $ 46,145 $ -- $ 1,804,152
NOW, statement and passbook accounts 1,408,525 42,209 140,581 95,683 203,911 1,890,909
Money market deposit accounts 983,016 -- -- -- -- 983,016
Borrowings:
Capital notes - subordinated -- -- -- -- 250,000 250,000
Other 227,493 1,476 4,357 21,274 15,751 270,351
------------ ------------ ------------- ------------ ------------ -------------
Total interest-bearing liabilities 3,717,997 459,030 388,637 163,102 469,662 5,198,428
Total non-interest bearing liabilities -- -- -- -- 527,739 527,739
Stockholders' equity -- -- -- -- 331,246 331,246
------------ ------------ ------------- ------------ ------------ -------------
Total liabilities & stockholders' equity $ 3,717,997 $ 459,030 $ 388,637 $ 163,102 $ 1,328,647 $ 6,057,413
============ ============ ============= ============ ============ =============
Gap $ (563,472) $ 614,245 $ 35,096 $ 42,138 $ (221,665)
Cumulative gap $ (563,472) $ 50,773 $ 85,869 $ 128,007 $ (93,658)
Adjustment for interest rate caps (1) $ 327,778 $ 219,444 $ 75,000 $ -- $ --
Adjusted cumulative gap $ (235,694) $ 270,217 $ 160,869 $ 128,007 $ (93,658)
Adjusted cumulative gap as a percentage
of total assets (3.9%) 4.5% 2.7% 2.1% (1.5)%
(1) At September 30, 1997, the Bank had $372,222 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 one-year gap, adjusted for the effect of the Bank's interest rate caps, as a
percentage of total assets, was 4.5% at September 30, 1997, compared to a
negative 4.8% at September 30, 1996. The improvement in the Bank's one-year gap
was primarily attributable to an increase in short-term assets at September 30,
1997 resulting from the scheduled maturity of mortgage-backed balloon securities
as well as an increase in one year ARM mortgage-backed securities.
During fiscal 1995, the Bank purchased a series of interest rate caps which
management believes will significantly limit its exposure to rising short-term
interest rates during a four-year period which began July 1, 1995 and will end
June 30, 1999. The Bank's Interest Rate Sensitivity Table reflects the reduction
in risk provided by these caps. The initial level of the protection was a
notional principal amount of $600 million, and such protection declined to $300
million at September 30, 1997, and will decline to $200 million by March 31,
1998. The remaining $200 million of protection will expire on June 30, 1999. In
the event that the one-month London Inter-Bank Offered Rate ("LIBOR") exceeds
7.00% on certain predetermined dates, the Bank is entitled to receive
compensatory payments from the cap provider, which is a counterparty receiving
the highest investment rating from Standard & Poor's Corporation. Such payments
would be equal to the product of (a) the amount by which one-month LIBOR exceeds
7.00% and (b) the then outstanding notional principal amount for a predetermined
period of time. The Bank has no obligation to make payments to the provider of
the cap or any other party.
During fiscal 1997, an additional interest rate cap agreement with a notional
amount of $72.2 million at September 30, 1997, was transferred and assigned to
the Bank at the termination of one of the Bank's credit card securitization
transactions. This interest rate cap agreement has a termination date of October
15, 1998 and entitles the Bank to receive compensatory payment from the cap
provider, which is a AA-rated (for long term debt as rated by Standard & Poor's)
counterparty, equal to the product of (a) the amount by which the one-month
LIBOR exceeds 9.00% and (b) the then outstanding notional principal amount for
the predetermined period of time.
In addition to gap measurements, the Bank measures and manages interest-rate
risk with the extensive use of computer simulation. This simulation includes
calculations of Market Value of Portfolio Equity and Net Interest Margin as
promulgated by the OTS's Thrift Bulletin 13 ("TB 13"). Under this regulation,
institutions are required to establish limits on the sensitivity of their net
interest income and net portfolio value ("NPV") to parallel changes in interest
rates. Such changes in interest rates are defined as instantaneous and sustained
movements to rates in 100 basis point increments. The following table shows the
estimated impact of parallel shifts in interest rates at September 30, 1997,
calculated in a manner consistent with the requirements of TB 13.
<PAGE>
Change In
------------------------------------
Change in Interest Net Net
Rates Interest Portofolio
(Basis Points) Income(1) Value(2)
---------------- -----------------
% $ Amount % $ Amount
- ------------------------------- ----- --------- ----- ---------
+ 200 (4.0) (28,837) (0.4) (3,510)
+ 100 (1.6) (11,287) (0.3) (2,452)
- 100 9.1 66,557 2.0 17,507
- 200 17.3 125,818 1.9 16,882
- ---------------------------------------------------------------------
(1)Represents the difference between net interest income for 12 months in a
stable interest rate environment and the various interest rate scenarios.
(2)Represents the difference between net portfolio value (NPV) of the Bank's
equity in a stable interest rate environment and the NPV in the various rate
scenarios. The OTS defines NPV as the present value of expected net cash flows
from existing assets minus the present value of expected net cash flows from
existing liabilities plus the present value of expected net cash flows from
existing off-balance sheet contracts.
While the Bank cannot predict future interest rates or their effects on NPV or
net interest income, the analysis under TB 13 indicates that a change in
interest rates of plus or minus 200 basis points is unlikely to have a material
adverse effect on the Bank's NPV or net interest income in future periods.
Computations of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, prepayments and deposit run-offs and should not be relied upon as
indicative of actual results. Certain limitations are inherent in such
computations. Although certain assets and liabilities may have similar maturity
or periods of repricing, they may react at different times and in different
degrees to changes in the market interest rates. The interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while rates on other types of assets and liabilities may lag
behind changes in market interest rates. Certain assets, such as adjustable rate
mortgage loans, generally have features which restrict changes in their interest
rates on a short term basis and over the life of the asset. In the event of a
change in interest rates, loan prepayments and early deposit withdrawal levels
could deviate significantly from those assumed in making the calculations set
forth above. Additionally, credit risk may increase if an interest rate increase
adversely affects the ability of many borrowers to service their debt.
At September 30, 1997, the Bank would not have been required to maintain
additional amounts of risk-based capital had the interest-rate risk component of
the OTS capital regulations been in effect. See "Business - Regulation -
Regulatory Capital."
<PAGE>
Inflation. The impact of inflation on the Bank is different from the impact on
an industrial company, because substantially all of the assets and liabilities
of the Bank are monetary in nature. The most direct impact of an extended period
of inflation would be to increase interest rates, and to place upward pressure
on the operating expenses of the Bank. However, the actual effect of inflation
on the net interest income of the Bank would depend on the extent to which the
Bank was able to maintain a spread between the average yield on interest-earning
assets and the average cost of interest-bearing liabilities, which would depend
to a significant extent on its asset-liability sensitivity. The effect of
inflation on the Bank's results of operations for the past three fiscal years
has been minimal.
Deferred Tax Asset. At September 30, 1997, the Bank recorded a net deferred tax
asset of $26.0 million, which generally represents the cumulative excess of the
Bank's actual income tax liability over its income tax expense for financial
reporting purposes.
Tax Sharing Payments. During fiscal 1997, after receiving OTS approval, the Bank
made tax sharing payments totaling $9.8 million to the Trust. See Note 25 to the
Consolidated Financial Statements in this report.
Capital. At September 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 September 30,
1997, in relation to the regulatory requirements in effect at that date. The
information below is based upon the Bank's understanding of the regulations and
interpretations currently in effect and may be subject to change.
<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 financial statements $ 363,246
Minority interest in REIT Subsidiary (1) 144,000
Net unrealized holding losses (2) 493
------------
507,739
Adjustments for tangible and core capital:
Intangible assets (44,251)
Non-allowable minority interest in
REIT Subsidiary (1) (38,758)
Non-includable subsidiaries (3) (3,762)
------------
Total tangible capital 420,968 6.96% $ 90,715 1.50% $ 330,253 5.46%
------------ ========== ============= ========== ============= ==========
Total core capital (4) 420,968 6.96% $ 241,907 4.00% $ 179,061 2.96%
------------ ========== ============= ========== ============= ==========
Tier 1 risk-based capital (4) 420,968 7.24% $ 232,713 4.00% $ 188,255 3.24%
------------ ========== ============= ========== ============= ==========
Adjustments for total risk-based capital:
Subordinated capital debentures 250,000
Allowance for general loan losses 92,962
------------
Total supplementary capital 342,962
Excess allowance for loan losses (19,989)
------------
Adjusted supplementary capital 322,973
--
----------
Total available capital 743,941
Equity investments (3) (14,556)
------------
Total risk-based capital (4) $ 729,385 13.50% $ 465,426 8.00% $ 263,959 5.50%
============ ========== ============= ========== ============= ==========
(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>
Board Resolution and Regulatory Requirements. At the request of the OTS, the
Board of Directors of the Bank adopted a resolution in March 1996 which, among
other things, permits the Bank: (i) to make tax sharing payments without OTS
approval to the Trust of up to $15.0 million relating to any single fiscal year;
and (ii) to declare dividends on its stock in any quarterly period up to the
lesser of (A) 50% of its after tax net income for the immediately preceding
quarter or (B) 50% of the average quarterly after tax net income for the
immediately preceding four quarter period, minus (in either case) dividends
declared on the Bank's preferred stock during that quarterly period. The
resolution also provides that the Bank will present a plan annually to the OTS
detailing anticipated consumer loan securitization activity.
The Bank has been able to maintain capital compliance in recent periods despite
the deduction of various assets from regulatory capital. As of September 30,
1997, the Bank had $36.2 million in supervisory goodwill, all of which was
excluded from core capital, $15.3 million in equity investments, after
subsequent valuation allowances, all of which were fully deducted from total
risk-based capital, and $4.0 million, after subsequent valuation allowances, of
extensions of credit to, and investments in, non-includable subsidiaries, all of
which were fully deducted from all three FIRREA capital requirements. Pursuant
to OTS guidelines, $1.0 million of general valuation allowances maintained
against the Bank's non-includable subsidiaries and equity investments are
available as a "credit" against the deduction from capital otherwise required
for such investments.
OTS capital regulations provide a five-year holding period (or such longer
period as may be approved by the OTS) for REO to qualify for an exception from
treatment as an equity investment. If an REO property is considered an equity
investment, its then-current book value is deducted from total risk-based
capital. Accordingly, if the Bank is unable to dispose of any REO property
(through bulk sales or otherwise) prior to the end of its applicable five-year
holding period and is unable to obtain an extension of such five-year holding
period from the OTS, the Bank could be required to deduct the then-current book
value of such REO property from total risk-based capital. In November 1996, the
Bank received from the OTS an extension of the holding periods for certain of
its REO properties through November 12, 1997. In addition, the Bank has
submitted to the OTS a request for a further extension of the holding periods
through fiscal 1998 for certain of its REO properties. Based on its capital
ratios at September 30, 1997, the Bank's capital ratios would have remained
above the levels required for well-capitalized institutions even if the book
value of REO properties for which an extension has not yet been received had
been deducted from total risk-based capital as of that date. The following table
sets forth the Bank's REO at September 30, 1997, after valuation allowances of
$140.7 million, by the fiscal year in which the property was acquired through
foreclosure.
<PAGE>
Fiscal Year (In thousands)
----------- --------------
1990 $ 22,667 (1)(2)
1991 47,724 (2)
1992 3,280 (2)
1993 4,050
1994 2,002
1995 8,036
1996 --
1997 2,910
--------------
Total REO $ 90,669
==============
- -------------------------
(1) Includes REO with an aggregate net book value of $14.6 million, which the
Bank treats as equity investments for regulatory capital purposes.
(2)Includes REO, with an aggregate net book value of $59.1 million, for which
the Bank received an extension of the holding periods through November 12, 1997.
Under the OTS prompt corrective action regulations, an institution is
categorized as "well capitalized" if it has a leverage (or core capital) ratio
of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0%, a total
risk-based capital ratio of at least 10.0% and is not subject to any written
agreement, order, capital directive or prompt corrective action directive to
meet and maintain a specific capital level. At September 30, 1997, the Bank's
leverage, tier 1 risk-based and total risk-based capital ratios were 6.96%,
7.24% and 13.50%, respectively, which exceeded the ratios established for "well
capitalized" institutions. The OTS has the discretion to reclassify an
institution from one category to the next lower category, for example from "well
capitalized" to "adequately capitalized," if, after notice and an opportunity
for a hearing, the OTS determines that the institution is in an unsafe or
unsound condition or has received and has not corrected a less than satisfactory
examination rating for asset quality, management, earnings or liquidity.
On December 3, 1996, the Bank sold $100.0 million principal amount of its 9 1/4%
Subordinated Debentures due 2008. 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.
<PAGE>
In addition, on December 3, 1996, the REIT Subsidiary sold $150.0 million of its
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 10 3/8%. 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 Series B Preferred Stock
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.
The Bank's acquisition of ASB Capital Management in November 1997 reduced the
Bank's regulatory capital ratios below the levels existing at September 30,
1997. See "Financial Condition - General." Failure to obtain the REO extensions
discussed above also could adversely affect those ratios. In addition, depending
on the outcome of a pending regulatory proposal relating to the regulatory
capital treatment of non-mortgage servicing assets and associated interest-only
strips, the Bank could be required to deduct additional amounts from its
regulatory capital. See "Business -- Regulation -- Regulatory Capital."
The Bank's ability to maintain or increase its capital levels in future periods
also will be subject to general economic conditions, particularly in the Bank's
local markets. Adverse general economic conditions or a renewed downturn in
local real estate markets could require further additions to the Bank's
allowances for losses and further charge-offs. Any such developments would
adversely affect the Bank's earnings and thus its regulatory capital levels.
<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, and the payment of capital improvement
costs. In the past, the Real Estate Trust 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. See the Consolidated Statements of Cash
Flows included in the Consolidated Financial Statements in this report.
Liquidity. The Real Estate Trust's ability to meet its liquidity needs,
including debt service payments in fiscal 1998 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,
the Bank's operating performance and income, regulatory restrictions on such
payments, including availability of Trust collateral to support 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.
See also the discussion of potential limitations on the payment of dividends by
the Bank contained in "Business - Banking - Regulation - Dividends and Other
Capital Distributions."
The Real Estate Trust believes that the financial condition and operating
results 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
(see "Banking Regulation - Regulatory Capital") should enhance prospects for the
Real Estate Trust to receive tax sharing payments and dividends from the Bank.
During fiscal 1997, the Bank made tax sharing payments totalling $9.8 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.
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 outstanding Unsecured Notes as they mature, it will finance such
repayments from other sources of funds.
<PAGE>
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"). See Note 4 to the Consolidated Financial Statements in
this report. The Indenture pursuant to which the Senior Secured Notes were
issued contains convenants 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 September 30, 1997, the Trust has purchased either in the open market or
through dividend reinvestment 1,810,104 shares of common stock of Saul Centers
(representing 14.7% of such company's outstanding common stock). Most of 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.
In fiscal 1995, the Real Estate Trust established a $15.0 million secured
revolving credit line with an unrelated bank. This facility was for an inital
two-year period subject to extension for one or more additional one-year terms.
In fiscal 1997, the facility was increased to $20.0 million and was renewed for
an additional two-year period. Interest is computed by reference to a floating
rate index. At September 30, 1997, there were no borrowings under the facility
and unrestricted availability was $10.0 million.
In fiscal 1996, the Real Estate Trust established an $8.0 million secured
revolving credit line with an unrelated bank. This facility was for a one-year
term, after which any outstanding loan amount would amortize over a two-year
period. During fiscal 1997, the line of credit was increased to $10.0 million
and was extended for an additional year. Interest is computed by reference to a
floating rate index. At September 30, 1997, there were no borrowings under the
facility and unrestricted availability was $4.8 million.
During fiscal 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 September
30, 1997 for fiscal years commencing October 1, 1997 is set forth in the
following table:
<PAGE>
Debt Maturity Schedule
(In thousands)
- -------------------------------------------------------------------------------
Notes Notes
Mortgage Payable- Payable-
Fiscal Year Notes Secured Unsecured Total
- ------------ --------- ----------- ----------- ------------
1998 $ 11,092 $ -- $ 7,610 $ 18,702
1999 9,736 -- 16,079 25,815
2000 20,095 -- 8,804 28,899
2001 9,790 -- 4,165 13,955
2002 11,343 175,000 5,081 191,424
Thereafter 118,148 -- 4,894 123,042
--------- ----------- ----------- ------------
Total $180,204 $ 175,000 $ 46,633 $ 401,837
========= =========== =========== ============
- -------------------------------------------------------------------------------
Of the $180.2 million of mortgage debt outstanding at September 30, 1997, $137.1
million was nonrecourse to the Real Estate Trust.
As the owner, directly and through two wholly-owned subsidiaries, of a
limited partnership interest in Saul Holdings Partnership, the Real Estate Trust
shares in cash distributions from operations and from capital transactions
involving the sale of properties. The partnership agreement of Saul Holdings
Partnership provides for quarterly cash distributions to the partners out of net
cash flow. See "Business - Real Estate Investment in Saul Holdings Limited
Partnership." In fiscal 1997, the Real Estate Trust received total cash
distributions $5.5 million from Saul Holdings Partnership.
Development and Capital Expenditures
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 located in
Gaithersburg, Maryland. The project is 100% pre-leased. The Real Estate Trust
has obtained a construction/permanent loan which is expected to cover all costs
except for the land and fees to related parties.
In September 1997, the Real Estate Trust commenced development of a 95-unit
extended stay lodging facility located on a 2.7 acre parcel adjacent to its
Hampton Inn and Holiday Inn in Sterling, Virginia. The new facility will be
franchised as a TownePlace Suites by Marriott and is expected to be completed
by July 1998. The Real Estate Trust has obtained a construction loan which is
expected to cover all costs except for the land, fees to related parties, taxes
and insurance.
On December 10, 1997, the Real Estate Trust purchased a 308-room Holiday Inn
located in Arlington, Virginia, near Washington National Airport and the Real
Estate Trust's Howard Johnsons Hotel. The purchase price was $25.8 million. Also
on December 10, 1997, the Real Estate Trust refinanced five other hotels in its
portfolio. Funds for the two transactions were provided by a lender in the
amount of $53.0 million. The new loans will have a 15 year term, a fixed
interest rate of 7.57%, and amortization based on a 25 year schedule.
The Real Estate Trust believes that its capital improvement costs in the next
several fiscal years will be in range of $6.0 to $7.0 million per year.
<PAGE>
BANKING
Liquidity. The standard measure of liquidity in the savings industry is the
ratio of cash and short-term U.S. Government and other specified securities to
net withdrawable accounts and borrowings payable in one year or less.
The OTS has established a minimum liquidity requirement, which may vary from
time to time depending upon economic conditions and deposit flows. The required
liquidity level under OTS regulations in effect until November 24, 1997 was
5.0%. The Bank's average liquidity ratio for the month ended September 30, 1997
was 11.1%, compared to 13.1% for the month ended September 30, 1996. The Bank
met the liquidity level requirements for each month of fiscal 1997. The OTS
reduced the liquidity requirements effective November 24, 1997. See "Business --
Regulation -- Liquidity Requirements."
The Bank's primary sources of funds historically have consisted of (i) principal
and interest payments on loans and mortgage-backed securities, (ii) savings
deposits, (iii) sales of loans and trading securities (iv) securitizations and
sales of loans and (v) borrowed funds (including funds borrowed from the FHLB of
Atlanta). The Bank's holdings of readily marketable securities constitute
another important source of liquidity. At September 30, 1997, the Bank's
portfolio included mortgage loans, U.S. Government securities and
mortgage-backed securities with outstanding principal balances of $188.6
million, $5.0 million and $2.0 billion, respectively. The estimated borrowing
capacity against mortgage loans, U.S. Government securities and mortgage-backed
securities that are available to be pledged to the FHLB of Atlanta and various
security dealers totaled $2.0 billion at September 30, 1997, after market-value
and other adjustments.
Chevy Chase has accessed the capital markets as an additional means of funding
its operations and managing its capital ratios and asset growth. Specifically,
the Bank has securitized financial assets, including credit card, home equity
credit line, home loan and automobile loan receivables, as well as single-family
residential loans, because such securitizations provide the Bank with a source
of financing at competitive rates and assist the Bank in maintaining compliance
with regulatory capital requirements. Additionally, the securitizations have
permitted the Bank to limit the credit risk associated with these assets while
continuing to earn servicing fees and other income associated with the
securitized assets.
Since 1988, the Bank has securitized approximately $10.6 billion of credit card,
home equity credit line, automobile and home loan receivables. These
transactions depend on sophisticated back-office systems to service complex
securitization structures and on personnel with the experience to design,
install and manage those systems. At September 30, 1997, the Bank serviced $4.0
billion, $459.1 million, $1.1 billion and $244.1 million of securitized credit
card, home equity credit line, automobile and home loan receivables,
respectively. Chevy Chase derives fee-based income from servicing these
securitized portfolios. However, such fee-based income has been adversely
affected in recent periods by increases in delinquencies and charge-offs related
to the receivables placed in these securitized pools.
<PAGE>
The Bank's securitization transactions transfer the risk of repayment on
securitized assets to a trust which holds the receivables and issues the
asset-backed certificates and ultimately the risk of repayment is transferred to
the holders of those certificates. The Bank retains risk with respect to the
assets transferred to the trust only to the extent that it retains recourse
based on the performance of the assets or holds certificates issued by the trust
(such as a "seller certificate"). In its securitizations, the Bank typically
retains a limited amount of recourse through one or more means. Most often,
limited recourse is retained through the establishment of "spread accounts."
Occasionally other structures, such as overcollateralization, are used. Spread
accounts are funded by initial deposits, if required, and by amounts generated
by the securitized assets over and above the amount required to pay interest,
defaults and other charges and fees on the investors' interest in the
securitization transaction. Because amounts on deposit in the spread accounts
are at risk depending upon performance of the securitized receivables, those
amounts represent recourse to the Bank.
Pursuant to OTS's "low level recourse rule" (which sets capital requirements for
assets sold with recourse at the lower of the applicable capital requirement or
the amount of recourse retained), the Bank maintains dollar-for-dollar capital
against the securitized assets in the amount of the recourse retained up to the
otherwise applicable capital requirement. Even if defaults on outstanding
receivables significantly exceed projected and historical levels so that a "pay
out event" is triggered, the immediate consequence is that investors will begin
receiving payments of principal from the securitized assets earlier than
originally scheduled. Even if payments are insufficient to repay investors in
full, the Bank's assets are not exposed to risk of loss beyond the relevant
amount of recourse retained (including amounts outstanding in the spread
accounts and the amount of any subordinated interest), which, as noted above,
constitute a dollar-for-dollar capital requirement for the Bank. The Bank also
retains risk through the Bank's interest in any seller certificate. Seller
certificates share collections on the securitized assets on an unsubordinated
basis with the investor certificates (unless and to the extent recourse is
retained through an express subordination) and are on-balance sheet assets
against which the Bank must maintain capital.
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
$1.1 billion of credit card receivables, $938.9 million of automobile loan
receivables, $139.8 million of home equity credit line receivables, $154.4
million of home loan receivables and $216.3 million of mortgage loan
receivables, consisting of home equity credit line and home loan receivables,
during fiscal 1997. Additionally, during fiscal 1997, the Bank 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. At September 30, 1997, the Bank was considering the
securitization and sale of (i) approximately $615.0 million of credit card
receivables, including $90.0 million of receivables outstanding at September 30,
1997 and $525.0 million of receivables which the Bank expects to become
available, either through additional fundings or amortization of existing
trusts, during the six months ending March 31, 1997; (ii) approximately $450.0
million of automobile loan receivables, including $80.0 million of receivables
outstanding at September 30, 1997 and $370.0 million of receivables which the
Bank expects to become available through additional fundings during the six
months ending March 31, 1997; and (iii) approximately $185.0 million of home
equity credit line receivables; including $50.0 million of receivables
outstanding at September 30, 1997 and $135.0 million of receivables which the
Bank expects to become available through additional fundings during the six
months ending March 31, 1997.
<PAGE>
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.
The Bank uses its liquidity primarily to meet its commitments to fund maturing
savings certificates and deposit withdrawals, fund existing and continuing loan
commitments, repay borrowings and meet operating expenses. For fiscal 1997, the
Bank used the cash provided by operating, investing and financing activities
primarily to meet its commitments to fund maturing savings certificates and
deposit withdrawals of $18.2 billion, repay borrowings of $9.0 billion, fund
existing and continuing loan commitments (including real estate held for
investment or sale) of $3.0 billion, purchase investments and loans of $1.1
billion and meet operating expenses, before depreciation and amortization, of
$454.6 million. These commitments were funded primarily through proceeds from
customer deposits and sales of certificates of deposit of $18.9 billion,
proceeds from borrowings of $8.4 billion, proceeds from sales of loans, trading
securities and real estate of $3.1 billion, and principal and interest collected
on investments, loans, and securities of $1.6 billion.
The Bank is obligated under various recourse provisions related to the
securitization and sale of credit card, home equity credit line, automobile and
home loan receivables and amounts on deposit in certain spread accounts through
the asset-backed securitizations. Of the $6.0 billion of outstanding trust
certificate balances at September 30, 1997, the primary recourse to the Bank was
approximately $142.0 million.
The Bank also is obligated under various recourse provisions related to the swap
of single-family residential loans for participation certificates issued to the
Bank by FHLMC. At September 30, 1997, recourse to the Bank under these
arrangements was approximately $1.0 million.
<PAGE>
The Bank's commitments at September 30, 1997 are set forth in the following
table:
(In thousands)
Commitments to originate loans $ 74,999
------------
Loans in process (collateralized loans):
Home equity 564,785
Real estate construction 51,815
Commercial and multifamily 265
------------
616,865
------------
Loans in process (unsecured loans):
Credit cards 16,556,107
Overdraft lines 77,770
Commercial 54,137
------------
16,688,014
------------
Total commitments to extend credit 17,379,878
Letters of credit 29,186
Recourse arrangements on asset-backed
securitizations 141,992
Recourse arrangements on mortgage-backed
securities 989
------------
Total commitments $17,552,045
============
Based on historical experience, the Bank expects to fund substantially less than
the total amount of its outstanding credit card and home equity credit line
commitments, which together accounted for 97.5% of commitments at September 30,
1997.
At September 30, 1997, repayments of borrowed money scheduled to occur during
the next 12 months were $227.2 million. Certificates of deposit maturing during
the next 12 months amounted to $1.2 billion, of which a substantial portion is
expected to remain with the Bank.
There were no material commitments for capital expenditures at September 30,
1997.
The Bank's liquidity requirements in years subsequent to fiscal 1997 will
continue to be affected both by the asset size of the Bank, the growth of which
may 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
The Real Estate Trust's ability to generate revenues from property ownership and
development is significantly influenced by a number of factors, including
national and local economic conditions, the level of mortgage interest rates,
governmental actions (such as changes in real estate tax rates) and the type,
location, size and stage of development of the Real Estate Trust's properties.
Debt service payments and most of the operating expenses associated with
income-producing properties are not decreased by reductions in occupancy or
rental income. Therefore, the ability of the Real Estate Trust to produce net
income in any year from its income-producing properties is highly dependent on
the Real Estate Trust's ability to maintain or increase the properties' levels
of gross income. The relative illiquidity of real estate investments tends to
limit the ability of the Real Estate Trust to vary its portfolio promptly in
response to changes in economic, demographic, social, financial and investment
conditions.
The Bank's operating results historically have depended primarily on its "net
interest spread," which is the difference between the rates of interest earned
on its loans and securities investments and the rates of interest paid on its
deposits and borrowings. In the last three fiscal years, non-interest income
from securitizations of credit card and home equity credit line receivables and
income from gains on sales of credit card accounts (or "relationships"), loans
and mortgage-backed securities have had a significant effect on net income. In
addition to interest paid on its interest-bearing liabilities, the Bank's
principal expenses are operating expenses.
FISCAL 1997 COMPARED TO FISCAL 1996
REAL ESTATE
The Real Estate Trust recorded a loss before depreciation and amortization of
debt expense of $7.8 million and an operating loss of $19.0 million for fiscal
1997, compared to a loss before depreciation and amortization of debt expense of
$13.5 million and an operating loss of $24.2 million for fiscal 1996. The
improvement was largely attributable to higher income after direct operating
expenses for hotels and office and industrial properties, increased income from
Saul Holdings Partnership and other partnership investments, and recognition of
gains on sales of properties.
Income after direct operating expenses from hotel properties increased
$2,771,000 (15.3%) in fiscal 1997 over the level achieved in fiscal 1996. In the
current period, room sales increased $4,542,000 (11.7%), while food and beverage
sales increased $565,000 (4.6%). The increase in total revenue of $5,219,000
(9.6%) exceeded the increase of $2,448,000 (6.8%) 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 acquired a new hotel in the
current period.
Income after direct operating expenses from commercial properties, which
consists of office and industrial properties, increased $2,992,000 (28.9%) in
fiscal 1997 compared to such income in fiscal 1996. Gross income increased
$3,507,000 (19.9%) in fiscal 1997, while expenses increased $515,000 (7.1%). The
improvement was the direct result of a higher leasing rate in the most recent
year. Expenses in fiscal 1997 were above the prior year's principally due to
higher property taxes and higher operating expenses.
<PAGE>
Other income, which includes interest income, income from other real estate
properties and miscellaneous receipts, declined by $996,000 (19.9%) in the
current fiscal year primarily due to lower cash balances on which interest was
earned. Other income in fiscal 1996 also included $695,000 received as refunds
of transfer taxes paid in a preceding year.
Land parcels and other expense increased $46,000 (2.8%) in fiscal 1997 as the
result of higher real estate taxes.
Interest expense increased $315,000 (0.8%) in fiscal 1997, primarily because of
the higher level of borrowings in the current period. The average balance of
outstanding borrowings increased to $400.3 million for fiscal 1997 from $395.6
million for the prior year. The change in average borrowings occurred as a
result of mortgage loan refinancings and unsecured note sales. The average cost
of borrowings was 10.30% in fiscal 1997 and 10.31% in fiscal 1996.
Depreciation increased $523,000 (5.2%) in fiscal 1997 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 $572,000
(7.7%) in fiscal 1997. The advisory fee in fiscal 1997 was $311,000 per month,
compared to $301,000 per month for the first six months of fiscal 1996 and
$306,000 per month for the second six months of fiscal 1996, which resulted in
an aggregate increase of $93,000 (2.6%). Management and leasing fees were higher
by $479,000 (12.7%) in the current fiscal year as a result of increased gross
income on which fees are based.
General and administrative expense decreased $129,000 (9.2%) in fiscal 1997, as
a result of lower administrative costs.
Equity in earnings of unconsolidated entities represents the Real Estate Trust's
share of earnings in its partnership investments. For fiscal 1997, the Real
Estate Trust recorded earnings of $4,150,000 from such investments compared to
earnings of $3,374,000 in the prior year.
Gain on sale of property in fiscal 1997 represents the gain on the sale of a
purchase-leaseback investment located in Casper, Wyoming and the gain on the
condemnation of a portion of a land parcel located in Atlanta, Georgia.
<PAGE>
BANKING
Overview. The Bank recorded operating income of $80.2 million for the year ended
September 30, 1997 ("fiscal 1997"), compared to operating income of $46.1
million for the year ended September 30, 1996 ("fiscal 1996"). The increase in
income for fiscal 1997 was primarily attributable to a $68.5 million increase in
other (non-interest) income and an $11.9 million increase in net interest income
before provision for loan losses, the effect of which was partially offset by a
$9.4 million increase in the provision for loan losses and a $37.0 million
increase in operating (non-interest) expense reflecting in part additional
expenses associated with steps taken by management to improve credit quality
and expand the Bank's core businesses, including the consumer loan program and
deposit franchise.
Net Interest Income. Net interest income, before the provision for loan losses,
increased $11.9 million (or 6.0%) in fiscal 1997. The Bank would have recorded
additional interest income of $6.9 million in fiscal 1997 if the Bank's
nonaccrual assets and restructured loans had been current in accordance with
their original terms. Interest income of $0.7 million was actually recorded on
non-accrual assets and restructured loans during the fiscal year. The Bank's net
interest income in future periods will continue to be adversely affected by the
Bank's non-performing assets. See "Financial Condition - Asset Quality -
Non-Performing Assets."
The following table sets forth, for the periods indicated, information regarding
the total amount of income from interest-earning assets and the resulting
yields, the interest expense associated with interest-bearing liabilities,
expressed in dollars and rates, and the net interest spread and net yield on
interest-earning assets.
<PAGE>
<TABLE>
NET INTEREST MARGIN ANALYSIS
(Dollars in thousands)
Year Ended September 30,
--------------------------------------------------------------------------------
1997 1996 1995
September 30, -------------------------- -------------------------- --------------------------
1997 Average Yield/ Average Yield/ Average Yield/
Yield/Rate Balances Interest Rate Balances Interest Rate Balances Interest Rate
------------- ---------- -------- ------ ---------- -------- ------ ---------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans receivable, net (1) 12.83% $3,578,639 $360,842 10.08% $2,940,242 $317,847 10.81% $2,968,376 $294,554 9.92%
Mortgage-backed securities 5.41 1,204,839 72,209 5.99 834,198 50,955 6.11 981,253 60,623 6.18
Federal funds sold and
securities purchased
under agreements to resell 5.97 128,268 7,066 5.51 185,794 10,195 5.49 65,865 3,756 5.70
Trading securities 9.00 15,436 1,530 9.91 13,477 953 7.07 4,843 373 7.70
Investment securities 6.07 8,346 481 5.76 6,033 315 5.22 4,405 194 4.40
Other interest-earning assets 5.56 196,444 8,352 4.25 164,783 7,246 4.40 126,792 5,815 4.59
---------- -------- ---------- -------- ---------- --------
Total 9.12 5,131,972 450,480 8.78 4,144,527 387,511 9.35 4,151,534 365,315 8.80
------------- -------- ------ -------- ------ --------- ------
Non-interest earning assets:
Cash 191,626 161,925 131,345
Real estate held for
investment or sale 115,948 161,092 287,564
Property and equipment, net 249,104 197,351 161,109
Cost in excess of net assets
acquired, net 1,728 3,289 5,470
Other assets 399,365 248,870 156,172
---------- ---------- ----------
Total assets $6,089,743 $4,917,054 $4,893,194
========== ========== ==========
Liabilities and stockholders'
equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits 2.42 $ 890,204 21,977 2.47 $ 846,796 23,137 2.73 $ 829,255 23,721 2.71
Savings deposits 3.44 975,264 33,106 3.39 944,211 31,936 3.38 1,048,783 35,125 3.35
Time deposits 5.57 1,420,613 75,180 5.29 1,261,685 69,179 5.48 1,025,111 53,033 5.17
Money market deposits 3.97 992,066 38,644 3.90 990,392 38,317 3.87 1,070,531 42,420 3.96
---------- -------- ---------- -------- ---------- --------
Total deposits 4.18 4,278,147 168,907 3.95 4,043,084 162,569 4.02 3,973,680 154,299 3.84
Borrowings 7.43 1,134,754 70,908 6.25 369,831 26,267 7.10 496,938 34,815 7.01
---------- -------- ---------- -------- ---------- --------
Total liabilities 4.50 5,412,901 239,815 4.43 4,412,915 188,836 4.28 4,470,618 189,114 4.19
------------- -------- ------ -------- ------ --------- ------
Non interest-bearing items:
Non-interest bearing deposits 196,620 149,158 116,030
Other liabilities 53,037 51,338 48,702
Minority interest 119,376 0 0
Stockholders' equity 307,809 303,643 257,844
---------- ---------- ----------
Total liabilities and
stockholders' equity $6,089,743 $4,917,054 $4,893,194
========== ========== ==========
Net interest income $210,665 $198,675 $176,201
======== ======== ========
Net interest spread (2) 4.35% 5.07% 4.61%
====== ====== ======
Net yield on interest-earning
assets (3) 4.10% 4.79% 4.24%
====== ====== ======
Interest-earning assets to
interest-bearing
liabilities 94.81% 93.92% 91.91%
====== ====== ======
(1) Includes loans held for sale and/or securitization. Interest on
non-accruing loans has been included only to the extent reflected in
the consolidated statements of operations; however, the loan balance is
included in the average amount outstanding until transferred to real
estate acquired in settlement of loans. Includes ($9,659), ($7,980),
and ($10,062) of amortized loan fees, premiums and discounts in
interest income for the years ended September 30, 1997, 1996 and 1995.
(2) Equals weighted average yield on total interest-earning assets less
weighted average rate on total interest-bearing liabilities.
(3) Equals net interest income divided by the average balances of total
interest-earning assets.
</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)
Year Ended September 30, 1997 Year Ended September 30, 1996
Compared to Compared to
Year Ended September 30, 1996 Year Ended September 30, 1995
Increase (Decrease) Increase (Decrease)
Due to Change in (1) Due to Change in (1)
---------------------------------------------- -----------------------------------------------
Total Total
Volume Rate Change Volume Rate Change
--------------- -------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans (2) $ 65,539 $ (22,544) $ 42,995 $ (2,823) $ 26,116 $ 23,293
Mortgage-backed securities 22,272 (1,018) 21,254 (8,989) (679) (9,668)
Federal funds sold and securities
purchased under agreements
to resell (3,166) 37 (3,129) 6,582 (143) 6,439
Trading securities 153 424 577 613 (33) 580
Investment securities 131 35 166 80 41 121
Other interest-earning assets 1,359 (253) 1,106 1,681 (250) 1,431
--------------- -------------- --------------- --------------- --------------- ---------------
Total interest income 86,288 (23,319) 62,969 (2,856) 25,052 22,196
--------------- -------------- --------------- --------------- --------------- ---------------
Interest expense:
Deposit accounts 9,233 (2,895) 6,338 2,697 5,573 8,270
Borrowings 48,142 (3,501) 44,641 (8,991) 443 (8,548)
--------------- -------------- --------------- --------------- --------------- ---------------
Total interest expense 57,375 (6,396) 50,979 (6,294) 6,016 (278)
--------------- -------------- --------------- --------------- --------------- ---------------
Increase in net interest income $ 28,913 $ (16,923) $ 11,990 $ 3,438 $ 19,036 $ 22,474
=============== ============== =============== =============== =============== ===============
- -----------------------------------------------------------------------------------------------------------------------------------
(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 fiscal 1997 increased $62.9 million from the level in fiscal
1996, primarily as a result of higher average balances of loans receivable and,
to a lesser extent, mortgage-backed securities. The effect on interest income of
higher average balances was offset in part by lower average yields earned by the
Bank on its loan portfolio.
The Bank's net yield on interest-earning assets decreased to 4.10% in fiscal
1997 from 4.80% in fiscal 1996. 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 and
promotional rates on certain products which the Bank has offered to new and
existing customers in an effort to stimulate usage.
Interest income on loans, the largest category of interest-earning assets,
increased by $42.9 million (or 13.5%) from fiscal 1996 primarily because of
higher average balances, which were partially offset by lower average yields on
the loan portfolio.
Higher average balances on credit card loans, which increased $159.5 million
(15.8%). The increase was primarily responsible for a $3.4 million (or 2.2%)
increase in interest income from credit card loans. Higher average balances of
automobile loans, which increased $64.2 million (or 35.1%), resulted primarily
from the higher origination volume of such loans, and was largely responsible
for a $16.2 million (or 75.3%) increase in interest income on automobile loans.
Interest income on the Bank's single-family residential loans increased by $15.8
million (or 15.6%) primarily because of increased originations, which resulted
in an increase of $355.8 million (or 25.2%) in the average balances of such
loans. Average balances of home equity credit line loans increased by $60.0
million (or 74.8%) primarily because of the $119.2 million purchase of such
loans in December 1996. Interest income on home equity credit line loans
increased by $5.7 million (or 124.4%) in the current year.
The average yield on the loan portfolio in fiscal 1997 decreased by 73 basis
points (to 10.08% from 10.81%) from the average yield in fiscal 1996. The lower
net yield was primarily due to a 182 basis point decrease in the average net
yield on credit card loans from 15.50% to 13.68%, the effect of which partially
offset the positive effect that the higher average balances had on income. The
decline in the net yield was primarily a result of marketing strategies to
introduce lower introductory rates to new customers, as well as a new program
offering reduced interest rates to previously risk-repriced accounts in an
attempt to encourage payments from delinquent customers. Also contributing to
the decreased average yield on the loan portfolio was a decrease in the average
yield on single-family residential loans from 7.21% to 6.65%. An increase in the
average yield on automobile loans from 11.75% to 15.24%, 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.
Interest income on mortgage-backed securities increased $21.3 million (or 41.7%)
primarily because of higher average balances. The increased mortgage-backed
securities balances in fiscal 1997 reflected the purchase of $649.7 million of
mortgage-backed securities near the end of fiscal year 1996 and the $1.1 billion
securitization of single-family residential loans in September 1997. The
positive effect of the higher average balances was partially offset by a
decrease in the average interest rates on these securities from 6.11% to 5.99%.
<PAGE>
Interest expense increased $51.0 million (or 27.0%) for fiscal 1997 primarily
because of an increase of $764.9 million (or 206.8%) in the average balances of
the Bank's borrowings. The increase in the average balances of borrowings
resulted in an increase of $44.6 million in interest expense for fiscal 1997 for
such liabilities. The increase in interest expense on borrowings is primarily
due to a $22.8 million, a $13.7 million and a $6.9 million increase in interest
expense on securities sold under repurchase agreements, Federal Home Loan Bank
advances and subordinated debentures, respectively, resulting primarily 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 6.25% from 7.10%), which reflected an
increase in lower-yielding FHLB advances and securities sold under repurchase
agreements.
An increase of $6.3 million in interest expense on deposits, the largest
category of interest-bearing liabilities, also contributed to the increased
interest expense. Interest expense on deposits increased primarily because of a
$160.2 million increase in the average balances.
Provision for Loan Losses. The Bank's provision for loan losses increased to
$125.1 million in fiscal 1997 from $115.7 million in fiscal 1996. The $9.4
million increase over the prior year was primarily attributable to a $7.8
million increase in the provision for losses on credit card loans. See
"Financial Condition - Asset Quality - Allowances for Losses."
Other Income. The $68.5 million (or 19.9%) increase in other (non-interest)
income to $413.0 million in fiscal 1997 from $344.5 million in fiscal 1996 was
primarily attributable to increases in gain on sales of loans, credit card fees,
deposit servicing fees and a decrease in loss on real estate held for investment
or sale. In addition, the Bank recognized a net unrealized gain on the valuation
of interest-only strips during fiscal 1997 resulting from the implementation of
SFAS 125, as discussed below. The positive effect of these items on other income
was partially offset by a decrease in loan servicing fees. Management expects
that the relative impact of gains recognized under SFAS 125 on the Bank's
earnings will diminish as the gains associated with these and other transactions
are amortized.
Gain on sales of loans increased by $50.6 million (or 217.6%) primarily because
of additional gains recognized on the securitization and sales of automobile,
home equity credit line and home loan receivables during fiscal 1997. In
addition, in accordance with the adoption of SFAS 125, the Bank also recognized
gains on the securitization and sales of credit card loan receivables during the
current year. See Notes to the Consolidated Financial Statements.
Credit card fees, consisting of membership fees, late charges, over-the-limit
fees, interchange fees and cash advance charges, increased $26.6 million (or
86.5%) in fiscal 1997 from the level in fiscal 1996. The increase was primarily
attributable to the impact of changes in the fee structure for the Bank's credit
card programs which were implemented in fiscal 1996 and 1997.
The $12.0 million (or 40.1%) increase in deposit servicing fees resulted
primarily from the additional fees generated through the Bank's ATM network,
and, to a lesser extent, an increase in the number of deposit accounts
outstanding during fiscal 1997.
The $5.7 million (or 23.5%) decrease in loss on real estate held for investment
or sale was primarily attributable to a decrease of $6.7 million in the
provision for losses on such assets, which was partially offset by a decrease of
$1.1 million in the gain recorded on sales of the Bank's real estate held for
investment or sale.
<PAGE>
In accordance with SFAS 125, the Bank recognized a $7.0 million net unrealized
gain on the valuation of its interest-only strips. This gain represents the
September 30, 1997 market-value adjustment on the interest-only strips related
to the credit card securitized assets. See Notes to the Consolidated Financial
Statements.
The decrease of $36.3 million (or 13.8%) in loan servicing fees was primarily
due to a decrease of $49.0 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 fiscal 1997 resulted primarily from an increase in
charge-offs on securitized credit card loans which is consistent with
management's expectations and generally reflects the trends that are affecting
the credit card industry as a whole. See "Financial Condition - Asset Quality -
Allowance for Losses."
Operating Expenses. Operating expenses for fiscal 1997 increased $37.0 million
(9.7%) from the level in fiscal 1996. The main components of the higher
operating expenses were increases in salaries and employee benefits, marketing
and data processing. The $33.6 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 $20.8 million
increase in marketing expenses was primarily attributable to a $14.4 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
$5.3 million increase in marketing expenses associated with the Bank's deposit
base. The $6.9 million increase in data processing expenses was principally
attributable to an increase in the number of credit card accounts outstanding
and the activity generated by such accounts during fiscal 1997. The $32.3
million decrease in deposit insurance premiums, which partially offset the
expense increases discussed above, was primarily because of the one-time SAIF
assessment recorded by the Bank in fiscal 1996. See "Business - Regulation
Deposit Insurance Premiums."
<PAGE>
FISCAL 1996 COMPARED TO FISCAL 1995
REAL ESTATE
The Real Estate Trust recorded a loss before depreciation and amortization of
debt expense of $13.5 million and an operating loss of $24.2 million for fiscal
1996, compared to a loss before depreciation and amortization of debt expense of
$17.2 million and an operating loss of $27.3 million for fiscal 1995. Of the
$3.1 million positive variance in the operating loss, approximately $2.1 million
was due to improved results from operations in fiscal 1996, and $1.0 million
reflected the net change from fiscal 1995 results which included a $2.7 million
writedown of real estate to net realizable value and a $1.7 gain on sale of
property.
Income after direct operating expenses from hotel properties increased
$2,104,000 (13.1%) from such income in fiscal 1995. Room sales increased by
$948,000 (2.5%) as a result of higher room rates. Food, beverage, and
miscellaneous sales were down by a total of $807,000 and payroll expense was
lower by $1,547,000, largely due to the sale of the Norfolk hotel early in
October 1995. Other operating expenses reflected decreases of $416,000, also due
to the sale.
Income after direct operating expenses from commercial properties decreased
$1,064,000 (9.9%) in fiscal 1996. Gross income declined $1,222,000 (6.8%)
largely due to vacancies at 8201 Greensboro Drive. Partially offsetting this
reduction in income was a decline in operating expenses of $158,000 (2.2%). The
leasing percentage of 8201 Greensboro Drive at September 30, 1996, was 85%.
Other income, which includes interest income, income from other real estate
properties, and miscellaneous receipts increased $635,000 (14.5%), primarily due
to $695,000 received as refunds of transfer taxes paid in a preceding year.
Land parcels and other expense increased $289,000 (21.4%) in fiscal 1996 as a
result of higher real estate taxes.
Interest expense decreased $724,000 (1.8%) in fiscal 1996 as a result of lower
average borrowings, which were $395.6 million in fiscal 1996 as compared to the
prior year's average borrowings of $403.7 million. The average cost of
borrowings increased slightly to 10.31% in fiscal 1996 from 10.25% during the
prior year.
Amortization of debt expense increased $198,000 (41.6%) due to the expense of a
new $8.0 million line of credit which was obtained in fiscal 1996 and the first
full year of expense for the $15.0 million line of credit which had been
obtained during fiscal 1995.
Depreciation increased $306,000 (3.2%) in fiscal 1996 as a result of new tenant
improvements and property renovations in excess of the reduction in depreciation
caused by the sale of a hotel.
Advisory, management and leasing fees paid to related parties increased $47,000
(0.6%) in fiscal 1996. The monthly advisory fee in fiscal 1996 was $301,000 for
the period October 1995 through March 1996 and $306,000 for the period April
1996 through September 1996 as compared to $292,000 throughout fiscal 1995,
which represented an aggregate increase of $141,000 (4.0%). Management and
leasing fees were lower in the current year by $94,000 (2.4%) as a result of
lower gross income on which fees are based.
<PAGE>
General and administrative expense decreased $918,000 (39.6%) in fiscal 1996,
principally as a result of high legal costs incurred in fiscal 1995 in
litigation with a tenant.
The fiscal 1995 write-down of real estate to net realizable value reflected as
$1.2 million reduction in the carrying value of a hotel property and a $1.5
million write-off of restaurant assets. The Real Estate Trust sold the hotel
property on October 6, 1995. There were no comparable write-downs or write-offs
during fiscal 1996.
Equity in earnings of unconsolidated entities represents the Real Estate Trust's
share of earnings in its partnership investments. For fiscal 1996, the Real
Estate Trust recorded earnings of $3,374,000 from such investments compared to
earnings of $3,681,000 in the prior year.
The loss on sale of property of $68,000 in fiscal 1996 represented additional
costs incurred on the sale of a hotel in Norfolk, Virginia. The gain on sale of
property of $1,664,000 in fiscal 1995 represented the gain on the condemnation
of a portion of a land parcel an Atlanta, Georgia.
BANKING
Overview. The Bank recorded operating income of $46.1 million for the year ended
September 30, 1996 ("fiscal 1996"), compared to operating income of $55.7
million for the year ended September 30, 1995 ("fiscal 1995"). The decrease in
operating income for fiscal 1996 was primarily attributable to a $60.8 million
increase in the provision for loan losses and an $83.1 million increase in
non-interest expenses (which included the $26.5 million SAIF assessment
discussed previously - see "Business Regulation - Deposit Insurance Premiums"),
the effect of which was partially offset by a $111.5 million increase in
non-interest income and a $22.5 million increase in net interest income.
Net Interest Income. Net interest income, before the provision for loan losses,
increased $22.5 million (or 12.8%) in fiscal 1996. The Bank would have recorded
additional interest income of $9.1 million in fiscal 1996 if the Bank's
non-accrual assets and restructured loans had been current in accordance with
their original terms. Interest income of $1.3 million was actually recorded on
non-accrual assets and restructured loans during the fiscal year. The Bank's net
interest income in future periods will continue to be adversely affected by the
Bank's non-performing assets. See "Financial Condition - Asset Quality -
Non-Performing Assets."
Interest income in fiscal 1996 increased $22.2 million from the level in fiscal
1995, primarily as a result of higher average yields earned by the Bank on its
loan portfolio. Higher average balances of federal funds sold and securities
purchased under agreements to resell and other interest-earning assets also
contributed to the increase in interest income. The effect on interest income of
higher average yields on the loan portfolio and higher average balances was
offset in part by lower average balances of mortgage-backed securities and loans
receivable.
The Bank's net yield on interest-earning assets increased to 4.79% in fiscal
1996 from 4.24% in fiscal 1995. The increase primarily reflected the upward
adjustment of interest rates on certain of the Bank's adjustable rate products
and higher yields on other consumer loans. The positive effect of the increase
on the Bank's net yield was offset in part by increased interest rates on the
Bank's interest-bearing liabilities.
<PAGE>
Interest income on loans, the largest category of interest-earning assets,
increased by $23.3 million (or 7.9%) from fiscal 1995 primarily because of
higher average yields on the loan portfolio, which were partially offset by
lower average balances. The average yield on the loan portfolio in fiscal 1996
increased by 89 basis points (to 10.81% from 9.92%) from the average yield in
fiscal 1995. The higher yields were primarily due to increases in the average
net yield on credit card loans from 13.94% to 15.50% and on automobile loans
from 8.84% to 11.75%. 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 and the expiration of promotional
introductory rates. The increase was primarily responsible for a $17.0 million
(or 12.2%) increase in interest income from credit card loans. 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
balances of consumer loans other than automobile loans, which increased $61.3
million (or 50.9%), also contributed to the increase in interest income on
loans. The increased average balances of other consumer loans resulted primarily
from the higher origination volume of home improvement and commercial loans
during fiscal 1996, and was largely responsible for an $11.2 million (or 102.5%)
increase in interest income on other consumer loans. The effect on interest
income of higher average net yields and higher average balances of certain
consumer loans was offset in part by an $84.3 million decrease in the average
balances of automobile loan receivables due to the securitization and sale of
$475.3 million of such receivables during fiscal 1996.
Interest income on mortgage-backed securities decreased $9.7 million (or 15.9%)
primarily because of lower average balances. The reduced mortgage-backed
securities balances in fiscal 1996 reflected the effects of scheduled principal
paydowns and unscheduled principal prepayments. The negative effect of the lower
average balances was compounded by a decrease in the average interest rates on
these securities from 6.18% to 6.11%.
Other interest income increased $7.9 million (or 82.2%) in fiscal 1996 primarily
as a result of higher average balances on federal funds sold and securities
purchased under agreements to resell which increased by $119.9 million (or
182.1%) and, to a lesser extent, higher average balances on other
interest-earning assets.
<PAGE>
Interest expense decreased $0.3 million in fiscal 1996 primarily because of a
decrease of $127.1 million (or 25.6%) in the average balances of the Bank's
borrowings, which resulted in an $8.5 million decrease in interest expense
during fiscal 1996 for such liabilities. The decrease in interest expense on
borrowings is primarily due to a $6.2 million, a $1.3 million and a $0.7 million
decrease in interest expense on securities sold under repurchase agreements,
bonds payable and FHLB advances, respectively, resulting from lower average
balances. The decrease in interest expense on securities sold under repurchase
agreements was primarily a result of a $101.9 million decrease in the average
balances of such liabilities as the Bank's deposit base has increased in recent
periods. The decrease in interest expense on bonds payable was due to the
assumption of bonds payable in April 1995 by the purchaser of two residential
apartment buildings that were securing the bonds. A $6.6 million decline in the
average balances of FHLB advances contributed to the $0.7 million decrease in
the interest expense on such liabilities. The positive effect of such lower
average balances was offset in part by an increase in the average borrowing rate
(to 7.10% from 7.01%).
The decrease in interest on borrowings was partially offset by an $8.3 million
increase in interest expense on deposits, the largest category of
interest-bearing liabilities. Interest expense on deposits increased primarily
as a result of an increase in average rates (to 4.02% from 3.88%), which
reflected a shift in the composition of the Bank's deposits to higher yielding
certificates of deposit and, to a lesser extent, an increase in average deposit
balances of $69.4 million.
Provision for Loan Losses. The Bank's provision for loan losses increased to
$115.7 million in fiscal 1996 from $55.0 million in fiscal 1995. The $60.8
million increase over the prior year was primarily attributable to a $56.7
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. See "Financial Condition -
Asset Quality - Allowances for Losses."
Other Income. The increase in other (non-interest) income to $344.5 million in
fiscal 1996 from $232.6 million in fiscal 1995 was primarily attributable to
increases in loan servicing fees, credit card fees and gain on sales of loans.
The positive effect of these items on other income was partially offset by an
increase in loss on real estate held for investment or sale.
An increase of $49.0 million in excess spread income and $20.8 million of
servicing fees earned by the Bank for servicing its portfolios of securitized
credit card loans contributed to an increase of $79.8 million (or 43.3%) in loan
servicing fees. Such excess spread income and servicing fees have increased in
recent periods as a result of greater securitization activity by the Bank.
Credit card fees, consisting of membership fees, late charges, over-the-limit
fees, interchange fees and cash advance charges, increased $20.9 million (or
212.2%) in fiscal 1996 from the level in fiscal 1995. The increase was primarily
attributable to changes in the fee structure for the Bank's credit card programs
during fiscal 1996.
Gain on sales of loans increased by $10.4 million (or 80.4%) primarily because
of additional gains recognized on the securitization and sales of automobile,
home equity credit line and home loan receivables during fiscal 1996.
<PAGE>
The $19.2 million increase in loss on real estate held for investment or sale
was primarily attributable to a decrease of $4.5 million in the equity earnings
in partnership income and a decrease of $12.5 million in the gain recorded on
sales of the Bank's real estate held for investment or sale.
Operating Expenses. Operating expenses for fiscal 1996 increased $83.1 million
(27.9%) from the level in fiscal 1995. The primary reason for the increase was
the $26.5 million SAIF assessment included in deposit insurance premiums. Other
expense categories with increases include salaries and employee benefits, loan
and data processing. The $19.2 million increase in salaries and employee
benefits resulted primarily from the addition of staff to the Bank's credit
card, consumer lending and branch operations. The $12.5 million increase in loan
expenses was primarily attributable to an increase in the amortization of
capitalized mortgage servicing rights, which resulted from acquisitions of
single-family residential mortgage servicing rights in recent periods, and a
$3.1 million valuation allowance against mortgage servicing rights. The $7.0
million increase in data processing expenses was principally attributable to an
increase in the number of credit card accounts outstanding and the activity
generated by such accounts during fiscal 1996.
<PAGE>
MANAGEMENT'S STATEMENT ON RESPONSIBILITY
The Consolidated Financial Statements and related financial information in this
report have been prepared by the Advisor (management) in accordance with
generally accepted accounting principles appropriate in the circumstances, based
on best estimates and judgments, with consideration given to materiality.
The Trust maintains a system of internal accounting control supported by
documentation to provide reasonable assurance that the books and records reflect
authorized transactions of the Trust, and that the assets of the Trust are
safeguarded.
The Board of Trustees exercises its responsibility for the Trust's financial
statements through its Audit Committee, which is composed of two outside
Trustees who meet periodically with the Trust's independent accountants and
management. The Committee considers the audit scope, discusses financial and
reporting subjects, and reviews management actions on these matters. The
independent accountants have full access to the Audit Committee.
The independent accountants are recommended by the Audit Committee and confirmed
by the Board of Trustees. They provide an objective assessment of the fairness
and accuracy of the financial statements, consider the adequacy of the system of
internal accounting controls, and perform such tests and other procedures as
they deem necessary to express an opinion on the fairness of the financial
statements. Management believes that the policies and procedures it has
established provide reasonable assurance that its operations are conducted in
conformity with law and a high standard of business conduct.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULES
To the Trusees and Shareholders of
B.F. Saul Real Estate Investment Trust
We have audited the consolidated financial statements of B.F. Saul Real Estate
Investment Trust (the "Trust") as of September 30, 1997 and 1996 and for the
years then ended in accordance with generally accepted auditing standards, and
have issued our report thereon dated December 9, 1997. Our audit was made for
the purpose of forming an opinion on the basic financial statements taken as a
whole. The schedules listed in Item 14 are the responsibility of the Trust's
management and are presented for purposes of complying with the Securities and
Exchange Commission's rules and are not part of the basic financial statements.
This information has been subjected to the auditing procedures applied in our
audit of the basic financial statements and, in our opinion, is fairly stated in
all material respects as to the financial data required to be set forth therein
in relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Washington, D.C.
December 9, 1997
<PAGE>
B.F. SAUL REAL ESTATE INVESTMENT TRUST
CONDENSED FINANCIAL INFORMATION SCHEDULE I
(a) Required consensed financial information on the Trust is disclosed in
the audited consolidated financial statements included herewith.
(b) Amounts of cash dividends paid to the Trust by consolidated subsidiaries
were as follows:
Year Ended September 30
---------------------------------------
1997 1996 1995
$7,200,000 $6,800,000 None
<PAGE>
<TABLE>
Consolidated Schedule of Investment Properties - Real Estate Trust Schedule III
September 30, 1997
(Dollars in Thousands)
Costs
Capitalized Basis at Close of Period
----------------------------------------------------------
Initial Subsequent Buildings
Basis to to and Leasehold
Hotels Trust Acquisition Land Improvements Interests Total
- ------------------------------------------ ------------- ------------- ----------- ------------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Hampton Inn-Dulles, Sterling VA $ -- $ 6,085 $ 290 $ 5,795 $ -- $ 6,085
Holiday Inn, Auburn Hills MI 10,450 876 1,031 10,295 -- 11,326
Holiday Inn, Cincinnati OH 6,859 2,428 245 9,042 -- 9,287
Holiday Inn, Sterling VA 6,950 20,023 862 26,111 -- 26,973
Holiday Inn, Gaithersburg MD 3,849 14,780 1,781 16,848 -- 18,629
Holiday Inn, Herndon VA 5,259 -- 1,178 4,081 -- 5,259
Holiday Inn, Pueblo CO 3,458 2,270 561 5,167 -- 5,728
Holiday Inn, Rochester NY 3,340 9,359 605 12,094 -- 12,699
Holiday Inn, Tysons Corner VA 6,976 12,593 3,107 16,462 -- 19,569
Howard Johnsons, Arlington VA 10,187 2,815 1,183 11,819 -- 13,002
------------- ------------- ----------- ------------------ ------------- -------------
Subtotal - Hotels $ 57,328 $ 71,229 $ 10,843 $ 117,714 $ -- $ 128,557
------------- ------------- ----------- ------------------ ------------- -------------
Commercial
- ------------------------------------------
900 Circle 75, Atlanta GA $ 33,434 $ 1,134 $ 563 $ 34,005 $ -- $ 34,568
1000 Circle 75, Atlanta GA 2,820 1,057 248 3,629 -- 3,877
1100 Circle 75, Atlanta GA 22,746 2,003 419 24,330 -- 24,749
8201 Greensboro, Tysons Corner VA 28,890 3,700 1,633 30,957 -- 32,590
Commerce Ctr-Ph II, Ft Lauderdale FL 4,266 719 782 4,203 -- 4,985
Dulles North, Loudoun County VA -- 5,552 421 5,131 -- 5,552
Metairie Tower, Metairie LA 2,729 578 403 2,904 -- 3,307
------------- ------------- ----------- ------------------ ------------- -------------
Subtotal - Commercial $ 94,885 $ 14,743 $ 4,469 $ 105,159 $ -- $ 109,628
------------- ------------- ----------- ------------------ ------------- -------------
</TABLE>
<PAGE>
<TABLE>
Consolidated Schedule of Investment Properties - Real Estate Trust Schedule III (Continued)
September 30, 1997
(Dollars in Thousands)
Costs
Capitalized Basis at Close of Period
----------------------------------------------------------
Initial Subsequent Buildings
Basis to to and Leasehold
Purchase-Leasebacks Trust Acquisition Land Improvements Interests Total
- ------------------------------------------ ------------- ------------- ----------- ------------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Chateau di Jon, Metairie, LA $ 1,125 $ -- $ 1,125 $ -- $ -- $ 1,125
Country Club, Knoxville, TN 500 -- 500 -- -- 500
Houston Mall, Warner Robbins, GA 650 -- 650 -- -- 650
Old National, Atlanta, GA 550 -- 550 -- -- 550
------------- ------------- ----------- ------------------ ------------- -------------
Subtotal - Purchase-Leasebacks $ 2,825 $ -- $ 2,825 $ -- $ -- $ 2,825
------------- ------------- ----------- ------------------ ------------- -------------
Miscellaneous investments $ 633 $ 807 $ 250 $ 1,041 $ 149 $ 1,440
------------- ------------- ----------- ------------------ ------------- -------------
Total Income-Producing Properties $ 155,671 $ 86,779 $ 18,387 $ 223,914 $ 149 $ 242,450
------------- ------------- ----------- ------------------ ------------- -------------
Land Parcels
- ------------------------------------------
Arvida Park of Commerce,
Boca Raton, FL $ 7,378 143 $ 7,521 $ -- $ -- $ 7,521
Avenel, Gaithersburg, MD 361 (82) 279 -- -- 279
Church Road, Loudoun Co., VA 2,586 2,272 4,858 -- -- 4,858
Circle 75, Atlanta, GA 12,927 4,276 17,203 -- -- 17,203
Flagship Centre, Rockville, MD 1,729 39 1,768 -- -- 1,768
Holiday Inn - Auburn Hills, Auburn Hills MI 656 656 -- -- 656
Holiday Inn - Rochester, Roch., NY 68 -- 68 -- -- 68
Overland Park, Overland Park, KA 3,771 398 4,169 -- -- 4,169
Prospect Indust. Pk, Ft. Laud., FL 2,203 10 2,213 -- -- 2,213
Sterling Blvd., Loudoun Co., VA -- 3,425 3,425 -- -- 3,425
------------- ------------- ----------- ------------------ ------------- -------------
Subtotal $ 31,023 $ 11,137 $ 42,160 $ -- $ -- $ 42,160
------------- ------------- ----------- ------------------ ------------- -------------
Total Investment Properties $ 186,694 $ 97,916 $ 60,547 $ 223,914 $ 149 $ 284,610
============= ============= =========== ================== ============= =============
</TABLE>
<PAGE>
<TABLE>
Consolidated Schedule of Investment Properties - Real Estate Trust Schedule III (Continued)
September 30, 1997
(Dollars in Thousands)
Buildings
and
Improvements
Accumulated Related Date of Date Depreciable
Hotels Depreciation Debt Construction Acquired Lives (Years)
- ------------------------------------------ ------------------- ------------------ -------------- --------------- ----------------
<S> <C> <C> <C> <C> <C>
Hampton Inn-Dulles, Sterling VA $ 2,263 $ 6,017 1987 4/87 31.5
Holiday Inn, Auburn Hills MI 1,084 7,254 1989 11/94 31.5
Holiday Inn, Cincinnati OH 4,723 5,738 1975 2/76 40
Holiday Inn, Dulles VA 11,227 12,133 1971 11/84 28
Holiday Inn, Gaithersburg MD 6,965 6,926 1972 6/75 45
Holiday Inn, Herndon VA 133 3,364 1987 10/96 40
Holiday Inn, Pueblo CO 2,582 3,604 1973 3/76 40
Holiday Inn, Rochester NY 5,710 13,256 1975 3/76 40
Holiday Inn, Tysons Corner VA 7,225 15,608 1971 6/75 47
Howard Johnsons, Arlington VA 5,358 9,014 1973 11/83 30
------------------- ------------------
Subtotal - Hotels $ 47,270 $ 82,914
------------------- ------------------
Commercial
- ------------------------------------------
900 Circle 75, Atlanta GA $ 12,226 $ 20,924 1985 12/85 35
1000 Circle 75, Atlanta GA 1,956 3,460 1974 4/76 40
1100 Circle 75, Atlanta GA 10,640 14,332 1982 9/82 40
8201 Greensboro, Tysons Corner VA 9,444 34,681 1985 4/86 35
Commerce Ctr-Ph II, Ft Lauderdale FL 1,428 3,028 1986 1/87 35
Dulles North, Loudoun County VA 1,093 3,172 1990 10/90 31.5
Metairie Tower, Metairie LA 1,544 -- 1974 11/76 40
------------------- ------------------
Subtotal - Commercial $ 38,331 $ 79,597
------------------- ------------------
</TABLE>
<PAGE>
<TABLE>
Consolidated Schedule of Investment Properties - Real Estate Trust Schedule III (Continued)
September 30, 1997
(Dollars in Thousands)
Buildings
and
Improvements
Accumulated Related Date of Date Depreciable
Purchase-Leasebacks Depreciation Debt Construction Acquired Lives (Years)
- ------------------------------------------ ------------------- ------------------ -------------- --------------- ----------------
<S> <C> <C> <C> <C> <C>
Chateau di Jon, Metairie, LA $ -- $ -- 11/73
Country Club, Knoxville, TN -- -- 5/76
Houston Mall, Warner Robbins, GA -- -- 2/72
Old National, Atlanta, GA -- -- 8/71
------------------- ------------------
Subtotal - Purchase-Leasebacks $ -- $ --
------------------- ------------------
Miscellaneous investments $ 314 $ --
------------------- ------------------
Total Income-Producing Properties $ 85,915 $ 162,511
------------------- ------------------
Land Parcels
- ------------------------------------------
Arvida Park of Commerce,
Boca Raton, FL $ -- $ 16,390 12/84 & 5/85
Avenel, Gaithersburg, MD -- -- 12/76
Church Road, Loudoun Co., VA -- -- 9/84 & 4/85
Circle 75, Atlanta, GA -- 2,312 2/77 & 1/84
Flagship Centre, Rockville, MD -- -- 8/85
Holiday Inn - Auburn Hills, Auburn Hills MI -- 499 7/97
Holiday Inn - Rochester, Roch., NY -- -- 9/86
Overland Park, Overland Park, KA -- -- 1/77 & 2/85
Prospect Indust. Pk, Ft. Laud., FL -- -- 10/83 & 8/84
Sterling Blvd., Loudoun Co., VA -- -- 4/84
------------------- ------------------
Subtotal $ -- $ 19,201
------------------- ------------------
Total Investment Properties $ 85,915 $ 181,712
=================== ==================
</TABLE>
<PAGE>
<TABLE>
Schedule III (Continued)
CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIES - REAL ESTATE TRUST
NOTES:
(1) See Summary of Significant Accounting Policies for basis of
recording investment properties and computing depreciation.
Investment properties are discussed in Note 3 to Consolidated
Financial Statements.
(2) A reconciliation of the basis of investment properties and
accumulated depreciation follows.
BASIS OF INVESTMENT PROPERTIES AND ACCUMULATED DEPRECIATION
(In thousands)
For The Year Ended September 30
-----------------------------------------------------------------------
1997 1996 1995
----------------------- ----------------------- -----------------------
<S> <C> <C> <C>
Basis of investment properties
- -------------------------------------------------
Balance at beginning of period $ 274,208 $ 277,385 $ 266,095
Additions (reductions) during the period:
Capital expenditures 12,069 7,408 16,462
Sales - nonaffiliates (525) (5,382) --
Write-down of assets to net realizable value -- -- (2,727)
Other (1,142) (5,203) (2,445)
----------------------- ----------------------- -----------------------
Balance at end of period $ 284,610 $ 274,208 $ 277,385
======================= ======================= =======================
Accumulated depreciation
- -------------------------------------------------
Balance at beginning of period $ 76,513 $ 75,140 $ 68,111
Additions (reductions) during the period:
Depreciation expense 10,543 10,020 9,714
Sales - nonaffiliates -- (3,441) --
Other (1,141) (5,206) (2,685)
----------------------- ----------------------- -----------------------
Balance at end of period $ 85,915 $ 76,513 $ 75,140
======================= ======================= =======================
</TABLE>
<PAGE>
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Public Accountant.
Consolidated Balance Sheets - As of September 30,
1997 and 1996.
Consolidated Statements of Operations - For the
years ended September 30, 1997, 1996 and 1995.
Consolidated Statements of Shareholders' Deficit - For the
years ended September 30, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows - For the
years ended September 30, 1997, 1996 and 1995.
Notes to Consolidated Financial Statements.
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Trustees and Shareholders of
B.F. Saul Real Estate Investment Trust
We have audited the accompanying consolidated balance sheets of B.F. Saul Real
Estate Investment Trust (the "Trust") and subsidiaries as of September 30, 1997
and 1996, and the related consolidated statements of operations, shareholders'
deficit, and cash flows for each of the three years in the period ended
September 30, 1997. These financial statements are the responsibility of the
Trust's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of B.F. Saul Real Estate
Investment Trust and subsidiaries as of September 30, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended September 30, 1997, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Washington, D.C.
December 9, 1997
<PAGE>
<TABLE>
Consolidated Balance Sheets
B. F. SAUL REAL ESTATE INVESTMENT TRUST
===================================================================================================================================
September 30
------------------------------
(In thousands) 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Real Estate
Income-producing properties
Hotel $ 128,557 $ 121,417
Office and industrial 109,628 106,496
Other 4,265 4,715
-------------- --------------
242,450 232,628
Accumulated depreciation (85,915) (76,513)
-------------- --------------
156,535 156,115
Land parcels 42,160 41,580
Construction in progress 2,480 --
Cash and cash equivalents 18,248 15,516
Other assets 81,150 81,292
-------------- --------------
Total real estate assets 300,573 294,503
- -----------------------------------------------------------------------------------------------------------------------------------
Banking
Cash and due from banks 238,169 213,394
Interest-bearing deposits 48,722 53,031
Federal funds sold and securities purchased under agreements to resell 365,000 --
Loans held for sale 102,749 76,064
Loans held for securitization and sale 220,000 450,000
Investment securities (market value $5,012 and $9,820, respectively) 4,998 9,818
Trading securities 7,899 --
Mortgage-backed securities (market value $1,984,667 and $1,307,838, respectively) 1,985,707 1,306,417
Loans receivable (net of allowance for losses of $105,679 and $95,523, respectively) 2,104,240 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 $140,936 and $126,710,
respectively) 94,290 123,489
Property and equipment, net 273,562 225,135
Goodwill and other intangible assets, net 8,846 2,399
Interest only strips, net 105,812 --
Excess-spread assets, net -- 42,602
Servicing assets, net 41,579 32,790
Other assets 422,670 353,028
-------------- --------------
Total banking assets 6,057,413 5,693,074
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 6,357,986 $ 5,987,577
- -----------------------------------------------------------------------------------------------------------------------------------
LIABILITIES
Real Estate
Mortgage notes payable $ 180,204 $ 173,345
Notes payable - secured 175,000 177,500
Notes payable - unsecured 46,633 42,367
Deferred gains - real estate 112,883 112,883
Accrued dividends payable - preferred shares of beneficial interest 36,231 31,563
Other liabilities and accrued expenses 39,959 40,434
-------------- --------------
Total real estate liabilities 590,910 578,092
- -----------------------------------------------------------------------------------------------------------------------------------
Banking
Deposit accounts 4,893,756 4,164,037
Securities sold under repurchase agreements and other short-term borrowings 74,821 637,141
Notes payable 7,019 7,277
Federal Home Loan Bank advances 188,511 269,065
Custodial accounts 2,809 7,415
Amounts due to banks 44,835 44,423
Other liabilities and accrued expenses 120,416 99,086
Capital notes -- subordinated 250,000 160,000
-------------- --------------
Total banking liabilities 5,582,167 5,388,444
- -----------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Minority interest held by affiliates 51,388 46,065
Minority interest -- other 218,306 74,307
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 6,442,771 6,086,908
- -----------------------------------------------------------------------------------------------------------------------------------
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 (142,642) (156,084)
Net unrealized holding loss (396) (1,500)
-------------- --------------
(42,937) (57,483)
Less cost of 1,814,688 common shares of beneficial interest in treasury (41,848) (41,848)
-------------- --------------
TOTAL SHAREHOLDERS' DEFICIT (84,785) (99,331)
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 6,357,986 $ 5,987,577
- -----------------------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
</TABLE>
<PAGE>
<TABLE>
Consolidated Statements of Operations
B. F. SAUL REAL ESTATE INVESTMENT TRUST
===================================================================================================================================
For the Year Ended September 30
----------------------------------------------
(In thousands, except per share amounts) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REAL ESTATE
Income
Hotels $ 59,464 $ 54,245 $ 54,104
Office and industrial properties 21,097 17,590 18,812
Other 4,008 5,004 4,369
-------------- -------------- --------------
Total income 84,569 76,839 77,285
- -----------------------------------------------------------------------------------------------------------------------------------
Expenses
Direct operating expenses:
Hotels 38,523 36,075 38,038
Office and industrial properties 7,766 7,251 7,409
Land parcels and other 1,683 1,637 1,348
Interest expense 40,155 39,840 40,564
Amortization of debt expense 664 674 476
Depreciation 10,543 10,020 9,714
Advisory, management and leasing fees - related parties 7,995 7,423 7,376
General and administrative 1,272 1,401 2,319
Write-down of real estate to net realizable value -- -- 2,727
-------------- -------------- --------------
Total expenses 108,601 104,321 109,971
- -----------------------------------------------------------------------------------------------------------------------------------
Equity in earnings of unconsolidated entities 4,150 3,374 3,681
Gain (loss) on sale of property 895 (68) 1,664
- -----------------------------------------------------------------------------------------------------------------------------------
REAL ESTATE OPERATING LOSS $ (18,987) $ (24,176) $ (27,341)
- -----------------------------------------------------------------------------------------------------------------------------------
BANKING
Interest income
Loans $ 360,842 $ 317,847 $ 294,554
Mortgage-backed securities 72,209 50,955 60,623
Trading securities 1,530 953 373
Investment securities 481 315 194
Other 15,418 17,441 9,571
-------------- -------------- --------------
Total interest income 450,480 387,511 365,315
- -----------------------------------------------------------------------------------------------------------------------------------
Interest expense
Deposit accounts 168,907 162,569 154,299
Short-term borrowings 47,378 10,407 18,094
Long-term borrowings 23,530 15,860 16,721
-------------- -------------- --------------
Total interest expense 239,815 188,836 189,114
-------------- -------------- --------------
Net interest income 210,665 198,675 176,201
Provision for loan losses (125,115) (115,740) (54,979)
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 85,550 82,935 121,222
- -----------------------------------------------------------------------------------------------------------------------------------
Other income
Loan servicing fees 227,817 264,139 184,275
Credit card fees 57,381 30,765 9,855
Deposit servicing fees 41,893 29,900 24,442
Gain (loss) on sales of trading securities, net 1,203 1,158 (600)
Loss on real estate held for investment or sale, net (18,688) (24,413) (5,549)
Gain on sales of loans, net 73,822 23,242 12,882
Net unrealized gain on valuation of interest-only strips 6,976 -- --
Other 22,573 19,713 7,320
-------------- -------------- --------------
Total other income 412,977 344,504 232,625
- -----------------------------------------------------------------------------------------------------------------------------------
Continued on following page.
</TABLE>
<PAGE>
<TABLE>
Consolidated Statements of Operations (Continued)
B. F. SAUL REAL ESTATE INVESTMENT TRUST
===================================================================================================================================
For the Year Ended September 30
----------------------------------------------
(In thousands, except per share amounts) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
BANKING (Continued)
Operating expenses
Salaries and employee benefits $ 160,949 $ 127,370 $ 108,218
Loan 29,943 28,284 15,745
Property and equipment 24,626 20,930 16,512
Marketing 74,504 53,705 46,117
Data processing 48,138 41,270 34,310
Depreciation and amortization 28,479 24,410 21,461
Deposit insurance premiums 5,033 37,362 10,749
Amortization of goodwill and other intangible assets 2,615 1,775 2,411
Other 44,059 46,222 42,641
-------------- -------------- --------------
Total operating expenses 418,346 381,328 298,164
- -----------------------------------------------------------------------------------------------------------------------------------
BANKING OPERATING INCOME $ 80,181 $ 46,111 $ 55,683
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPANY
Operating income $ 61,194 $ 21,935 $ 28,342
Income tax provision 12,810 8,301 2,021
-------------- -------------- --------------
Income before minority interest 48,384 13,634 26,321
Minority interest held by affiliates (6,848) (3,962) (5,721)
Minority interest -- other (22,676) (9,750) (9,750)
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPANY NET INCOME (LOSS) $ 18,860 $ (78) 10,850
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) AVAILABLE TO COMMON
SHAREHOLDERS $ 13,442 $ (5,498) $ 5,430
NET INCOME (LOSS) PER COMMON SHARE
Income before minority interest $ 8.90 $ 1.70 $ 4.33
Minority interest held by affiliates (1.42) (0.82) (1.19)
Minority interest -- other (4.70) (2.02) (2.02)
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) PER COMMON SHARE $ 2.78 $ (1.14) $ 1.12
- -----------------------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
</TABLE>
<PAGE>
<TABLE>
Consolidated Statements of Shareholders' Deficit
B. F. SAUL REAL ESTATE INVESTMENT TRUST
===================================================================================================================================
For the Year Ended September 30
----------------------------------------------
(Dollars in thousands, except per share amounts) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PREFERRED SHARES OF BENEFICIAL INTEREST
Beginning and end of year (516,000 shares) $ 516 $ 516 $ 516
-------------- -------------- --------------
COMMON SHARES OF BENEFICIAL INTEREST
Beginning and end of year (6,641,598 shares) 6,642 6,642 6,642
-------------- -------------- --------------
PAID-IN SURPLUS
Beginning and end of year 92,943 92,943 92,943
-------------- -------------- --------------
DEFICIT
Beginning of year (156,084) (123,943) (134,793)
Net income (loss) 18,860 (78) 10,850
Dividends:
Real Estate Trust preferred shares of beneficial interest:
Distributions ($0.97 per share in 1996) -- (500) --
Distributions payable ($10.50 and $61.17 per share in 1997 and 1996,
respectively) (5,418) (31,563) --
-------------- -------------- --------------
End of year (142,642) (156,084) (123,943)
-------------- -------------- --------------
Net unrealized holding losses (396) (1,500) (2,490)
-------------- -------------- --------------
TREASURY SHARES
Beginning and end of year (1,814,688 shares) (41,848) (41,848) (41,848)
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' DEFICIT $ (84,785) $ (99,331) $ (68,180)
- -----------------------------------------------------------------------------------------------------------------------------------
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
===================================================================================================================================
For the Year Ended September 30
----------------------------------------------
(In thousands) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Real Estate
Net loss $ (8,531) $ (15,924) $ (12,032)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation 10,543 10,020 9,714
(Gain) loss on sale of property (895) 68 (1,654)
Write-down of real estate to net realizable value -- -- 2,727
(Increase) decrease in accounts receivable and accrued income 17 (4,869) (224)
(Increase) decrease in deferred tax asset (3,252) 1,881 10,836
Increase in accounts payable and accrued expenses 1,058 430 317
(Increase) decrease in tax sharing receivable 2,492 14,533 (5,685)
Amortization of debt expense 664 674 476
Equity in earnings of unconsolidated entities (4,150) (3,374) (3,681)
Other 8,965 5,593 3,530
-------------- -------------- --------------
6,911 9,032 4,324
-------------- -------------- --------------
Banking
Net income 27,391 15,846 28,603
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization (accretion) of premiums, discounts and net deferred loan fees 7,130 (163) (435)
Depreciation and amortization 28,708 24,635 21,690
Amortization of goodwill and other intangible assets 2,633 1,795 2,436
Provision for loan losses 125,115 115,740 54,979
Capitalized interest on real estate held for investment or sale (2,212) (3,462) (4,512)
Purchases of trading securities (7,899) -- --
Proceeds from sales of trading securities 430,938 363,364 239,147
Net fundings of loans held for sale (697,593) (690,589) (390,634)
Proceeds from sales of loans held for sale and/or securitization 2,599,860 1,984,484 2,188,531
Proceeds from sales of spread accounts 144,200 42,140 59,200
Earnings on real estate (1,156) (2,278) (18,882)
Provision for losses on real estate held for investment or sale 19,623 26,341 26,321
(Gain) loss on sales of trading securities, net (1,203) (1,158) 600
Gain on sales of loans, net (73,822) (23,242) (12,882)
Unrealized gain on valuation of interest-only strips (6,976) -- --
Increase in interest-only strips (105,812) -- --
(Increase) decrease in excess spread assets 42,602 (16,962) (442)
Increase in servicing assets (8,806) (4,238) (13,294)
Increase in other assets (207,883) (103,211) (145,918)
Increase in other liabilities and accrued expenses 21,741 23,724 34,903
Increase (decrease) in tax sharing payable (2,492) (14,533) 5,685
Minority interest held by affiliates 6,848 3,962 --
Minority interest - other 9,750 9,750 9,750
Other 8,006 (12,440) 3,176
-------------- -------------- --------------
2,358,691 1,739,505 2,088,022
-------------- -------------- --------------
Net cash provided by operating activities 2,365,602 1,748,537 2,092,346
- -----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Real Estate
Capital expenditures - properties (10,120) (7,408) (6,270)
Property acquisitions (4,709) -- (10,193)
Property sales 1,399 1,812 --
Equity investment in unconsolidated entities 1,723 639 (733)
Other 43 50 53
-------------- -------------- --------------
(11,664) (4,907) (17,143)
-------------- -------------- --------------
Banking
Net proceeds from maturities of investment securities 5,000 4,410 100
Net proceeds from redemption of Federal Home Loan Bank stock 9,482 -- --
Net proceeds from sales of real estate 23,624 58,874 133,300
Net fundings of loans receivable (1,898,904) (1,702,926) (2,295,069)
Principal collected on mortgage-backed securities 771,095 221,698 183,166
Purchases of Federal Home Loan Bank stock (10,712) -- --
Purchases of investment securities -- (9,725) --
Purchases of mortgage-backed securities (311,554) (649,688) (107,127)
Purchases of loans receivable (754,515) (391,878) (88,518)
Purchases of property and equipment (77,859) (69,749) (55,924)
Acquisition of other intangible assets (9,063) -- --
Disbursements for real estate held for investment or sale (14,199) (14,447) (32,834)
Other 1,036 (5,950) 1,103
-------------- -------------- --------------
(2,266,569) (2,559,381) (2,261,803)
-------------- -------------- --------------
Net cash used in investing activities (2,278,233) (2,564,288) (2,278,946)
- -----------------------------------------------------------------------------------------------------------------------------------
Continued on following page.
</TABLE>
<PAGE>
<TABLE>
Consolidated Statements of Cash Flows (Continued)
B. F. SAUL REAL ESTATE INVESTMENT TRUST
===================================================================================================================================
For the Year Ended September 30
----------------------------------------------
(In thousands) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Real Estate
Proceeds from mortgage financing $ 27,072 $ -- $ 11,400
Principal curtailments and repayments of mortgages (19,977) (8,573) (12,424)
Proceeds from secured note financing -- 2,500 500
Repayments of secured notes (2,500) (500) --
Proceeds from sales of unsecured notes 5,822 3,708 4,428
Repayments of unsecured notes (1,556) (2,398) (3,659)
Costs of obtaining financings (626) (201) (516)
Dividends paid - preferred shares of beneficial interest (750) (500) --
-------------- -------------- --------------
7,485 (5,964) (271)
-------------- -------------- --------------
Banking
Proceeds from customer deposits and sales of certificates of deposit 18,915,801 15,312,125 14,086,575
Customer withdrawals of deposits and payments for maturing certificates of deposit (18,186,082) (15,307,340) (13,936,084)
Net increase (decrease) in securities sold under repurchase agreements (574,217) 574,400 777
Advances from the Federal Home Loan Bank 877,483 429,459 992,073
Repayments of advances from the Federal Home Loan Bank (958,037) (315,446) (937,021)
Proceeds from other borrowings 6,271,193 2,469,675 793,261
Repayments of other borrowings (6,259,554) (2,417,606) (816,755)
Cash dividends paid on preferred stock (9,750) (9,750) (9,750)
Cash dividends paid on common stock (9,000) (8,500) --
Repayment of capital notes - subordinated (10,000) -- --
Net proceeds received from capital notes - subordinated 96,112 -- --
Net proceeds from issuance of preferred stock 144,000 -- --
Other (4,605) 2 (12,110)
-------------- -------------- --------------
293,344 727,019 160,966
-------------- -------------- --------------
Net cash provided by financing activities 300,829 721,055 160,695
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 388,198 (94,696) (25,905)
Cash and cash equivalents at beginning of period 281,941 376,637 402,542
-------------- -------------- --------------
Cash and cash equivalents at end of period $ 670,139 $ 281,941 $ 376,637
- -----------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information: Cash paid during the year
for:
Interest (net of amount capitalized) $ 267,758 $ 237,568 $ 217,186
Income taxes paid (refunded) (2,552) 4,356 (1,327)
Shares of Saul Centers, Inc. common stock 6,111 4,864 7,757
Cash received during the year from:
Dividends on shares of Saul Centers, Inc. common stock 2,539 1,952 1,380
Distributions from Saul Holdings Limited Partnership 5,453 5,453 5,453
Supplemental disclosures of noncash activities:
Rollovers of notes payable - unsecured 4,195 3,725 3,588
Loans held for sale exchanged for trading securities 430,786 363,257 133,014
Mortgage-backed securities available-for-sale transferred to mortgage-backed
securities held-to-maturity -- -- 942,085
Investment securities available-for-sale transferred to investment securities
held-to-maturity -- -- 4,354
Real estate held for investment transferred to real estate held for sale -- -- 9,273
Loans receivable transferred to loans held for sale and/or securitization 2,026,478 1,594,262 2,387,690
Loans made in connection with the sale of real estate 7,769 46,537 10,826
Loans receivable transferred to real estate acquired in settlement of loans 4,706 5,972 9,822
Loans receivable exchanged for mortgage-backed securities held-to-maturity 1,136,180 -- 23,155
Loans held for sale and/or securitization transferred to loans receivable -- -- 50,000
Loans held for sale transferred to loans receivable -- 3,146 --
- -----------------------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
B.F. Saul Real Estate Investment Trust and its wholly owned subsidiaries
(collectively, the "Real Estate Trust") operate as a Maryland real estate
investment trust. The principal business activity of the Real Estate Trust is
the ownership and development of income-producing properties. The properties
owned by the Real Estate Trust are located predominantly in the Mid-Atlantic and
Southeastern regions of the United States and consist principally of hotels,
office projects, and various undeveloped land parcels.
B.F. Saul Real Estate Investment Trust also owns 80% of the outstanding common
stock of Chevy Chase Bank, F.S.B. and its subsidiaries (collectively the "Bank"
or the "Corporations"), whose assets accounted for approximately 95% of the
consolidated assets of the B.F. Saul Real Estate Investment Trust and its
consolidated subsidiaries (the "Trust") at September 30, 1997. The Bank is a
federally chartered and federally insured stock savings bank. The B. F. Saul
Real Estate Investment Trust is a thrift holding company by virtue of its
ownership of a majority interest in the Bank and is subject to regulation by the
Office of Thrift Supervision ("OTS"). The accounting and reporting practices of
the Trust conform to generally accepted accounting principles and, as
appropriate, predominant practices within the real estate and banking
industries.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Real Estate
Trust and its subsidiaries. Accordingly, the accompanying financial statements
reflect the assets, liabilities, operating results, and cash flows for two
business segments: Real Estate and Banking. Entities in which the Trust holds a
non-controlling interest (generally 50% or less) are accounted for on the equity
method. See Note 2.
USE OF ESTIMATES
The financial statements have been prepared in conformity with generally
accepted accounting principles. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
liabilities as of the date of the balance sheet and revenues and expenses for
the reporting period. Actual results could differ from those estimates.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets and certain identifiable intangibles to be held and used are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. If the sum of the
expected cash flows (undiscounted and without interest charges) is less than the
carrying amount of the asset, the Trust recognizes an impairment loss.
Measurement of an impairment loss for long-lived assets and identifiable
intangibles that the Trust expects to hold and use is based on the fair value of
the asset. Long-lived assets and certain identifiable intangibles to be disposed
of are generally reported at the lower of carrying amount or fair value less the
cost to sell.
<PAGE>
INCOME TAXES
The Trust files a consolidated federal income tax return which includes
operations of all 80% or more owned subsidiaries. It voluntarily terminated its
qualification as a real estate investment trust under the Internal Revenue Code
during fiscal 1978.
The Trust uses an asset and liability approach in accounting for income taxes.
Deferred income taxes are recorded using currently enacted tax laws and rates.
To the extent that realization of deferred tax assets is more likely than not,
such assets are recognized.
NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share is determined by dividing net income (loss),
after deducting preferred share dividend requirements, by the weighted average
number of common shares outstanding during the year. For fiscal years 1997, 1996
and 1995, the weighted average number of shares used in the calculation was
4,826,910.
RECLASSIFICATIONS
Certain reclassifications have been made to the consolidated financial
statements for the years ended September 30, 1996 and 1995 to conform with the
presentation used for the year ended September 30, 1997.
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED
SFAS No. 129, "Disclosure of Information about Capital Structure" ("SFAS 129")
establishes standards for disclosing information about an entity's capital
structure. SFAS 129 supersedes capital structure disclosure requirements found
in previous accounting pronouncements and consolidates them into one statement
for ease of retrieval and greater visibility for non-public entities. SFAS 129
is effective for financial statements for periods ending after December 15,
1997. Because SFAS 129 addresses only disclosure related issues, its adoption
will not have an impact on the Trust's financial condition or its results of
operations.
SFAS No. 130, "Reporting Comprehensive Income" ("SFAS 130") was issued in June
1997 and establishes accounting standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS 130 requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. SFAS 130 also requires an enterprise to classify
items of other comprehensive income by their nature in a financial statement and
to display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of a
statement of financial position. SFAS 130 is effective for fiscal years
beginning after December 15, 1997. The adoption of SFAS 130 will not have an
impact on the Trust's financial condition or its results of operations.
<PAGE>
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"), was also issued in June 1997. SFAS 131 establishes
accounting standards for the way business enterprises report information about
operating segments in annual and interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS 131 requires
that a business enterprise report financial and descriptive information,
including profit or loss, certain specific revenue and expense items, and
segment assets, about its reportable operating segments. Operating segments are
defined as components of an enterprise about which separate financial
information is available that is evaluated regularly by management in deciding
how to allocate resources and in assessing performance. SFAS 131 is effective
for financial statements for periods beginning after December 15, 1997. Because
SFAS 131 addresses only disclosure related issues, its adoption will not have an
impact on the Trust's financial condition or its results of operations.
<PAGE>
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - REAL ESTATE TRUST
CASH EQUIVALENTS
The Real Estate Trust considers all highly liquid, temporary investments with an
original maturity of three months or less to be cash equivalents.
PROPERTIES
Income-producing properties are stated at the lower of depreciated cost (except
those which were acquired through foreclosure or equivalent proceedings, the
carrying amounts of which are based on the lower of cost or fair value at the
time of acquisition) or net realizable value.
Interest, real estate taxes and other carrying costs are capitalized on projects
under construction. Once construction is completed and the assets are placed in
service, rental income, direct operating expenses, and depreciation associated
with such properties are included in current operations. The Real Estate Trust
considers a project to be substantially complete and held available for
occupancy upon completion of tenant improvements, but no later than one year
from the cessation of major construction activity. Substantially completed
portions of a project are accounted for as separate projects. Expenditures for
repairs and maintenance are charged to operations as incurred.
Depreciation is calculated using the straight-line method and estimated useful
lives of 31.5 to 47 years for buildings and up to 20 years for certain other
improvements. Tenant improvements are amortized over the lives of the related
leases using the straight-line method.
INCOME RECOGNITION
The Real Estate Trust derives room and other revenues from the operations of its
hotel properties. The Real Estate Trust derives rental income under
noncancelable long-term leases from tenants at its commercial properties.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments.
Cash and Cash Equivalents
The carrying amount approximates fair value because of the short-term maturity
of these instruments.
Liabilities
The carrying amount of mortgage notes payable and notes payable - secured
approximates their fair value since most of the debt has been financed in recent
periods at prevailing market interest rates. The fair value of Notes payable -
unsecured is based on the rates currently offered by the Real Estate Trust for
similar notes. At September 30, 1997 and 1996 the fair value of Notes payable -
unsecured was $47.9 and $43.8 million, respectively.
<PAGE>
C. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - THE BANK
The Bank is a federally chartered and federally insured stock savings bank and,
as such, is subject to comprehensive regulation, examination and supervision by
the Office of Thrift Supervision ("OTS") and by the Federal Deposit Insurance
Corporation ("FDIC"). The Bank is principally engaged in the business of
attracting deposits from the public and using such deposits, together with
borrowings and other funds, to make loans secured by real estate, primarily
residential mortgage loans, and various types of consumer loans, primarily
credit card and automobile loans. The Bank's principal deposit market is the
Washington, D.C. metropolitan area.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks, interest - bearing deposits, federal funds sold and securities
purchased under agreements to resell.
Regulation D of the Federal Reserve Act requires the Bank to maintain reserves
in the form of cash and deposits at the Federal Reserve Bank. The total average
reserve balances maintained by the Bank, which consisted primarily of cash, were
$114.6, $105.2, and $87.8 million during the years ended September 30, 1997,
1996, and 1995, respectively.
LOANS HELD FOR SALE
The Bank engages in mortgage banking activities. At September 30, 1997 and 1996,
loans held for sale are composed of single-family residential loans originated
or purchased for sale in the secondary market and are carried at aggregate cost
which is lower than aggregate market value. Single-family residential loans held
for sale will either be sold or will be exchanged for mortgage-backed securities
and then sold. Gains and losses on sales of whole loans held for sale are
determined using the specific identification method. See "Trading Securities."
LOANS HELD FOR SECURITIZATION AND SALE
The Bank periodically securitizes and sells certain pools of loan receivables in
the public and private markets. These securitizations are recorded as sales.
Gains on the sale of loans are limited to amounts related to loans existing at
the date of sale and do not include amounts related to loans expected to be sold
during any future reinvestment period.
Loans held for securitization and sale are the lesser of loans eligible for
securitization or loans that management contemplates to securitize within six
months. Such loans held for securitization and sale are reported at the lower of
aggregate cost or aggregate market value for each asset type.
INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES
The Bank classifies its investment and mortgage-backed securities as either
"held-to-maturity," "available-for-sale" or "trading" at the time such
securities are acquired. Prior to fiscal 1995, the Bank classified all of its
investment and mortgage-backed securities as available-for-sale.
<PAGE>
During fiscal 1995, the Bank transferred all of its investment securities and
mortgage-backed securities previously classified as available-for-sale to
held-to-maturity. These securities were transferred at their fair value. Net
unrealized holding losses, net of the related income tax effect, amounting to
$3.5 million as of the date of the transfer, and $493,000 as of September 30,
1997, continue to be reported as a separate component of stockholders' equity
and are being amortized to income over the remaining lives of the securities
using the level-yield method. All investment securities and mortgage-backed
securities are classified as held-to-maturity at September 30, 1997 and 1996.
Premiums and discounts on investment securities and mortgage-backed securities
are amortized or accreted using the level-yield method. Realized gains and
losses are determined using the specific identification method.
TRADING SECURITIES
As part of its mortgage banking activities, the Bank exchanges loans held for
sale for mortgage-backed securities and then sells the mortgage-backed
securities, which are classified as trading securities, to third party investors
in the month of issuance. Proceeds from sales of trading securities were $430.9,
$363.4 and $239.1 million during the years ended September 30, 1997, 1996 and
1995, respectively. The Bank realized net gains of $1.2 and $1.2 million on the
sales of trading securities for the years ended September 30, 1997 and 1996,
respectively. The Bank realized net losses of $600,000 on the sales of trading
securities for the year ended September 30, 1995. Gains and losses on sales of
trading securities are determined using the specific identification method.
There were no mortgage securities classified as trading securities at September
30, 1997 and 1996.
At September 30, 1997, the Bank held one automobile loan-backed security in the
amount of $7.9 million, which was classified as trading. Such security was
established in conjunction with an automobile loan securitization transaction
and represents a separate class of certificates, all of which was retained by
the Bank. See Note 14.
LOAN ORIGINATION AND COMMITMENT FEES
Nonrefundable loan fees, such as origination and commitment fees, and
incremental loan origination costs relating to loans originated or purchased are
deferred. Net deferred fees (costs) related to loans held for investment are
amortized over the life of the loan using the level-yield or straight-line
method. Net fees (costs) related to loans held for sale are deferred until such
time as the loan is sold, at which time the net deferred fees (costs) become a
component of the gain or loss on sale.
CREDIT CARD FEES AND COSTS
Credit card membership fees are deferred and recognized as income on a
straight-line basis over the period the fee entitles the cardholder to use the
card, which is one year. Credit card origination costs are deferred and
recognized as a reduction of income on a straight-line basis over the privilege
period which is generally one year.
<PAGE>
IMPAIRED LOANS
A loan is considered impaired when, based on all current information and events,
it is probable that the Bank will be unable to collect all amounts due according
to the contractual terms of the agreement, including all scheduled principal and
interest payments. Such impaired loans are measured based on the present value
of expected future cash flows, discounted at the loan's effective interest rate
or, as a practical expedient, impairment may be measured based on the loan's
observable market price, or, if the loan is collateral-dependent, the fair value
of the collateral. When the measure of the impaired loan is less than the
recorded investment in the loan, the impairment is recorded through a valuation
allowance. Loans for which foreclosure is probable continue to be accounted for
as loans. Certain credit card loans for which customers have agreed to modified
payment terms are also classified as impaired loans.
Each impaired real estate loan is evaluated individually to determine the income
recognition policy. Generally, payments received are applied in accordance with
the contractual terms of the note or as a reduction of principal. Interest
income on impaired credit card loans is recognized using the current interest
rate of the loan and the accrual method. Interest income continues to accrue on
delinquent credit card loans until such loan is either paid or charged off.
At September 30, 1997 and 1996, the Bank had two impaired real estate loans with
aggregate book values of $1.0 and $1.3 million, respectively, before the related
allowance for losses of $545,000 and $364,000, respectively. At September 30,
1997, the Bank had impaired credit card loans with a carrying value of $116.9
million, before the related allowance for losses of $18.9 million. At September
30, 1996, the Bank had impaired credit card loans with a carrying value of $55.9
million, before the related allowance for losses of $4.0 million. The average
recorded investment in impaired credit card and real estate loans for the years
ended September 30, 1997, 1996 and 1995 was $99.0, $49.8, and $33.5 million,
respectively. The Bank recognized interest income of $13.1, $7.3, and $5.3
million on its impaired loans for the years ended September 30, 1997, 1996 and
1995, respectively.
TROUBLED DEBT RESTRUCTURINGS
At September 30, 1997 and 1996, the Bank had $11.9 and $13.6 million,
respectively, of loans accounted for as troubled debt restructurings, all of
which were performing loans. At September 30, 1997, the Bank had commitments to
lend $85,000 of additional funds on loans which have been restructured.
ALLOWANCES FOR LOSSES
Management reviews the loan, real estate held for investment and real estate
held for sale portfolios to establish allowances for estimated losses. The
allowances for losses are reviewed periodically, and allowances are provided
after consideration of the borrower's financial condition and/or the estimated
value of collateral or real estate, including estimated selling and holding
costs. Allowances are also provided by management after considering such factors
as the economy in lending areas, delinquency statistics, past loss experience
and estimated future losses.
The allowances for losses are based on estimates, and ultimate losses may vary
from current estimates. As adjustments to the allowances become necessary,
provisions for losses are reported in operations in the periods they are
determined to be necessary.
<PAGE>
ACCRUED INTEREST RECEIVABLE ON LOANS
Loans, other than credit card loans, are reviewed on a monthly basis and are
placed on non-accrual status when, in the opinion of management, the full
collection of principal or interest has become unlikely. Uncollectible accrued
interest receivable on non-accrual loans is charged against current period
interest income.
Effective 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.
REAL ESTATE HELD FOR INVESTMENT OR SALE
Real Estate Held for Investment
At September 30, 1997 and 1996, real estate held for investment consists of
developed land owned by one the Bank's subsidiaries. Real estate held for
investment is carried at the lower of aggregate cost or net realizable value.
See Note 12.
Real Estate Held for Sale
Real estate held for sale consists of real estate acquired in settlement of
loans ("REO") and is carried at the lower of cost or fair value. Costs relating
to the development and improvement of property, including interest, are
capitalized, whereas costs relating to the holding of property are expensed.
Capitalized interest amounted to $2.2, $3.5 and $4.5 million for the years ended
September 30, 1997, 1996 and 1995, respectively.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost, net of accumulated depreciation and
amortization. Depreciation and amortization are computed using the straight-line
method which allocates the cost of the applicable assets over their estimated
useful lives. Major improvements and alterations to office premises and
leaseholds are capitalized. Leasehold improvements are amortized over the
shorter of the terms of the respective leases (including renewal options that
are expected to be exercised) or 20 years. Maintenance and repairs are charged
to operating expenses as incurred.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill is stated net of accumulated amortization and is being amortized using
the straight-line method generally over a period of 15 years. At September 30,
1997 and 1996, goodwill totaled $1.1 and $2.4 million, respectively. During
fiscal 1997, the Bank purchased approximately $138.0 million of home equity
loans. The amount of the premium attributable to the value of the home equity
relationships has been included in goodwill and other intangible assets in the
Consolidated Balance Sheets. This premium is being amortized over the estimated
lives of the underlying loans. Other intangible assets totaled $7.7 million at
September 30, 1997. Accumulated amortization of goodwill and other intangible
assets was $37.8 and $35.1 million at September 30, 1997 and 1996, respectively.
<PAGE>
SERVICING ASSETS
Effective January 1, 1997, the Bank adopted Statement of Financial Accounting
Standards ("SFAS") No. 125 ("SFAS 125"), "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," (described below under
the caption "Adoption of Recently Issued Accounting Standards") which
supersedes, but generally retains, the requirements of SFAS No. 122, "Accounting
for Mortgage Servicing Rights" ("SFAS 122"). Both statements require that
entities that acquire servicing assets through either purchase or origination of
loans and sell or securitize those loans with servicing assets retained must
allocate the total cost of the loans to the servicing assets and the loans
(without the servicing assets) based on their relative fair values.
Servicing assets, which are stated net of accumulated amortization, are
amortized in proportion to the remaining net servicing revenues estimated to be
generated by the underlying loans. Amortization of these assets amounted to
$9.0, $7.8 and $2.2 million for the years ended September 30, 1997, 1996 and
1995, respectively. Accumulated amortization was $56.7 and $47.7 million at
September 30, 1997 and 1996, respectively. During fiscal 1997, 1996 and 1995,
the Bank recorded $15.8, $16.1 and $16.3 million respectively, of servicing
assets related to the sale and/or securitization of loans.
The Bank periodically evaluates its servicing assets for impairment based upon
fair value. For purposes of evaluating impairment, the Bank stratifies its
servicing assets taking into consideration relevant risk characteristics
including loan type, note rate and date of acquisition. To the extent the
carrying value of servicing assets exceeds the fair value of such assets, a
valuation allowance is recorded. The aggregate fair value of servicing assets at
September 30, 1997 was $46.0 million.
Activity in the valuation allowance for servicing assets is summarized as
follows. No valuation allowances were recorded during fiscal 1995.
Year Ended
September 30,
-----------------------------------
(In thousands) 1997 1996
- -------------------------------- --------------- ---------------
Balance at beginning of year $ 3,142 $ -
Additions charged / (reductions)
credited to loan expenses (2,013) 3,142
--------------- ---------------
Balance at end of year $ 1,129 $ 3,142
=============== ===============
During fiscal 1996, the Bank sold $947,000 of rights to service mortgage loans
with principal balances of $59.7 million, which were originated by the Bank in
connection with its mortgage banking activities. In fiscal 1995, the Bank sold
the rights to service mortgage loans with principal balances of $148.1 million,
which were originated by the Bank in connection with its mortgage banking
activities, and recognized a gain of $1.4 million. There were no sales of rights
to service mortgage loans during fiscal 1997.
<PAGE>
INTEREST-ONLY STRIPS
Upon the Bank's adoption of SFAS 125, effective January 1, 1997, previously
recognized excess spread assets were reclassified as interest-only strips.
Interest-only strips represent rights to certain future net cash flows from
securitized assets that are available after all expenses of the transaction have
been paid ("residual cash flow"). Interest-only strips are amortized using the
effective yield method over the estimated lives of the underlying loans.
Amortization of these assets amounted to $26.1 million for the nine months ended
September 30, 1997. Accumulated amortization was $129.2 million at September 30,
1997. Interest-only strips capitalized in the nine months ended September 30,
1997 of $80.1 million were related to the securitization and sale of credit
card, home equity, automobile and home loan receivables. See Note 14.
Prior to January 1, 1997, when loans (other than credit card) were sold with the
residual cash flow retained by the Bank, the net present value of such residual
cash flow was recorded as an adjustment to the sales price of the loans. See
"Accounting Standards Issued but not yet Adopted." Estimated future losses were
deducted in the computation of such residual cash flows. The resulting excess
spread assets were amortized using the level-yield ("interest") method over the
estimated lives of the underlying loans. Amortization of these assets amounted
to $4.9, $17.8 and $14.5 million for the three months ended December 31, 1996
and for the years ended September 30, 1996 and 1995, respectively. Accumulated
amortization was $103.2 and $98.3 million at December 31, 1996 and September 30,
1996, respectively. Excess spread assets capitalized in the three months ended
December 31, 1996 and in fiscal 1996 and 1995 of $14.0, $34.7 and $15.0 million,
respectively, were the result of the residual cash flow retained upon the
securitization and sale of home equity credit line, automobile and home loan
receivables.
SFAS 125 requires a periodic assessment of the carrying value of interest-only
strips. Because these assets can be contractually prepaid or otherwise settled
such that the Bank would not recover substantially all of its recorded
investment, the assets are being measured like available-for-sale securities or
trading securities, under SFAS No. 115 ("SFAS 115"), "Accounting for Certain
Investments in Debt and Equity Securities." At September 30, 1997, the Bank
accounted for its interest-only strips as trading securities, and accordingly
carries them at fair value.
The Bank estimates the fair value of the interest-only strips on a discounted
cashflow basis using appropriate discount rates. Adjustments to the fair market
value are recognized as unrealized gains or losses. Unrealized gains in the
aggregate amount of $7.0 million, are included in the Consolidated Statements of
Operations and represent the September 30, 1997 adjustment on the interest-only
strips related to the credit card securitized assets.
<PAGE>
DERIVATIVE FINANCIAL INSTRUMENTS
The Bank uses various strategies to minimize interest-rate risk, including
interest-rate cap agreements and forward sale or purchase commitments. Premiums
paid for interest-rate cap agreements are included in other assets in the
Consolidated Balance Sheets and are amortized to expense over the terms of the
interest-rate caps on a straight-line basis. Funds payable to the Bank are
recognized as income in the month such funds are earned. At September 30, 1997
and 1996, unamortized premiums amounted to $3.1 and $6.2 million, respectively.
Gains and losses on forward sale or purchase commitments are deferred and
recorded as a component of the gain on sales of loans at the time the forward
sale or purchase commitment matures. See Note 26. The Bank does not hold any
derivative financial instruments for trading purposes.
ADOPTION OF RECENTLY ISSUED ACCOUNTING STANDARDS
Effective January 1, 1997, the Bank adopted 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. Under SFAS 125, a transfer of financial assets in
which the transferor surrenders control over those assets is accounted for as a
sale to the extent that consideration other than beneficial interests in the
transferred assets is received in exchange. SFAS 125 requires that liabilities
and derivatives incurred or obtained by transferors as part of a transfer of
financial assets be initially measured at fair value, if practicable. It also
requires that servicing assets and other retained interests in the transferred
assets be measured by allocating the previous carrying amount between the assets
sold, if any, and retained interests, if any, based on their relative fair
values at the date of the transfer. As a result of the adoption of SFAS 125, the
Bank recognized gains of $33.1 million during fiscal 1997 (of which a portion
represents the unrealized gains recognized), upon the securitization and sale of
credit card receivables based upon the estimated fair value of the expected cash
flows to be generated by the underlying receivables.
Under SFAS 125, the Bank records a gain on the securitization and sale of credit
card receivables based on the estimated fair value of assets obtained and
liabilities incurred in the sale. The gain recognized at the time of the sale
principally represents the estimated fair value of the interest-only strip
retained reduced by the estimated fair value of future losses. During the
revolving period of each transaction, gains are recorded on the sale of new
receivables to the trusts to replenish the investors' interest in trust
receivables. See Note 14.
Prior to January 1, 1997, no gain or loss was recorded on the securitization and
sale of credit card receivables; rather, loan servicing fees were recognized
over the life of the transaction when earned.
SFAS 125 amends and extends to all servicing assets and liabilities the
accounting standards for mortgage servicing rights now in SFAS 65, and
supersedes, but generally retains, the requirements of SFAS 122. 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>
1. LIQUIDITY AND CAPITAL RESOURCES - REAL ESTATE TRUST
Historically, the Real Estate Trust's total cash requirements have exceeded the
cash generated by its operations. As described below, this condition persisted
in 1997 and is expected to continue 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 sold to the public, the payment of interest on the
Senior Secured Notes (as defined below), and the payment of capital improvement
costs. In the past, the Real Estate Trust 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 and dividend payments from the Bank.
The Real Estate Trust's ability to meet its liquidity needs, including debt
service payments in fiscal 1998 and subsequent years, will depend in significant
part on its receipts of tax sharing payments and dividends from the Bank. The
availability and amount of dividends and tax sharing payments in future periods,
is dependent upon, among other things, 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 Trust for federal
income tax purposes.
The Real Estate Trust believes that the financial condition and operating
results 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 fiscal 1997, the Bank made tax
sharing payments totalling $9.8 million and dividend payments totalling $7.2
million to the Real Estate Trust. During fiscal 1996 and fiscal 1995, the Bank
made tax sharing payments of $25.0 and $20.5 million, respectively, to the Real
Estate Trust. During fiscal 1996, the Bank made dividend payments of $6.8
million to the Real Estate Trust. No dividends were paid in fiscal 1995.
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.
The Real Estate Trust is currently selling Unsecured Notes, with maturities
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 outstanding Unsecured Notes as they mature, it will finance such
repayments from other sources of funds.
<PAGE>
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"). See Note 4. The Indenture pursuant to which the Senior
Secured Notes were issued contains convenants 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 September 30, 1997, the Trust purchased either in the open market or
through dividend reinvestment 1,810,104 shares of common stock of Saul Centers,
Inc. (representing 14.7% of such company's outstanding common stock). Most of
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.
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 additional one-year terms. Interest is computed
by reference to a floating rate index. At September 30, 1997, the Trust had
pledged as collateral for this credit line approximately 30.5% of its investment
in Saul Holdings. At that date there were no borrowings under the facility and
based on the collateral pledged, unrestricted availability was $10.0 million.
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 any outstanding loan amount amortizes over a two-year period.
Interest is computed by reference to a floating rate index. During fiscal 1997,
the line of credit was increased to $10.0 million. At September 30, 1997, the
Trust had pledged as collateral for this credit line approximately 14.5% of its
investment in Saul Holdings. At that date there were no borrowings under the
facility and based on the collateral pledged, unrestricted availability was $4.8
million.
During fiscal 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.
As the owner, directly and through a wholly owned subsidiary, of a 21.5% limited
partnership interest in Saul Holdings Limited Partnership, the Real Estate Trust
shares in cash distributions from operations and from capital transactions
involving the sale of properties. See Note 2. The partnership agreement provides
for quarterly cash distributions to the partners out of net cash flow. During
each of the fiscal years 1995 - 1997, the Real Estate Trust received
distributions in the amount of $5.5 million from Saul Holdings Limited
Partnership.
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 located in
Gaithersburg, Maryland. The project is 50% pre-leased. Construction is expected
to be completed by December 1997 and leasing by mid-year 1998. The Real Estate
Trust has obtained a construction/permanent loan which is expected to cover all
costs except for the land and fees to related parties. See Note 7.
<PAGE>
In September 1997, the Real Estate Trust commenced development of a 95-unit
extended stay lodging facility located on a 2.7 acre parcel adjacent to its
Hampton Inn and Holiday Inn in Sterling, Virginia. The new facility will be
franchised as a TownePlace Suites by Marriott and is expected to be completed
by July 1998. The Real Estate Trust has obtained a construction loan which is
expected to cover all costs except for the land, fees to related parties, taxes
and insurance. See Note 7.
In September 1997, the Real Estate Trust entered into a contract to purchase a
308-room Holiday Inn located in Arlington, Virginia, near Washington National
Airport and the Real Estate Trust's Howard Johnson Hotel. The purchase price is
$25.8 million and settlement is projected for December 1997. The Real Estate
Trust has obtained a lenders' commitment in the amount of $53 million which will
provide funds for the new acquisition and the refinancing of five other hotels
in the Real Estate Trust's portfolio. The six new loans will have a 15 year
term, a fixed interest rate of 7.9%, and amortization based on a 25 year
schedule.
While the Real Estate Trust's ability to satisfy its liquidity requirements is
contingent on future events, which include the sale of new Unsecured Notes in
amounts sufficient to finance most of the scheduled maturities of outstanding
Unsecured Notes and the Bank's ability to pay tax sharing payments and
dividends, the Real Estate Trust believes it will be able to consummate the
transactions described above as well as explore other financing opportunities in
order to raise sufficient proceeds to fund its liquidity requirements.
2. SAUL HOLDINGS LIMITED PARTNERSHIP - REAL ESTATE TRUST
In fiscal 1993, the Real Estate Trust entered into a series of transactions
undertaken in connection with an initial public offering of common stock of a
newly organized corporation, Saul Centers, Inc. ("Saul Centers"). The Real
Estate Trust transferred its 22 shopping centers and one of its office
properties together with the debt associated with such properties to a newly
formed partnership, Saul Holdings Limited Partnership ("Saul Holdings"), in
which the Real Estate Trust owns (directly or through one of its wholly owned
subsidiaries) a 21.5% interest, other entities affiliated with the Real Estate
Trust own a 5.5% interest, and Saul Centers owns a 73.0% interest. B. Francis
Saul II, Chairman of the Board of Trustees of the Trust, is also Chairman of the
Board of Directors and Chief Executive Officer of Saul Centers, which is the
sole general partner of Saul Holdings. As of September 30, 1997, the Real Estate
Trust had pledged 36% of its interest in Saul Holdings to the Bank related to
payments under the Tax Sharing Agreement.
In connection with the transfer of its properties to Saul Holdings, the Real
Estate Trust was relieved of approximately $196 million in mortgage debt and
deferred interest. Pursuant to a reimbursement agreement among the partners of
Saul Holdings and its subsidiary limited partnerships (collectively, the
"Partnerships"), the Real Estate Trust and its subsidiaries that are partners in
the Partnerships have agreed to reimburse Saul Centers and the other partners in
the event the Partnerships fail to make payments with respect to certain
portions of the Partnerships' debt obligations and Saul Centers or any such
other partners personally make payments with respect to such debt obligations.
At September 30, 1997, the maximum potential obligations of the Real Estate
Trust and its subsidiaries under this agreement totaled approximately $115.5
million.
<PAGE>
The fair market value of each of the properties contributed to the Partnerships
by the Real Estate Trust at the date of transfer (the FMV of each such property)
exceeded the tax basis of such property (with respect to each property, such
excess is referred to as the FMV-Tax Difference). In the event Saul Centers, as
general partner of the Partnerships, causes the Partnerships to dispose of one
or more of such properties, a disproportionately large share of the total gain
for federal income tax purposes would be allocated to the Real Estate Trust or
its subsidiaries. In general, if the gain recognized by the Partnerships on a
property disposition is less than or equal to the FMV-Tax Difference for such
property (as previously reduced by the amounts of special tax allocations of
depreciation deductions to the partners), a gain equal to the FMV-Tax Difference
(as adjusted) will be allocated to the Real Estate Trust. To the extent the gain
recognized by the Partnerships on the property disposition exceeds the FMV-Tax
Difference (as adjusted), such excess generally will be allocated among all the
partners in Saul Holdings based on their relative percentage interests. In
general, the amount of gain allocated to the Real Estate Trust in the event of
such a property disposition is likely to exceed, perhaps substantially, the
amount of cash, if any, distributable to the Real Estate Trust as a result of
the property disposition. In addition, future reductions in the level of the
Partnerships' debt, or any release of the guarantees of such debt by the Real
Estate Trust, could cause the Real Estate Trust to have taxable constructive
distributions without the receipt of any corresponding amounts of cash.
Currently, management does not intend to seek a release of or a reduction in the
guarantees or to convert its limited partner units in Saul Holdings into shares
of Saul Centers common stock.
At the date of transfer of the Real Estate Trust properties to Saul Holdings,
liabilities exceeded assets transferred by approximately $104.3 million on an
historical cost basis. The assets and liabilities were recorded by Saul Holdings
and Saul Centers at their historical cost rather than market value because of
affiliated ownership and common management and because the assets and
liabilities were the subject of the business combination between Saul Centers
and Saul Holdings, newly formed entities with no prior operations.
Immediately subsequent to the business combination and initial public offering
of common stock by Saul Centers, Saul Centers had total owners' equity of
approximately $16.4 million of which approximately $3.5 million related to the
Real Estate Trust's 21.5% ownership interest. Recognition by the Real Estate
Trust of the change in its investment in the properties of approximately $107.8
million has been deferred due to the Real Estate Trust's guarantee of $115.5
million under the Saul Centers reimbursement agreement. The deferred gain of
$107.8 million is included in "Deferred gains - real estate" in the financial
statements. The gain will be recognized in future periods to the extent the Real
Estate Trust's obligations are terminated under the reimbursement agreement.
The management of Saul Centers has adopted a strategy of maintaining a ratio of
total debt to total asset value, as estimated by management, of fifty percent or
less. The management of Saul Centers has concluded at September 30, 1997 that
the total debt of Saul Centers remains below fifty percent of total asset value.
As a result, the management of the Real Estate Trust has concluded that fundings
under the reimbursement agreement are remote.
<PAGE>
In addition to the deferred gains, as of September 30, 1997, the Real Estate
Trust's investment in the consolidated entities of Saul Centers, which is
accounted for under the equity method, consisted of the following.
(In thousands)
- ------------------------------------------------------------------------------
Saul Holdings:
Distributions in excess of allocated net income $ (6,656)
Saul Centers:
Acquisition of common shares 29,030
Distributions in excess of allocated net income (3,731)
-----------
Total $ 18,643
===========
The $18.6 million balance is included in "Other assets" in the financial
statements.
As of September 30, 1997, the Real Estate Trust, through its partnership
interest in Saul Holdings and its ownership of common shares of Saul
Centers, effectively owns 31.8% of the consolidated entities of Saul Centers.
Most of these shares and/or units have been deposited as collateral for the
Senior Secured Notes and the Trust's revolving lines of credit. See Note 4.
The Condensed Consolidated Balance Sheet at September 30, 1997 and 1996, and the
Condensed Consolidated Statements of Operations for the twelve-month periods
ended September 30, 1997, 1996 and 1995 of Saul Centers follow.
<PAGE>
Saul Centers, Inc.
Condensed Consolidated Balance Sheets (Unaudited)
September 30,
-------------------------
(In thousands) 1997 1996
------------ ------------
Assets
Real estate investments $ 346,253 $ 335,137
Accumulated depreciation (102,186) (99,349)
Other assets 25,182 33,986
------------ ------------
Total assets $ 269,249 $ 269,774
============ ============
Liabilities and stockholders' equity (deficit)
Notes payable $ 283,370 $ 276,981
Other liabilities 16,184 15,583
------------ ------------
Total liabilities 299,554 292,564
Total stockholders' equity (deficit) (30,305) (22,790)
------------ ------------
Total Liabilities and stockholders' equity (deficit) $ 269,249 $ 269,774
============ ============
Saul Centers, Inc.
Condensed Consolidated Statements of Operations (Unaudited)
For the Twelve Months Ended September 30
--------------------------------------
(In thousands) 1997 1996 1995
------------ ------------ ------------
Revenue
Base rent $ 51,157 $ 49,646 $ 46,606
Other revenue 15,613 13,727 14,173
------------ ------------ ------------
Total revenue 66,770 63,373 60,779
------------ ------------ ------------
Expenses
Operating expenses 14,624 14,407 13,703
Interest expense 19,404 18,200 17,271
Amortization of deferred debt expense 2,286 2,921 2,254
Depreciation and amortization 10,839 10,978 9,996
General and administrative 3,250 3,071 2,967
------------ ------------ ------------
Total expenses 50,403 49,577 46,191
------------ ------------ ------------
Operating income 16,367 13,796 14,588
Non-operating item
Sales of interest rate protection
agreements (972) -- --
------------ ------------ ------------
Net income before extraordinary
item and minority interest 15,395 13,796 14,588
Extraordinary item - loss on early
extinguishment of debt (956) (998) --
------------ ------------ ------------
Net income before minority interest 14,439 12,798 14,588
Minority interest (6,854) (6,852) (6,855)
------------ ------------ ------------
Net income $ 7,585 $ 5,946 $ 7,733
============ ============ ============
<PAGE>
3. INVESTMENT PROPERTIES - REAL ESTATE TRUST
The following table summarizes the cost basis of income-producing properties and
land parcels together with their related debt.
Buildings
and Leasehold Related
(Dollars in thousands) No. Land Improvements Interests Total Debt
- ---------------------- --- ------- ---------------- --------- -------- --------
September 30, 1997:
Income-producing
properties
Hotels 10 $10,843 $ 117,714 $ -- $128,557 $ 82,914
Commercial 7 4,469 105,159 -- 109,628 79,597
Other 6 3,075 1,041 149 4,265 --
--- ------- ---------------- --------- -------- --------
23 $18,387 $ 223,914 $ 149 $242,450 $162,511
=== ======= ================ ========= ======== ========
Land Parcels 10 $42,160 $ -- $ -- $ 42,160 $ 19,201
=== ======= ================ ========= ======== ========
September 30, 1996:
Income-producing
properties
Hotels 9 $ 9,662 $ 111,755 $ -- $121,417 $ 75,654
Commercial 7 4,469 102,027 -- 106,496 77,888
Other 7 3,575 991 149 4,715 --
--- -------- --------------- --------- -------- --------
23 $ 17,706 $ 214,773 $ 149 $232,628 $153,542
=== ======== =============== ========= ======== ========
Land Parcels 9 $ 41,580 $ -- $ -- $ 41,580 $ 23,662
=== ======== =============== ========= ======== ========
4. DEBT - REAL ESTATE TRUST
Mortgage notes payable are secured by various income-producing properties and
land parcels. Almost all mortgage notes are payable in monthly installments,
have maturity dates ranging to 2009 and accrue interest at annual rates from
6.3% to 10.0%. Certain mortgages contain a number of restrictions, including
cross default provisions.
Notes payable - unsecured includes notes which have been sold by the Real Estate
Trust directly to investors at varying interest rates with maturities of one to
ten years. These notes do not contain any provisions for conversion, sinking
fund or amortization, but are subject to a provision permitting the Real Estate
Trust to call them prior to maturity. The weighted average interest rates at
September 30, 1997 and 1996 were 10.4%. During fiscal 1997 and 1996, the Real
Estate Trust sold notes amounting to approximately $10.0 and $7.4 million,
respectively.
<PAGE>
On March 30, 1994, the Real Estate Trust issued $175.0 million aggregate
principal amount of its Senior Secured Notes. The Senior Secured Notes are
general obligations of the Real Estate Trust ranking pari passu with all other
unsubordinated obligations of the Trust and are secured by a first priority
perfected security interest in 80% (8,000 shares) of the issued and outstanding
common stock of the Bank and by certain other assets of the Trust as described
herein. After paying offering expenses of $8.9 million, third-party mortgage
indebtedness of $74.1 million, and affiliate indebtedness of $8.9 million, the
Real Estate Trust retained $83.1 million of the net proceeds of the offering for
application to general corporate purposes, including a loan to an affiliate of
$15.0 million. Of the remaining amount, approximately $25.8 million was
deposited with the Trustee for the Senior Secured Notes to satisfy one of the
initial collateral requirements with respect to such securities. This collateral
requirement, which will remain in effect as long as any Senior Secured Notes are
outstanding, is recalculated each calendar quarter based on the estimated amount
of one year's interest payments on then outstanding Senior Secured Notes and
Unsecured Notes and may be satisfied through deposits of cash or marketable
securities. Concurrently with the application of the net proceeds of the
offering to repay third-party mortgage indebtedness, the terms of certain of the
mortgage loans repaid in part were modified to waive deferred interest, reduce
interest rates and extend maturities. After the application of such net proceeds
and the modification of such loans, the final maturity of loans with total
balances of $111.1 million was 12 years and the final maturity of a loan with a
balance of $15.1 million was 15 years. As of September 30, 1997, the Real Estate
Trust was required to maintain deposits of $25.2 million and had deposited
1,535,104 shares of common stock of Saul Centers (See Note 1) with the Trustee
for the Senior Secured Notes to satisfy in part the collateral requirements for
those deposits. The common stock of Saul Centers is reflected in other assets in
the accompanying balance sheets. The Senior Secured Notes may be redeemed in
whole or in part at any time on or after April 1, 1998, subject to, among other
things, prepayment premiums.
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 September 30, 1997, the
Trust had pledged as collateral for this credit line approximately 30.5% of its
investment in Saul Holdings. At that date there were no borrowings under the
facility and based on the collateral pledged, unrestricted availability was
$10.0 million.
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 any outstanding loan amount would amortize over a two-year
period. Interest is computed by reference to a floating rate index. During
fiscal 1997, the line of credit was increased to $10.0 million. At September 30,
1997, the Trust had pledged as collateral for this credit line approximately
14.5% of its investment in Saul Holdings. At that date there were no borrowings
under the facility and based on the collateral pledged, unrestricted
availability was $4.8 million.
<PAGE>
The maturity schedule for the Real Estate Trust's outstanding debt at September
30, 1997 for the fiscal years commencing October 1, 1997 is set forth in the
following table.
Debt Maturity Schedule
(In thousands)
- -------------------------------------------------------------------------------
Notes Notes
Fiscal Mortgage Payable - Payable -
Year Notes Secured Unsecured Total
- ------------ ------------ ------------ ------------ -----------
1998 $ 11,092 $ -- $ 7,610 $ 18,702
1999 9,736 -- 16,079 25,815
2000 20,095 -- 8,804 28,899
2001 9,790 -- 4,165 13,955
2002 11,343 175,000 5,081 191,424
Thereafter 118,148 -- 4,894 123,042
------------ ------------ ------------ -----------
Total $ 180,204 $ 175,000 $ 46,633 $ 401,837
- -------------------------------------------------------------------------------
Of the $180.2 million of mortgage debt outstanding at September 30, 1997, $137.1
million was nonrecourse to the Real Estate Trust.
5. LONG-TERM LEASE OBLIGATIONS - REAL ESTATE TRUST
The Real Estate Trust has one noncancelable long-term lease which provides for
periodic adjustments of the basic annual rent. This lease will expire in 2061.
The minimum future rental commitments under this lease amount to $101,000 per
year for the next five fiscal years; thereafter, the total commitment is $5.8
million.
The Real Estate Trust paid minimum ground rent expense of $101,000 each year in
fiscal 1997, 1996 and 1995. In addition to the minimum ground rent payments,
real estate taxes on the land are an obligation of the Real Estate Trust.
6. INCOME FROM COMMERCIAL PROPERTIES - REAL ESTATE TRUST
Income from commercial properties consists of minimum rent arising from
noncancelable commercial leases. Minimum rent for fiscal years 1997, 1996, and
1995 amounted to $19.7, $16.8 and $17.9 million, respectively. Future minimum
rentals as of September 30, 1997 under noncancelable leases are as follows:
Fiscal
Year (In thousands)
---------------------------------------------------------------------
1998 $ 18,817
1999 15,962
2000 12,247
2001 9,130
2002 6,184
Thereafter 12,281
-------------------------------------------------------------------
<PAGE>
7. TRANSACTIONS WITH RELATED PARTIES - REAL ESTATE TRUST
TRANSACTIONS WITH B. F. SAUL COMPANY AND ITS SUBSIDIARIES
The Real Estate Trust is managed by B. F. Saul Advisory Company (the Advisor), a
wholly-owned subsidiary of B. F. Saul Company ("Saul Co."). All of the Real
Estate Trust officers and three Trustees of the Trust are also officers and/or
directors of Saul Co. The Advisor is paid a fixed monthly fee which is subject
to annual review by the Trustees. The monthly fee was $292,000 during the period
October 1994 through September 1995, $301,000 during the period October 1995
through March 1996, $306,000 during the period April 1996 through September
1996, and $311,000 during the period October 1996 through September 1997. The
advisory contract has been extended until September 30, 1998, and will continue
thereafter unless canceled by either party at the end of any contract year.
Certain loan agreements prohibit termination of this contract.
Saul Co. and Franklin Property Company ("Franklin"), a wholly-owned subsidiary
of Saul Co., provide services to the Real Estate Trust through commercial
property management and leasing, hotel management, development and construction
management, and acquisitions, sales and financings of real property. Fees paid
to Saul Co. and Franklin amounted to $5.1, $4.8 and $4.8 million in fiscal 1997,
1996 and 1995, respectively.
The Real Estate Trust reimburses the Advisor and Franklin for costs and expenses
incurred on behalf of the Real Estate Trust, in-house legal expenses, and for
all travel expenses incurred in connection with the affairs of the Real Estate
Trust.
The Real Estate Trust pays the Advisor fees equal to 1% of the principal amount
of the unsecured notes as they are issued to offset its costs of administering
the program. These payments amounted to $102,000, $74,000 and $80,000 in fiscal
1997, 1996 and 1995, respectively.
A subsidiary of Saul Co. is a general insurance agency which receives
commissions and countersignature fees in connection with the Real Estate Trust's
insurance program. Such commissions and fees amounted to approximately $158,000,
$152,000 and $158,000 in fiscal 1997, 1996 and 1995, respectively.
In April 1994 the Real Estate Trust made an unsecured loan to the Saul Company
of $15.0 million bearing interest at 1/2 percent over prime and due on demand.
In fiscal 1995 the loan balance was reduced to $12.7 million. In fiscal 1996 the
Real Estate Trust made new loans aggregating $3.5 million to the Saul Company.
During fiscal 1997 a curtail of $750,000 was paid by the Saul Company. At
September 30, 1997 the total due the Real Estate Trust was $15.4 million.
Interest accrued on these loans amounted to $1.4, $1.4 and $1.2 million during
fiscal 1997, 1996 and 1995, respectively.
REMUNERATION OF TRUSTEES AND OFFICERS
For fiscal years 1997, 1996, and 1995, the Real Estate Trust paid the Trustees
$89,000, $79,000 and $81,000, respectively, for their services. No compensation
was paid to the officers of the Real Estate Trust for acting as such; however,
one Trustee was paid by the Bank for his services as Chairman and Chief
Executive Officer of the Bank, and four received payments for their services as
directors of the Bank. Four of the Trustees and all of the officers of the Real
Estate Trust receive compensation from Saul Co. as directors and/or officers.
<PAGE>
LEGAL SERVICES
The law firm in which one of the Trustees is a partner received $0.3, $0.1 and
$0.8 million, excluding expense reimbursements, during fiscal 1997, 1996, and
1995, respectively, for legal services to the Real Estate Trust and its
wholly-owned subsidiaries.
SAUL HOLDINGS LIMITED PARTNERSHIP
The Real Estate Trust accounts for this investment under the equity method. The
Real Estate Trust's share of earnings for fiscal 1997, 1996 and 1995 were $3.0,
$2.7 and $3.1 million, respectively. See Note 2.
OTHER TRANSACTIONS
The Real Estate Trust leases space to the Bank and Franklin at two of its
income-producing properties. Minimum rents and recoveries paid by these
affiliates amounted to approximately $239,000, $143,000 and $55,000, in fiscal
1997, 1996 and 1995, respectively.
<PAGE>
8. LOANS HELD FOR SECURITIZATION AND SALE - THE BANK
Loans held for securitization and sale are composed of the following:
September 30,
(In thousands) 1997 1996
- --------------------------------------------- ------------ ------------
Credit card $ 90,000 $ 225,000
Automobile 80,000 225,000
Home equity 50,000 -
------------ ------------
Total $ 220,000 $ 450,000
============ ============
9. INVESTMENT SECURITIES - THE BANK
At September 30, 1997 and 1996, all investment securities are classified as
held-to-maturity. Gross unrealized holding gains and losses on the Bank's
investment securities at September 30, 1997 and 1996 are as follows:
Gross Gross
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
(In thousands) Cost Gains Losses Value
- --------------------------- --------- ---------- ---------- ---------
September 30, 1997
U.S. Government securities:
Maturing within one year $ 4,998 $ 14 $ - $ 5,012
========= ========== ========== =========
Gross Gross
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
(In thousands) Cost Gains Losses Value
- --------------------------- --------- ---------- ---------- ---------
September 30, 1996
U.S. Government securities:
Maturing within one year $ 4,822 $ 3 $ - $ 4,825
Maturing after one year,
but within five years 4,996 - (1) 4,995
--------- ---------- ---------- ---------
Total U.S. Government
securities $ 9,818 $ 3 $ (1) $ 9,820
========= ========== ========== =========
There were no sales of investment securities during the years ended September
30, 1997, 1996 and 1995.
<PAGE>
10. MORTGAGE-BACKED SECURITIES - THE BANK
At September 30, 1997 and 1996, all mortgage-backed securities are classified as
held-to-maturity. Gross unrealized holding gains and losses on the Bank's
mortgage-backed securities at September 30, 1997 and 1996 are as follows:
Gross Gross
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
(In thousands) Cost Gains Losses Value
- ----------------------------- ----------- ----------- ----------- ------------
September 30, 1997
FNMA $ 333,563 $ 1,425 $ (1,948) $ 333,040
FHLMC 856,522 6,480 (2,835) 860,167
Private label, AAA-rated 734,632 - (4,828) 729,804
Private label, AA-rated 60,990 666 - 61,656
----------- ----------- ----------- ------------
Total $ 1,985,707 $ 8,571 $ (9,611) $ 1,984,667
=========== =========== =========== ============
Gross Gross
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
(In thousands) Cost Gains Losses Value
- ----------------------------- ----------- ----------- ----------- ------------
September 30, 1996
FNMA $ 432,527 $ 2,253 $ (162) $ 434,618
FHLMC 792,752 1,266 (2,802) 791,216
Private label, AA-rated 81,138 866 - 82,004
----------- ----------- ----------- ------------
Total $ 1,306,417 $ 4,385 $ (2,964) $ 1,307,838
=========== =========== =========== ============
There were no sales of mortgage-backed securities from the available-for-sale or
the held-to-maturity portfolios during the years ended September 30, 1997, 1996
and 1995. See Summary of Significant Accounting Policies - The Bank - "Trading
Securities."
Accrued interest receivable on mortgage-backed securities totaled $11.9 and $8.1
million at September 30, 1997 and 1996, respectively, and is included in other
assets in the Consolidated Balance Sheets.
At September 30, 1997, certain mortgage-backed securities were pledged as
collateral for Federal Home Loan Bank of Atlanta advances, other short-term
borrowings and other recourse arrangements. See Notes 18, 19 and 26. Other
mortgage-backed securities with a book value of $24.7 million were pledged as
collateral primarily for credit card settlement obligations.
<PAGE>
11. LOANS RECEIVABLE - THE BANK
Loans receivable is composed of the following:
September 30,
(In thousands) 1997 1996
- --------------------------------------- ------------- ------------
Single-family residential $ 747,070 $ 1,525,322
Home equity 44,088 32,052
Commercial real estate and multifamily 53,816 78,951
Real estate construction 77,221 41,561
Ground 29,592 44,723
Commercial 152,483 85,372
Credit card 987,149 893,271
Automobile 137,111 72,560
Home improvement and related loans 49,551 94,316
Overdraft lines of credit and
other consumer 36,029 37,954
------------- ------------
2,314,110 2,906,082
------------- ------------
Less:
Undisbursed portion of loans 106,217 50,811
Unearned discounts 449 836
Net deferred loan origination costs (2,475) (14,055)
Allowance for losses on loans 105,679 95,523
------------- ------------
209,870 133,115
------------- ------------
Total $ 2,104,240 $ 2,772,967
============= ============
The Bank serviced loans owned by others amounting to $9,731.8 and $7,998.5
million at September 30, 1997 and 1996, respectively.
Accrued interest receivable on loans totaled $19.0 and $33.2 million at
September 30, 1997 and 1996, respectively, and is included in other assets in
the Consolidated Balance Sheets.
<PAGE>
12. REAL ESTATE HELD FOR INVESTMENT OR SALE - THE BANK
Real estate held for investment or sale is composed of the following:
September 30,
(In thousands) 1997 1996
- -------------------------------------------------- -------------- -------------
Real estate held for investment $ 3,819 $ 3,819
-------------- -------------
Real estate held for sale 231,407 246,380
-------------- -------------
Less:
Allowance for losses on real estate held
for investment 198 191
Allowance for losses on real estate held for sale 140,738 126,519
------------- -------------
140,936 126,710
Total real estate held for investment or sale $ 94,290 $ 123,489
============= =============
Loss on real estate held for investment or sale is composed of the following:
September 30,
(In thousands) 1997 1996 1995
- ------------------------------------------- ---------- ---------- ----------
Provision for losses $ (19,623) $ (26,341) $ (26,321)
Net income (loss) from operating properties (221) (350) 1,890
Equity earnings from investments in
limited partnerships - - 4,470
Net gain on sales 1,156 2,278 14,412
---------- ---------- ----------
Total $ (18,688) $ (24,413) $ (5,549)
========== ========== ==========
<PAGE>
13. ALLOWANCES FOR LOSSES - THE BANK
Activity in the allowances for losses on loans receivable and real estate held
for investment or sale is summarized as follows:
Real Estate
Held for
Loans Investment
(In thousands) Receivable or Sale
- ----------------------------------------- ------------ -----------
Balance, September 30, 1994 $ 50,205 $ 118,973
Provision for losses 54,979 26,321
Charge-offs (56,577) (10,058)
Recoveries 11,889 -
------------ -----------
Balance, September 30, 1995 60,496 135,236
Provision for losses 115,740 26,341
Charge-offs (92,047) (34,867)
Recoveries 11,334 -
------------ -----------
Balance, September 30, 1996 95,523 126,710
Provision for losses 125,115 19,623
Increase due to acquisition of loans 118 -
Charge-offs (126,506) (5,397)
Recoveries 11,429 -
------------ -----------
Balance, September 30, 1997 $ 105,679 $ 140,936
============ ===========
The allowances for losses at September 30, 1997 are based on management's
estimates of the amount of allowances required to reflect the losses incurred in
the loan and real estate portfolios based on circumstances and conditions known
at the time. As adjustments to the allowances become necessary, provisions for
losses are reported in operations in the periods they are determined to be
necessary.
14. ASSET-BACKED TRANSACTIONS - THE BANK
The Bank periodically sells various receivables through asset-backed
securitizations, in which receivables are transferred to trusts, and
certificates are sold to investors.
The Bank sold credit card receivables and received gross proceeds of $1,084.5,
$919.0 and $1,550.0 million during the years ended September 30, 1997, 1996 and
1995, respectively. During fiscal 1997, the Bank recognized gains of $33.1
million on credit card transactions. Of the $33.1 million gain, $26.2 million
represents gains recognized on 1997 securitizations and sales of additional
receivables for previous transactions, and the remainder represents gains
recognized to adjust the interest-only strips to fair market value. See Summary
of Significant Accounting Policies - The Bank. Outstanding trust certificate
balances related to these and previous securitizations were $4,015.2 and
$3,889.7 million at September 30, 1997 and 1996, respectively. The related
receivable balances contained in the trusts were $4,659.7 and $4,587.1 million
at September 30, 1997 and 1996, respectively. The Bank continues to service the
underlying loans and is contingently liable under various credit enhancement
facilities related to these transactions. See Note 26.
<PAGE>
The Bank sold amounts on deposit in certain spread accounts associated with
certain outstanding credit card securitizations and received gross proceeds of
$144.2, $42.1 and $59.2 million during fiscal 1997, 1996 and 1995, respectively.
A loss of $7.2 million was recognized on the 1997 transaction and is included in
gain on sales of loans, net, in the Consolidated Statements of Operations. No
gains or losses were recorded on the transactions during fiscal 1996 and 1995.
Outstanding trust certificate balances related to these securitizations were
$225.9 and $91.8 million at September 30, 1997 and 1996, respectively.
The Bank sold automobile loan receivables and received gross proceeds of $938.9,
$475.3 and $252.2 million during fiscal 1997, 1996 and 1995, respectively. Gains
recognized on these transactions were $26.9, $7.3 and $4.0 million,
respectively. The outstanding trust certificate balances and the related
receivable balances contained in the trusts were $1,083.0 and $505.6 million at
September 30, 1997 and 1996, respectively, $7.9 million of which represents a
separate class of certificates retained by the Bank in conjunction with one 1997
transaction. These certificates were classified as trading securities at
September 30, 1997. The Bank continues to service the underlying loans and is
contingently liable under various credit enhancement facilities related to these
transactions. See Note 26.
The Bank sold home equity credit line receivables and received gross proceeds of
$139.8, $96.5 and $150.5 million, during the years ended September 30, 1997,
1996 and 1995, respectively. Gains recognized on these transactions were $3.4,
$4.7 and $7.6 million, during the years ended September 30, 1997, 1996 and 1995,
respectively. The $3.4 million amount recognized in income for fiscal 1997
represents gains recognized on the sale of new receivables into existing trusts.
The outstanding trust certificate balances and the related receivable balances
contained in the trusts were $325.8 and $459.1 million, respectively, at
September 30, 1997, and $416.4 and $440.4 million, respectively, at September
30, 1996. The Bank continues to service the underlying loans and is contingently
liable under various credit enhancement facilities related to these
transactions. See Note 26.
During the year ended September 30, 1997, the Bank sold home loan and home
equity receivables in an asset-backed transaction to investors representing
interests in the trust. The gross proceeds received on this sale were $216.3
million. The gain recognized on this transaction was $11.2 million. Pursuant to
a subsequent competitive auction, the Bank purchased the receivables related to
the home loan portion of the trust. At September 30, 1997, the outstanding trust
certificate balances and the related receivable balances (consisting solely of
home equity receivables at September 30, 1997) contained in the trust were
$133.3 million. The Bank continues to service the underlying loans and is
contingently liable under a credit enhancement facility related to this
transaction. See Note 26.
The Bank sold home loan receivables and received gross proceeds of $154.4 and
$153.5 million for the years ended September 30, 1997 and 1996, respectively.
Gains recognized on these transactions were $7.2 and $9.5 million, respectively.
The outstanding trust certificate balances and the related receivable balances
contained in the trusts were $246.8 and $244.1 million, respectively, at
September 30, 1997, and $153.5 and 141.1 million, respectively, at September 30,
1996. The Bank continues to service the underlying loans and is contingently
liable under credit enhancement facilities related to these transactions. See
Note 26.
<PAGE>
15. PROPERTY AND EQUIPMENT - THE BANK
Property and equipment is composed of the following:
Estimated
Useful September 30,
(Dollars in thousands) Lives 1997 1996
- -------------------------- ---------------- ------------ -----------
Land - $ 49,925 $ 45,211
Construction in progress - 1,950 18,596
Buildings and improvements 10-45 years 122,326 88,362
Leasehold improvements 5-20 years 83,526 65,467
Furniture and equipment 5-10 years 182,044 149,470
Automobiles 3-5 years 2,303 1,964
------------ -----------
442,074 369,070
Less:
Accumulated depreciation
and amortization 168,512 143,935
------------ ----------
Total $ 273,562 $ 225,135
============ ==========
Depreciation and amortization expense amounted to $28.5, $24.4 and $21.5 million
for the years ended September 30, 1997, 1996 and 1995, respectively.
16. LEASES - THE BANK
The Bank has noncancelable, long-term leases for office premises and retail
space, which have a variety of terms expiring from 1998 to 2019 and ground
leases which have terms expiring from 2029 to 2080. These leases are accounted
for as operating leases. Some of the leases are subject to rent adjustments in
the future based upon changes in the Consumer Price Index and some also contain
renewal options. The following is a schedule by years of future minimum lease
payments required at September 30, 1997:
Year Ending
September 30, (In thousands)
------------- --------------
1998 $ 13,700
1999 11,696
2000 10,862
2001 9,474
2002 10,620
Thereafter 73,448
--------------
Total $ 129,800
==============
Future minimum sublease rental income at September 30, 1997 totaled $226,000.
Rent expense totaled $16.1, $13.5 and $11.2 million for the years ended
September 30, 1997, 1996 and 1995, respectively.
<PAGE>
17. DEPOSIT ACCOUNTS - THE BANK
An analysis of deposit accounts and the related weighted average effective
interest rates at year-end are as follows:
September 30,
1997 1996
-------------------- -------------------
Weighted Weighted
Average Average
(Dollars in thousands) Amount Rate Amount Rate
- -------------------------------------- ----------- ------ ----------- -------
Demand accounts $ 215,678 - $ 156,517 -
NOW accounts 904,697 2.42% 851,385 2.42%
Money market deposit accounts 983,016 3.97% 1,002,688 3.88%
Statement savings accounts 907,141 3.48% 881,285 3.47%
Other deposit accounts 79,071 2.99% 68,487 2.98%
Certificate accounts, less than $100 1,156,724 5.50% 1,030,401 5.30%
Certificate accounts, $100 or more 647,429 5.69% 173,274 5.41%
----------- -----------
Total $ 4,893,756 3.99% $ 4,164,037 3.75%
=========== ===========
Interest expense on deposit accounts is composed of the following:
Year Ended September 30,
(In thousands) 1997 1996 1995
- ------------------------------- ----------- ----------- -----------
NOW accounts $ 21,882 $ 23,044 $ 23,692
Money market deposit accounts 38,644 38,317 42,420
Statement savings accounts 30,927 30,034 33,394
Certificate accounts 75,180 69,180 53,033
Other deposit accounts 2,274 1,994 1,760
----------- ----------- -----------
Total $ 168,907 $ 162,569 $ 154,299
=========== =========== ===========
Outstanding certificate accounts at September 30, 1997 mature in the years
indicated as follows:
Year Ending
September 30, (In thousands)
------------- --------------
1998 $ 1,514,252
1999 139,458
2000 104,298
2001 19,459
2002 26,686
--------------
Total $ 1,804,153
==============
<PAGE>
At September 30, 1997, certificate accounts of $100,000 or more have contractual
maturities as indicated below:
(In thousands)
--------------
Three months or less $ 294,151
Over three months through six months 154,288
Over six months through 12 months 171,852
Over 12 months 27,138
-------------
Total $ 647,429
=============
18. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER
SHORT-TERM BORROWINGS - THE BANK
Short-term borrowings are summarized as follows:
September 30,
(Dollars in thousands) 1997 1996 1995
- ----------------------------------------------- -------- -------- --------
Securities sold under repurchase agreements:
Balance at year-end $ 2,606 $576,823 $ 2,424
Average amount outstanding during the year 483,076 59,687 161,599
Maximum amount outstanding at any month-end 946,090 576,823 355,991
Amount maturing within 30 days 2,606 576,576 2,424
Weighted average interest rate during the year 5.48% 5.50% 6.01%
Weighted average interest rate on year-end
balances 5.35% 5.41% 5.45%
Other short-term borrowings:
Balance at year-end $72,215 $60,318 $ 8,011
Average amount outstanding during the year 39,126 13,641 17,896
Maximum amount outstanding at any month-end 72,241 60,318 50,842
Amount maturing within 30 days 72,215 60,318 8,011
Weighted average interest rate during the year 5.11% 5.04% 5.58%
Weighted average interest rate on year-end
balances 5.34% 5.63% 5.77%
The investment and mortgage-backed securities underlying the repurchase
agreements were delivered to the dealers who arranged the transactions. The
dealers may have loaned such securities to other parties in the normal course of
their operations and agreed to resell to the Bank the identical securities at
the maturities of the agreements.
At September 30, 1997, the Bank had pledged mortgage-backed securities with a
book value of $100.1 million to secure certain other short-term borrowings.
<PAGE>
19. FEDERAL HOME LOAN BANK ADVANCES - THE BANK
At September 30, 1997, advances from the Federal Home Loan Bank of Atlanta
("FHLB") totaled $188.5 million. Of the total advances at September 30, 1997,
$150.0 million have a weighted average interest rate of 5.63%, adjust quarterly
based on the three-month London Interbank Offered Rate ("LIBOR") and mature over
varying periods between November 1997 and March 1998. The weighted average
interest rate on the remaining $38.5 million is 6.62% which is fixed for the
term of the advances which mature over varying periods between December 1997 and
September 2007.
Under a Specific Collateral Agreement with the FHLB, advances are secured by all
of the Bank's FHLB stock and mortgage-backed securities with a book value of
$257.3 million. The FHLB requires that members maintain qualifying collateral at
least equal to 100% of the member's outstanding advances at all times. The
collateral held by the FHLB in excess of the September 30, 1997 advances is
available to secure additional advances from the FHLB, subject to its
collateralization guidelines.
20. CAPITAL NOTES - SUBORDINATED - THE BANK
Capital notes, which are subordinated to the interest of deposit account
holders, are composed of the following:
September 30, Interest
(Dollars in thousands) 1997 1996 Rate
- ----------------------------------- ------------ ------------ -------------
Private placement:
BACOB Bank, s.c.,
due December 1996 $ - $ 10,000 LIBOR + 3.0%
Public placement:
Subordinated debentures due 2005 150,000 150,000 9 1/4%
Subordinated debentures due 2008 100,000 - 9 1/4%
------------ ------------
Total $ 250,000 $ 160,000
============ ============
On December 3, 1996, the Bank sold $100.0 million 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 Bank received OTS approval to include the principal
amount of the 1996 Debentures in the Bank's supplementary capital for regulatory
capital purposes.
On November 23, 1993, the Bank sold $150.0 million of its 9 1/4% Subordinated
Debentures due 2005 (the "1993 Debentures"). The Bank received net proceeds of
$143.6 million from the sale of the 1993 Debentures, of which approximately
$134.2 million was used to redeem $78.5 million of debentures due in 2002 and
$50.0 million of debentures due in 2003 on December 23, 1993 and December 24,
1993, respectively. The remaining net proceeds were used for general corporate
purposes. The Bank incurred a loss of $6.3 million, after related income taxes,
in connection with the redemption of these debentures. The OTS approved the
inclusion of the principal amount of the 1993 Debentures in the Bank's
supplementary capital for regulatory capital purposes.
<PAGE>
The indenture pursuant to which the 1993 Debentures were sold (the "Indenture")
provides that the Bank may not pay dividends on its capital stock unless, after
giving effect to the dividend, no event of default shall have occurred and be
continuing and the Bank is in compliance with its regulatory capital
requirements. In addition, the amount of the proposed dividend may not exceed
the sum of (i) $15.0 million, (ii) 66 2/3% of the Bank's consolidated net income
(as defined in the Indenture) accrued on a cumulative basis commencing on
October 1, 1993 and (iii) the aggregate net cash proceeds received by the Bank
after October 1, 1993 from the sale of qualified capital stock or certain debt
securities, minus the aggregate amount of any restricted payments made by the
Bank. Notwithstanding the above restrictions on dividends, provided no event of
default has occurred or is continuing, the Indenture does not restrict the
payment of dividends on the 13% Preferred Stock (as defined below) or any
payment-in-kind preferred stock issued in lieu of cash dividends on the
Preferred Stock or the redemption of any such payment-in-kind preferred stock.
The indenture pursuant to which the 1996 Debentures were sold provides that the
proposed dividend may not exceed the sum of the restrictions discussed above for
the 1993 Indenture and the aggregate liquidation preference of the new series of
preferred stock of the Bank, if issued in exchange for the outstanding REIT
Preferred Stock (as defined below). See Note 21.
Deferred debt issuance costs, net of accumulated amortization, amounted to $9.4
and $5.6 million at September 30, 1997 and 1996, respectively, and are included
in other assets in the Consolidated Balance Sheets.
On November 15, 1996, the Bank redeemed the $10.0 million private placement
note.
21. REAL ESTATE INVESTMENT TRUST SUBSIDIARY - THE BANK
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 10 3/8%. 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 received OTS approval to
include the proceeds 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 until
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 in minority interest -- other in the Trust's Consolidated Balance
Sheets. Dividends on the REIT Preferred Stock are presented as a reduction of
net income in the Consolidated Statements of Operations.
22. PREFERRED STOCK - THE BANK
In April 1993, the Bank sold $75.0 million of its Noncumulative Perpetual
Preferred Stock, Series A ("Preferred Stock") in a private offering. Cash
dividends on the Preferred Stock are payable quarterly in arrears at an annual
rate of 13%. If the Board of Directors does not declare the full amount of the
noncumulative cash dividend accrued in respect of any quarterly dividend period,
in lieu thereof the Board of Directors will be required to declare (subject to
regulatory and other restrictions) a stock dividend in the form of a new series
of payment-in-kind preferred stock of the Bank.
<PAGE>
The OTS has approved the inclusion of the Preferred Stock as tier 1 or core
capital and has approved the payment of dividends on the Preferred Stock,
provided certain conditions are met. The Preferred Stock is not redeemable until
May 1, 2003 and is redeemable thereafter at the option of the Bank. The holders
of the Preferred Stock have no voting rights, except in certain limited
circumstances.
Holders of the Preferred Stock will be entitled to receive a liquidating
distribution in the amount of $25 per share, plus accrued and unpaid
dividends for the then-current dividend period in the event of any voluntary
liquidation of the Bank, after payment of the deposit accounts and other
liabilities of the Bank, and out of the assets available for distribution to
shareholders. The Preferred Stock ranks superior and prior to the issued and
outstanding common stock of the Bank with respect to dividend and liquidation
rights.
23. RETIREMENT PLAN - THE BANK
The Bank participates in a defined contribution profit sharing retirement plan
(the "Plan") which covers those full-time employees who meet the requirements as
specified in the Plan. The Plan, which can be modified or discontinued at any
time, requires participating employees to contribute 2.0% of their compensation.
Corporate contributions, at the discretionary amount of three times the employee
contribution, were $5.6, $4.7 and $3.9 million for the years ended September 30,
1997, 1996 and 1995, respectively. There are no past service costs associated
with the Plan and the Bank has no liability under the Plan other than its
current contributions. The Plan owns 4.0% of the Bank's common stock.
24. REGULATORY MATTERS - THE BANK
Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA"), the Bank's regulatory capital requirements at September 30, 1997
were a 1.5% tangible capital requirement, a 3.0% core capital requirement and an
8.0% total risk-based capital requirement. Under the OTS "prompt corrective
action" regulations, the Bank must maintain minimum leverage, tier 1 risk-based
and total risk-based capital ratios of 4.0%, 4.0% and 8.0%, respectively, to
meet the ratios established for "adequately capitalized" institutions. At
September 30, 1997, the Bank was in compliance with its tangible, core and total
risk-based regulatory capital requirements and exceeded the capital standards
established for "well capitalized" institutions under the "prompt corrective
action" regulations. The information below is based upon the Bank's
understanding of the applicable FIRREA and "prompt corrective action"
regulations and related interpretations.
<PAGE>
<TABLE>
SEPTEMBER 30, 1997
---------------------------------------------------------------------------------------------
MINIMUM EXCESS
ACTUAL CAPITAL REQUIREMENT CAPITAL
----------------------------- ------------------------------ --------------------------------
As a % of As a % of As a % of
(Dollars in thousands) Amount Assets(4) Amount Assets Amount Assets
- ----------------------------------- ------------ ---------------- ------------- ---------------- --------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Capital per financial statements $ 363,246
Minority interest in REIT
Subsidiary(1) 144,000
Net unrealized holding losses(2) 493
------------
Adjusted capital 507,739
Adjustments for tangible and
core capital:
Intangible assets (44,251)
Non-allowable minority interest
in REIT Subsidiary(1) (38,758)
Non-includable subsidiaries(3) (3,762)
------------
Total tangible capital 420,968 6.96% $ 90,715 1.50% $ 330,253 5.46%
------------ ================ ============= ================ =============== ================
Total core capital(4) 420,968 6.96% $ 241,907 4.00% $ 179,061 2.96%
------------ ================ ============= ================ =============== ================
Tier 1 risk-based capital(4) 420,968 7.24% $ 232,713 4.00% $ 188,255 3.24%
------------ ================ ============= ================ =============== ================
Adjustments for total risk-based
capital:
Subordinated capital debentures 250,000
Allowance for general loan losses 92,962
------------
Total supplementary capital 342,962
Excess allowance for loan losses (19,989)
------------
Adjusted supplementary capital 322,973
------------
Total available capital 743,941
Equity investments(3) (14,556)
------------
Total risk-based capital(4) $ 729,385 13.50% $ 465,426 8.00% $ 263,959 5.50%
============ ================ ============= ================ =============== ================
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(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 $964 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%.
<PAGE>
At September 30, 1996, the Bank was in compliance with its tangible, core and
total risk-based regulatory capital requirements and exceeded the capital
standards established for "adequately capitalized" institutions under the
"prompt corrective action" regulations. The information below is based upon the
Bank's understanding of the applicable FIRREA and "prompt corrective action"
regulations and related interpretations.
<PAGE>
<TABLE>
SEPTEMBER 30, 1996
---------------------------------------------------------------------------------------------
MINIMUM EXCESS
ACTUAL CAPITAL REQUIREMENT CAPITAL
----------------------------- ------------------------------ --------------------------------
As a % of As a % of As a % of
(Dollars in thousands) Amount Assets(4) Amount Assets Amount Assets
- ----------------------------------- ------------ ---------------- ------------- ---------------- --------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Capital per financial statements $ 339,160
Net unrealized holding losses(1) 1,875
------------
Adjusted capital 341,035
Adjustments for tangible and
core capital:
Intangible assets (41,051)
Non-includable subsidiaries(2)(4) (3,622)
------------
Total tangible capital 296,362 5.21% $ 85,255 1.50% $ 211,107 3.71%
------------ ================ ============= ================ =============== ================
Total core capital(3) 296,362 5.21% $ 227,346 4.00% $ 69,016 1.21%
------------ ================ ============= ================ =============== ================
Tier 1 risk-based capital(3) 296,362 5.80% $ 204,519 4.00% $ 91,843 1.80%
------------ ================ ============= ================ =============== ================
Adjustments for total risk-based
capital:
Subordinated capital debentures 150,000
Allowance for general loan losses 87,953
------------
Total supplementary capital 237,953
Excess allowance for loan losses (23,744)
------------
Adjusted supplementary capital 214,209
------------
Total available capital 510,571
Equity investments(2) (19,657)
------------
Total risk-based capital(3) $ 490,914 10.14% $ 409,038 8.00% $ 81,876 2.14%
============ ================ ============= ================ =============== ================
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Pursuant to OTS policy, net unrealized holding gains (losses) are excluded
from regulatory capital.
(2) Reflects an aggregate offset of $1.2 million representing the allowance for
general loan losses maintained against theBank's equity investments and
non-includable subsidiaries which, pursuant to OTS guidelines, is available as a
"credit" against the deductions from capital otherwise required for such
investments.
(3) Under the OTS "prompt corrective action" regulations, the standards for
classification as "well capitalized" are a leverage (or "core capital") ratio of
at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0% and a total
risk-based capital ratio of at least 10.0%.
(4) Effective July 1, 1996, the percentage of non-includable subsidiaries
phased-out from core capital increased from 60% to 100%.
<PAGE>
At September 30, 1997 and 1996, the Bank had $4.0 and $3.8 million,
respectively, in loans to and investments in subsidiaries engaged in activities
impermissible for national banks ("non-includable subsidiaries") which were
fully deducted from all three capital requirements. At September 30, 1997 and
1996, the Bank also had two equity investments with an aggregate balance, after
subsequent valuation allowances, of $15.3 and $20.7 million, respectively, which
were fully deducted from total risk-based capital.
As of September 30, 1997 and 1996, the Bank had $36.2 and $40.2 million,
respectively, in supervisory goodwill, all of which was excluded from core
capital pursuant to statutory provisions.
OTS capital regulations provide a five-year holding period (or such longer
period as may be approved by the OTS) for REO to qualify for an exception from
treatment as an equity investment. If an REO property is considered an equity
investment, its then-current book value is deducted from total risk-based
capital. Accordingly, if the Bank is unable to dispose of any REO property
(through bulk sales or otherwise) prior to the end of its applicable five-year
holding period and is unable to obtain an extension of such five-year holding
period from the OTS, the Bank could be required to deduct the then-current book
value of such REO property from total risk-based capital. In November 1996, the
Bank received from the OTS an extension of the holding periods for certain of
its REO properties through November 12, 1997. In addition, the Bank has
submitted to the OTS a request for a further extension of the holding periods
through fiscal 1998 for certain of its REO properties. Based on its capital
ratios at September 30, 1997, the Bank's capital raios would have remained above
the levels required for well-capitalized institutions even if the book value of
REO properties for which an extension has not yet been received had been
deducted from total risk-based capital as of that date. The following table sets
forth the Bank's REO at September 30, 1997, after valuation allowances of $140.7
million, by the fiscal year in which the property was acquired through
foreclosure.
Fiscal Year (In thousands)
----------- -----------------
1990 $ 22,667(1)(2)
1991 47,724(2)
1992 3,280(2)
1993 4,050
1994 2,002
1995 8,036
1996 -
1997 2,910
------------
Total REO $ 90,669
============
- --------------------------------------------------------------------------------
(1) Includes REO with an aggregate net book value of $14.6 million, which the
Bank treats as equity investments for regulatory capital purposes. (2) Includes
REO, with an aggregate net book value of $59.1 million, for which the Bank
received an extension of the holding periods through November 12, 1997.
<PAGE>
At the request of the OTS, the Board of Directors of the Bank adopted a
resolution in March 1996 which, among other things, permits the Bank: (i) to
make tax sharing payments without OTS approval to the Trust of up to $15.0
million relating to any single fiscal year; and (ii) to declare dividends on its
common stock in any quarterly period up to the lesser of (a) 50% of its after
tax net income for the immediately preceding quarter or (b) 50% of the average
quarterly after tax net income for the immediately preceding four quarter
period, minus (in either case) dividends declared on the Bank's preferred stock
during that quarterly period. The resolution also provides that the Bank will
present a plan annually to the OTS detailing anticipated consumer loan
securitization activity.
Legislation was enacted on September 30, 1996 that, among other things, imposed
on thrift institutions a one-time assessment of 65.7 basis points on their
SAIF-insured deposits to capitalize the SAIF. The one-time SAIF assessment of
$26.4 million, which was accrued during fiscal 1996 and is included in deposit
insurance premiums in the Consolidated Statements of Operations, was paid during
fiscal 1997.
25. TRANSACTIONS WITH RELATED PARTIES - THE BANK
Loans Receivable
From time to time, in the normal course of business, the Bank may make loans to
executive officers and directors, their immediate family members or companies
with which they are affiliated. These loans are on substantially the same terms
as similar loans with unrelated parties. An analysis of activity with respect to
these loans for the year ended September 30, 1997 is as follows:
(In thousands)
---------------
Balance, September 30, 1996 $ 2,737
Additions 451
Reductions (756)
---------------
Balance, September 30, 1997 $ 2,432
===============
Services
B. F. Saul Company, which is a shareholder of the Trust, and its subsidiaries
provide certain services to the Bank. These services include property
management, cafeteria management (discontinued during fiscal 1997), insurance
brokerage and leasing. Fees for these services were $42,000, $366,000 and
$460,000 for the years ended September 30, 1997, 1996 and 1995, respectively.
The law firm in which one director of the Bank is a partner received $4.9, $3.2
and $2.8 million for legal services rendered to the Bank during the years ended
September 30, 1997, 1996 and 1995 respectively.
<PAGE>
For the years ended September 30, 1997, 1996 and 1995, one of the directors of
the Bank was paid $50,000, $37,000 and $30,000, respectively, for consulting
services rendered to the Bank. Another director of the Bank was paid total fees
of $100,000, $100,000 and $75,000 for the years ended September 30, 1997, 1996
and 1995, respectively, for consulting services. Another director of the Bank
was paid $17,000 for consulting services rendered to the Bank during fiscal year
1997.
Tax Sharing Agreement
The Bank and the other companies in the Trust's affiliated group are parties to
a tax sharing agreement dated June 28, 1990 (the "Tax Sharing Agreement"). The
Tax Sharing Agreement provides for payments to be made by members of the Trust's
affiliated group to the Trust based on their separate company tax liabilities.
The Tax Sharing Agreement also provides that, to the extent net operating losses
or tax credits of a particular member are used to reduce the overall tax
liability of the Trust's affiliated group, such member will be reimbursed by the
other members of the affiliated group that have taxable income in an amount
equal to such tax reduction. The Bank paid $9.8, $25.0 and $20.5 million to the
Trust during fiscal 1997, 1996 and 1995, respectively, under the Tax Sharing
Agreement. OTS approval of the tax sharing payments during fiscal 1997, 1996 and
1995 was conditioned on a pledge by the Trust of certain assets to secure
certain of its obligations under the Tax Sharing Agreement. Under the terms of
the Bank's board resolution, the Bank is permitted to make tax sharing payments
to the Trust of up to $15.0 million relating to any fiscal year without OTS
approval. See Note 24. There was no tax sharing payment payable to the Trust by
the Bank at September 30, 1997 and 1996.
Other
The Bank paid $4.8, $4.5 and $4.2 million for office space leased from or
managed by companies affiliated with the Bank or its directors during the years
ended September 30, 1997, 1996 and 1995, respectively.
The Trust, the B. F. Saul Company, Chevy Chase Lake Corporation ("Lake") and Van
Ness Square Corporation, affiliates of the Bank, from time to time maintain
interest-bearing deposit accounts with the Bank. Those accounts totaled $26.5
million at September 30, 1997. The Bank paid interest on the accounts amounting
to $599,000 in fiscal 1997.
During fiscal 1995, the Bank purchased land and building plans from Lake for
$1.3 million. During fiscal 1996, construction was completed and the Bank began
occupying the building.
26. FINANCIAL INSTRUMENTS - THE BANK
The Bank, in the normal course of business, is a party to financial instruments
with off-balance-sheet risk and other derivative financial instruments to meet
the financing needs of its customers and to reduce its own exposure to
fluctuations in interest rates. These financial instruments include commitments
to extend credit at both fixed and variable rates, letters of credit,
interest-rate cap agreements and assets sold with limited recourse. All such
financial instruments are held or issued for purposes other than trading.
These instruments involve, to varying degrees, elements of credit and
interest-rate risk in excess of the amount recognized in the Consolidated
Balance Sheets.
<PAGE>
The contract or notional amount of these instruments reflect the extent of
involvement the Bank has in particular classes of financial instruments. For
interest-rate cap agreements, assets sold with limited recourse and forward
purchase and sale commitments, the contract or notional amounts do not represent
exposure to credit loss in the event of nonperformance by the other party. The
Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments. The Bank is also a
party to derivative financial instruments that do not have off-balance-sheet
risk (e.g. interest-rate cap agreements).
Commitments to Extend Credit
The Bank had approximately $17 billion of commitments to extend credit at
September 30, 1997. Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Because many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. These commitments are subject to
the Bank's normal underwriting and credit evaluation policies and procedures.
Loans approved but not closed are commitments for fixed or adjustable-rate
residential loans which are secured by real estate. The Bank currently requires
borrowers to obtain private mortgage insurance on all loans where the
loan-to-value ratio exceeds 80%.
Standby Letters of Credit
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. At September 30, 1997,
the Bank had written standby letters of credit in the amount of $29.2 million,
which were issued to guarantee the performance of and irrevocably assure payment
by customers under construction projects.
Of the total, $19.2 million will expire in fiscal 1998 and the remainder will
expire over time through fiscal 2001. The credit risk involved in issuing
standby letters of credit is essentially the same as that involved in extending
loan commitments to customers. Mortgage-backed securities with a book value of
$2.3 million were pledged as collateral for certain of these letters of credit
at September 30, 1997.
Recourse Arrangements
The Bank is obligated under various recourse provisions (primarily related to
credit losses) related to the securitization and sale of credit card
receivables, home equity credit line receivables, automobile loan receivables,
home loan receivables and amounts on deposit in certain spread accounts through
the asset-backed securitizations described in Note 14. At September 30, 1997 and
1996, the primary recourse to the Bank was $142.0 and $128.0 million,
respectively. As a result of these recourse provisions, the Bank maintained
restricted cash accounts amounting to $145.8 and $128.2 million, at September
30, 1997 and 1996, respectively, which are included in other assets in the
Consolidated Balance Sheets.
<PAGE>
The Bank is obligated under various recourse provisions related to the swap of
single-family residential loans for participation certificates and
mortgage-backed securities issued to the Bank by FHLMC and FNMA. At September
30, 1997, recourse to the Bank under these arrangements was $989,000. As
security for the payment of funds due under certain of the FHLMC recourse
obligations, the Bank is required to post collateral. At September 30, 1997,
mortgage-backed securities pledged as collateral under these obligations had a
book value of $2.4 million. In addition, the Bank maintained a restricted cash
account amounting to $325,000 at September 30, 1997 and 1996, which is included
in other assets in the Consolidated Balance Sheets.
Derivative Financial Instruments
Interest-rate cap agreements are used to limit the Bank's exposure to rising
short-term interest rates related to the retained portion of certain of its
asset-backed securitizations. At September 30, 1997, the Bank was a party to
four interest-rate cap agreements with an aggregate notional amount of $372.2
million with maturity dates ranging from December 31, 1997 through June 30,
1999. Three of the interest-rate cap agreements with an aggregate notional
amount of $300.0 million entitle the Bank to receive compensatory payments from
the cap provider, which is a AAA-rated (by Standard & Poor's) counterparty,
equal to the product of (a) the amount by which the one-month LIBOR exceeds
7.00% and (b) the then outstanding notional principal amount for a predetermined
period of time. The fourth interest-rate cap agreement with a notional amount of
$72.2 million entitles the Bank to receive compensatory payments from the cap
provider, which is a AA-rated (for long term debt as rated by Standard & Poor's)
counterparty, equal to the product of (a) the amount by which the one-month
LIBOR exceeds 9.00% and (b) the then outstanding notional principal amount for
the predetermined period of time. The Bank has no obligation to make payments to
the provider of the cap or any other party. The Bank is exposed to credit losses
in the event of nonperformance by the counterparty, but does not expect the
counterparty to fail to meet its obligation given its credit rating.
To manage the potentially adverse impact of interest rate movements on the
fixed-rate mortgage loan pipeline, the Bank hedges its pipeline by entering into
whole loan and mortgage-backed security forward sale commitments and
mortgage-backed security forward purchase commitments. Forward sale commitments
are used to sell specific financial instruments (whole loans or mortgage-backed
securities) at a future date for a specified price. Forward sale commitments
generally settle within 90 days. Gains and losses are deferred and recorded as a
component of the gain on sales of loans at the time the forward sale commitment
matures. At September 30, 1997, the Bank had whole loan and mortgage-backed
security forward sale commitments of $0.3 and $149.1 million, respectively. In
addition, at September 30, 1997, the Bank had $19.8 million in mortgage-backed
security forward purchase commitments related to its hedging activities. Forward
purchase commitments generally settle within 90 days. Gains and losses are
deferred and recorded as a component of the gain on sales of loans at the time
the forward purchase commitment matures.
Concentrations of Credit
The Bank's principal real estate lending market is the metropolitan Washington,
D.C. area. In addition, a significant portion of the Bank's consumer loan
portfolio, including credit cards, was generated by customers residing in the
metropolitan Washington, D.C. area. Service industries and federal, state and
local governments employ a significant portion of the Washington, D.C. area
labor force. Adverse changes in economic conditions could have a direct impact
on the timing and amount of payments by borrowers.
<PAGE>
27. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS - THE BANK
The majority of the Bank's assets and liabilities are financial instruments;
however, certain of these financial instruments lack an available trading
market. Significant estimates, assumptions and present value calculations were
therefore used for the purposes of the following disclosure, resulting in a
great degree of subjectivity inherent in the indicated fair value amounts.
Because the fair value is estimated as of the balance sheet date, the amount
which will actually be realized or paid upon settlement or maturity could be
significantly different. Comparability among financial institutions may be
difficult due to the wide range of permitted valuation techniques and the
numerous estimates and assumptions which must be made. The estimated fair values
of the Bank's financial instruments at September 30, 1997 and 1996 are as
follows:
September 30,
---------------------------------------------
1997 1996
--------------------- ---------------------
Carrying Fair Carrying Fair
(In thousands) Amount Value Amount Value
- ---------------------------------- ---------- ---------- ---------- ----------
Financial assets:
Cash, due from banks,
interest-bearing deposits,
federal funds sold and
securities purchased under
agreements to resell $ 651,891 $ 651,891 $ 266,425 $ 266,425
Loans held for sale 102,749 103,819 76,064 76,064
Loans held for securitization
and sale 220,000 220,000 450,000 450,000
Trading securities 7,899 7,899 - -
Investment securities 4,998 5,012 9,818 9,820
Mortgage-backed securities 1,985,707 1,984,667 1,306,417 1,307,838
Loans receivable, net 2,104,240 2,207,229 2,772,967 2,834,726
Interest-rate cap agreements 3,114 169 6,179 1,832
Other financial assets 513,735 515,218 392,265 393,748
Financial liabilities:
Deposit accounts with
no stated maturities 3,089,603 3,089,603 2,960,362 2,960,362
Deposit accounts with
stated maturities 1,804,153 1,810,245 1,203,675 1,210,497
Securities sold under
repurchase agreements and
other short-term borrowings,
notes payable and Federal
Home Loan Bank advances 270,351 270,920 913,483 914,418
Capital notes-subordinated 240,618(1) 256,875 154,383(1) 161,875
Other financial liabilities 108,684 108,684 80,760 80,760
- --------------------------------------------------------------------------------
(1) Net of deferred debt issuance costs which are included in other assets in
the Consolidated Balance Sheets.
<PAGE>
The following methods and assumptions were used to estimate the fair value
amounts at September 30, 1997 and 1996:
Cash, due from banks, interest-bearing deposits, federal funds sold and
securities purchased under agreements to resell: Carrying amount approximates
fair value.
Loans held for sale: Fair value is determined using quoted prices for loans, or
securities backed by loans with similar characteristics, or outstanding
commitment prices from investors.
Loans held for securitization and sale: The carrying value of loans held for
securitization and sale approximates fair value because such receivables are
sold at face value.
Trading securities: Fair value is equal to carrying value.
Investment securities: Fair value is based on quoted market prices.
Mortgage-backed securities: Fair value is based on quoted market prices, dealer
quotes or estimates using dealer quoted market prices for similar securities.
Loans receivable, net: Fair value of certain homogeneous groups of loans (e.g.
single-family residential, automobile loans, home improvement loans and
fixed-rate commercial and multifamily loans) is estimated using discounted cash
flow analyses based on contractual repayment schedules. The discount rates used
in these analyses are based on either the interest rates paid on U.S. Treasury
securities of comparable maturities adjusted for credit risk and non-interest
operating costs, or the interest rates currently offered by the Bank for loans
with similar terms to borrowers of similar credit quality. For loans which
reprice frequently at market rates (e.g. home equity, variable-rate commercial
and multifamily, real estate construction and ground loans), the carrying amount
approximates fair value. Because credit card receivables are generally sold at
face value through the Bank's securitization program, such face value is used as
the estimated fair value of these receivables. The fair value of the Bank's loan
portfolio as presented above does not include the value of established credit
card and home equity credit line customer relationships, or the value relating
to estimated cash flows from future receivables and the associated fees
generated from existing customers.
Interest-rate cap agreements: Fair value is based on dealer quotes.
Other financial assets: The carrying amount of Federal Home Loan Bank stock,
accrued interest receivable, interest-bearing deposits maintained pursuant to
various asset securitizations and other short-term receivables approximates fair
value. Interest-only strips are carried at fair value. The fair value of one of
the Bank's investments is based on quoted market prices.
Deposit accounts with no stated maturities: Deposit liabilities payable on
demand, consisting of NOW accounts, money market deposits, statement savings and
other deposit accounts, are assumed to have an estimated fair value equal to
carrying value. The indicated fair value does not consider the value of the
Bank's established deposit customer relationships.
<PAGE>
Deposit accounts with stated maturities: Fair value of fixed-rate certificates
of deposit is estimated based on discounted cash flow analyses using the
remaining maturity of the underlying accounts and interest rates currently
offered on certificates of deposit with similar maturities.
Borrowings: These instruments consist of securities sold under repurchase
agreements and other short-term borrowings, notes payable and Federal Home Loan
Bank advances. For borrowings which either reprice frequently to market interest
rates or are short-term in duration, the carrying amount approximates fair
value. Fair value of the remaining amounts borrowed is estimated based on
discounted cash flow analyses using interest rates currently charged by the
lender for comparable borrowings with similar remaining maturities.
Capital notes-subordinated: Fair value of the 1993 Debentures and the 1996
Debentures is based on quoted market prices. The carrying amount of the $10.0
million private placement capital note approximated fair value at September 30,
1996.
Other financial liabilities: The carrying amount of custodial accounts, amounts
due to banks, accrued interest payable and other short-term payables
approximates fair value.
Off-balance sheet instruments: The difference between the original fees charged
by the Bank for commitments to extend credit and letters of credit and the
current fees charged to enter into similar agreements is immaterial. Fair value
of forward commitments is based on the estimated amount that the Bank would pay
to terminate the arrangements at the reporting date, taking into account the
remaining terms of the arrangements and the counterparties' credit standing,
where applicable, which is immaterial.
28. LITIGATION - THE BANK
During the normal course of business, the Bank is involved in certain
litigation, including litigation arising out of the collection of loans, the
enforcement or defense of the priority of its security interests, the continued
development and marketing of certain of its real estate properties and certain
employment claims. Although the amounts claimed in some of these suits in which
the Bank is a defendant are material, the Bank denies liability and, in the
opinion of management, litigation which is currently pending will not have a
material impact on the financial condition or future operations of the Bank.
29. SUBSEQUENT EVENT - THE BANK
On November 12, 1997 the Bank purchased 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 has approximately $3.0
billion of assets under management. The Bank anticipates that the acquisition
will provide an additional source of fee-based revenues. The Bank has obtained
regulatory approval from the OTS to obtain trust powers through a new operating
subsidiary which acquired ASB. Although the acquisition generated additional
goodwill which reduced the Bank's regulatory capital levels, the Bank's capital
levels immediately following the acquisition remained above the levels
established for well-capitalized institutions.
<PAGE>
30. COMMITMENTS AND CONTINGENCIES - THE TRUST
The Trust is involved in a number of lawsuits arising from the normal course of
its business. On the basis of consultations with counsel, management does not
believe that any material loss will result.
31. INCOME TAXES - THE TRUST
The Trust voluntarily terminated its qualification as a real estate investment
trust under the Internal Revenue Code during fiscal 1978.
The provisions for income taxes for the years ended September 30, 1997, 1996 and
1995, consist of the following:
Year Ended September 30,
---------------------------------------
(In thousands) 1997 1996 1995
- -------------------------------------- ------------ ------------ -----------
Current provision (benefit):
Federal $(1,800) $ 5,628 $ (37)
State 1,658 2,799 (4,186)
------------ ------------ -----------
(142) 8,427 (4,223)
------------ ------------ -----------
Deferred provision (benefit):
Federal 16,113 (513) 5,964
State (3,159) 386 280
------------ ------------ -----------
12,954 (127) 6,244
------------ ------------ -----------
Subtotal 12,812 8,300 2,021
Tax effect of other items:
Tax effect of net unrealized
holding gains (losses) reported
in stockholders' equity 904 809 7,207
------------ ------------ -----------
Total $13,716 $ 9,109 $ 9,228
============ ============ ===========
<PAGE>
The Trust's effective income tax rate varies from the statutory Federal income
tax rate as a result of the following factors:
Year Ended September 30,
---------------------------------------
(In thousands) 1997 1996 1995
- ------------------------------------ ------------ ------------ -----------
Computed tax at statutory Federal
income tax rate $21,418 $ 7,003 $ 9,920
Increase (reduction) in taxes
resulting from:
Minority interest (4,524) -- --
Goodwill and other purchase
accounting adjustments 699 1,626 1,164
Change in valuation allowance
for deferred tax asset
allocated to income tax expense 7,066 8,883 --
State income taxes (7,953) (12,277) (3,540)
Other (3,894) 3,066 (5,523)
------------ ------------ -----------
$12,812 $ 8,301 $ 2,021
============ ============ ===========
The components of the net deferred tax asset were as follows:
September 30,
-------------------------
(In thousands) 1997 1996
- ---------------------------------------------------- ------------ -----------
Deferred tax assets:
Provision for losses in excess of deductions $ 44,571 $ 51,166
Deferred BIF/SAIF assessment -- 11,151
Unrealized losses on real estate owned 4,198 3,545
Property 7,211 7,211
State net operating losses 21,351 12,224
Partnership investments 2,384 2,288
Forgiveness of debt 3,928 4,375
Depreciation 2,307 1,973
Other 5,268 3,856
------------ -----------
Gross deferred tax assets 91,218 97,789
------------ -----------
Deferred tax liabilities:
Net unrealized holding gains on
securities available-for-sale (3,342) (5,806)
Deferred loan fees (541) (5,764)
Asset securitizations (16,565) (3,125)
Saul Holdings (4,509) (7,682)
Depreciation (4,096) (5,750)
FHLB stock dividends (3,525) (5,375)
Other (3,879) (2,804)
------------ -----------
Gross deferred tax liabilities (36,457) (36,306)
------------ -----------
Valuation allowance (19,349) (12,283)
------------ -----------
Net deferred tax asset $ 35,412 $ 49,200
============ ===========
<PAGE>
A valuation allowance is provided when it is more likely than not that some
portion of the deferred tax asset will not be realized. As of September 30,
1997, management has maintained a valuation allowance in part to reduce the net
deferred tax asset for net operating loss carryforwards related to state taxes.
Historically, the Bank has generated taxable income while the Real Estate Trust
has generated taxable losses. The net operating loss carryforwards are not
expected to be realizable for state tax purposes. For federal tax purposes,
there are no net operating loss carryforwards.
Management believes the existing net deductible temporary differences will
reverse during periods in which the Bank generates taxable income in excess of
Real Estate Trust taxable losses. Management believes that the positive
consolidated earnings will continue as a result of the Bank's earnings.
TAX SHARING AGREEMENT
The Trust's affiliated group, including the Bank, entered into a tax sharing
agreement dated June 28, 1990. This agreement provides that payments be made by
members of the affiliated group to the Trust based on their respective allocable
shares of the overall federal income tax liability of the affiliated group for
taxable years and partial taxable years beginning on or after that date.
Allocable shares of the overall tax liability are prorated among the members
with taxable income calculated on a separate return basis. The agreement also
provides that, to the extent net operating losses or tax credits of a particular
member are used to reduce overall tax liability of the Trust's affiliated group,
such member will be reimbursed on a dollar-for-dollar basis by the other members
of the affiliated group that have taxable income in an amount equal to such tax
reduction. Under the tax sharing agreement, the Bank paid $9.8, $25.0 and $20.5
million, respectively, to the Trust during fiscal 1997, 1996 and 1995.
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 of September 30, 1997, the alternative minimum tax carryforward was $3.1
million.
<PAGE>
32. SHAREHOLDERS' EQUITY - THE TRUST
In June 1990, the Trust acquired from affiliated companies an additional equity
interest in the Bank, which raised the Trust's ownership share of the Bank to
80%. In exchange for the interest acquired, the Trust issued 450,000 shares of a
new class of $10.50 cumulative preferred shares of beneficial interest with a
par value of $1 ("preferred shares"). The transaction has been accounted for at
historical cost in a manner similar to the pooling of interests method because
the entities are considered to be under common control. In addition, the Trust
acquired two real estate properties from an affiliate in exchange for 66,000
preferred shares.
At September 30, 1997, 1996, and 1995, the amount of dividends in arrears on the
preferred shares was $36.2 million ($70.21 per share), $31.6 million ($61.17 per
share) and $26.6 million ($51.64 per share), respectively. Based on the
dividends paid on the preferred shares during fiscal 1996, the Trust recorded a
liability at September 30, 1996, equal to the total dividends in arrears on that
date. The Trust paid preferred dividends of $750,000 and $500,000 in fiscal 1997
and 1996, repsectively.
<PAGE>
33. QUARTERLY FINANCIAL DATA (UNAUDITED) - THE TRUST
Year Ended September 30, 1997
(In thousands, except ----------------------------------------------------
per share amounts) December March June September
- ------------------------- ------------ ----------- ----------- ------------
Real Estate Trust:
Total income $ 19,020 $ 18,653 $ 23,448 $ 23,448
Operating loss (7,092) (6,762) (2,167) (2,966)
The Bank:
Interest income 115,271 123,286 120,748 91,175
Interest expense 57,544 61,911 61,246 59,114
Provision for loan
losses (26,840) (26,922) (36,129) (35,224)
Other income 87,611 88,096 90,158 147,112
Operating income (loss) 19,958 20,126 10,672 29,425
Total Company:
Operating income 12,866 13,364 8,505 26,459
Income (loss) before
minority interest 7,735 10,333 3,444 26,872
Net income (loss) 2,303 2,743 (3,079) 16,893
Net income (loss) per
common share 0.20 0.29 (0.91) 3.20
- -------------------------------------------------------------------------------
Year Ended September 30, 1996
(In thousands, except ----------------------------------------------------
per share amounts) December March June September
- ------------------------- ------------ ----------- ----------- ------------
Real Estate Trust:
Total income $ 18,159 $ 17,206 $ 20,696 $ 20,778
Operating loss (7,032) (7,430) (4,564) (5,150)
The Bank:
Interest income 93,589 91,230 99,254 103,438
Interest expense 48,269 46,800 45,401 48,366
Provision for loan
losses (11,913) (28,850) (30,062) (44,915)
Other income 66,212 89,324 96,935 91,990
Operating income (loss) 15,984 21,341 31,617 (22,831)
Total Company:
Operating income (loss) 8,952 13,911 27,053 (27,981)
Income (loss) before
minority interest 5,199 7,842 15,621 (15,028)
Net income (loss) 1,294 3,225 10,054 (14,651)
Net income (loss) per
common share (0.01) 0.39 1.80 (3.32)
- -------------------------------------------------------------------------------
<PAGE>
34. INDUSTRY SEGMENT INFORMATION - TRUST
Industry segment information with regard to the Real Estate Trust is presented
below. For information regarding the Bank, please refer to the "Banking"
sections of the accompanying financial statements.
Year Ended September 30
---------------------------------------
(In thousands) 1997 1996 1995
- ------------------------------------- ------------ ----------- ------------
INCOME
Hotels $ 59,464 $ 54,245 $ 54,104
Commercial properties 21,097 17,590 18,812
Other 4,008 5,004 4,369
------------ ----------- ------------
$ 84,569 $ 76,839 $ 77,285
============ =========== ============
OPERATING PROFIT (LOSS)
Hotels $ 14,755 $ 12,635 $ 10,836
Commercial properties 9,020 5,893 6,951
Other 6,429 6,702 6,670
------------ ----------- ------------
30,204 25,230 24,457
Gain (loss) on sales of property 895 (68) 1,664
Interest and debt expense (40,819) (40,514) (41,040)
Advisory fee, management and leasing
fees - related parties (7,995) (7,423) (7,376)
General and administrative (1,272) (1,401) (2,319)
Write-down of assets to net
realizable value -- -- (2,727)
------------ ----------- ------------
Operating loss $ (18,987) $ (24,176) $ (27,341)
============ =========== ============
IDENTIFIABLE ASSETS (AT YEAR END)
Hotels $ 86,815 $ 84,255 $ 87,143
Commercial properties 78,063 78,388 81,821
Other 135,695 129,923 144,448
------------ ----------- ------------
$ 300,573 $ 292,566 $ 313,412
============ =========== ============
DEPRECIATION
Hotels $ 6,186 $ 5,535 $ 5,230
Commercial properties 4,311 4,446 4,452
Other 46 39 32
------------ ----------- ------------
$ 10,543 $ 10,020 $ 9,714
============ =========== ============
CAPITAL EXPENDITURES
Hotels $ 8,462 $ 4,769 $ 13,815
Commercial properties 5,288 2,444 2,544
Other 1,079 195 103
------------ ----------- ------------
$ 14,829 $ 7,408 $ 16,462
============ =========== ============
<PAGE>
35. CONDENSED FINANCIAL STATEMENTS - THE TRUST
These condensed financial statements reflect the Real Estate Trust and all its
consolidated subsidiaries except for the Bank which has been reflected on the
equity method.
CONDENSED BALANCE SHEETS
September 30
-----------------------------------
(In thousands) 1997 1996
- ------------------------------------------- ----------------- -----------------
ASSETS
Income-producing properties $ 242,450 $ 232,628
Accumulated depreciation (85,915) (76,513)
----------------- -----------------
156,535 156,115
Land parcels 42,160 41,580
Construction in progress 2,480 --
Equity investment in bank 205,552 184,258
Cash and cash equivalents 18,248 15,516
Other assets 81,150 81,292
----------------- -----------------
TOTAL ASSETS $ 506,125 $ 478,761
================= =================
LIABILITIES
Mortgage notes payable $ 180,204 $ 173,345
Notes payable - secured 175,000 177,500
Notes payable - unsecured 46,633 42,367
Deferred gains - real estate 112,883 112,883
Accrued dividends payable - preferred
shares of beneficial interest 36,231 31,563
Other liabilities and accrued expenses 39,959 40,434
----------------- -----------------
Total liabilities 590,910 578,092
----------------- -----------------
TOTAL SHAREHOLDERS' DEFICIT* (84,785) (99,331)
----------------- -----------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 506,125 $ 478,761
================= =================
* See Consolidated Statements of
Shareholders' Deficit
<PAGE>
CONDENSED STATEMENTS OF OPERATIONS
For the Year Ended September 30
-------------------------------
(In thousands) 1997 1996 1995
- ---------------------------------------------- --------- --------- ---------
Total income $ 84,569 $ 76,839 $ 77,285
Total expenses (108,601) (104,321) (109,971)
Equity in earnings of partnership investments 4,150 3,374 3,681
Gain (loss) on sales of property 895 (68) 1,664
--------- --------- ---------
Real estate operating loss (18,987) (24,176) (27,341)
Equity in earnings of bank 27,391 15,846 22,882
--------- --------- ---------
Total company operating income (loss) 8,404 (8,330) (4,459)
Income tax benefit (10,456) (8,252) (15,309)
--------- --------- ---------
TOTAL COMPANY NET INCOME (LOSS) $ 18,860 $ (78) $ 10,850
========= ========= =========
<PAGE>
CONDENSED STATEMENTS OF CASH FLOWS
For the Year Ended September 30
-------------------------------
(In thousands) 1997 1996 1995
- ------------------------------------------------- --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 18,860 $ (78) $ 10,850
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation 10,543 10,020 9,714
Write-down of real estate to net realizable
value -- -- 2,727
(Gain) loss on sales of property (895) 68 (1,654)
Equity in earnings of bank (27,391) (15,846) (22,882)
(Increase) decrease in deferred tax asset (3,252) (192) 10,836
(Increase) decrease in tax sharing receivable 2,492 16,606 (5,685)
(Increase) decrease in accounts receivable and
accrued income 17 (4,869) (224)
Increase in accounts payable and
accrued expenses 1,058 430 317
Other 5,479 2,893 325
--------- --------- ---------
Net cash provided by operating activities 6,911 9,032 4,324
--------- --------- ---------
CASH FLOW FROM INVESTING ACTIVITIES
Capital expenditures - properties (10,120) (7,408) (6,270)
Property acquisitions (4,709) -- (10,193)
Property sales 1,399 1,812 --
Equity investment in unconsolidated entities 1,723 639 (733)
Other investing activities 43 50 53
--------- --------- ---------
Net cash used in investing activities (11,664) (4,907) (17,143)
--------- --------- ---------
CASH FLOW FROM FINANCING ACTIVITIES
Proceeds from long-term debt 32,894 6,208 16,328
Repayments of long-term debt (24,033) (11,471) (16,083)
Costs of obtaining financings (626) (201) (516)
Dividends paid (750) (500) --
--------- --------- ---------
Net cash provided by (used in) financing
activities 7,485 (5,964) (271)
--------- --------- ---------
Net increase (decrease) in cash and cash
equivalents 2,732 (1,839) (13,090)
Cash and cash equivalents at beginning of year 15,516 17,355 30,445
--------- --------- ---------
Cash and cash equivalents at end of year $ 18,248 $ 15,516 $ 17,355
========= ========= =========
<PAGE>
<TABLE>
EXECUTIVE OFFICES OF TRUST TRUSTEES PRINCIPAL OFFICERS
- ------------------------------------ --------------------------------- ----------------------------------------
<S> <C> <C>
B. F. Saul Real Estate Garland J. Bloom, Jr.(A) B. Francis Saul II
Investment Trust Real Estate Consultant CHAIRMAN OF THE BOARD
8401 Connecticut Avenue Chairman of the Board
Chevy Chase, Maryland 20815 Gilbert M. Grosvenor(A) and President, Chevy Chase
(301) 986-6000 Chairman Bank, F.S.B., B.F. Saul
National Geographic Company and B.F. Saul
NOTE SALES OFFICE Society Advisory Company, Chairman &
7200 Wisconsin Avenue, Suite 903 Chief Executive Officer,
Bethesda, Maryland 20814 George M. Rogers, Jr.(E,N) Saul Centers, Inc.
(301) 986-6207 Partner, Shaw, Pittman,
Potts & Trowbridge Philip D. Caraci
ADVISOR (Attorneys at Law) SENIOR VICE PRESIDENT AND
B.F. Saul Advisory Company SECRETARY
8401 Connecticut Avenue B. Francis Saul II(E) Executive Vice President, B.F. Saul
Chevy Chase, Maryland 20815 Chairman of the Board and Company, Senior Vice President,
(301) 986-6000 President, Chevy Chase B.F. Saul Advisory Company,
Bank, F.S.B., B.F. Saul President Franklin Property Company,
REAL ESTATE MANAGER Company and B.F. Saul and Saul Centers, Inc.
Franklin Property Company Advisory Company, Chairman
8401 Connecticut Avenue and Chief Executive Officer, Stephen R. Halpin, Jr.
Chevy Chase, Maryland 20815 Saul Centers, Inc. VICE PRESIDENT AND
(301) 986-6000 CHIEF FINANCIAL OFFICER
B. Francis Saul III Executive Vice President
GENERAL COUNSEL Director/Officer, Chevy Chase and Chief Financial
Shaw, Pittman, Potts & Trowbridge Bank, F.S.B., B.F. Saul Officer, Chevy Chase Bank,
Washington, DC 20037 Company, B.F. Saul Advisory FSB and B.F. Saul Company
Company, Franklin Property
INDEPENDENT ACCOUNTANTS Company and Saul Centers, Inc. Ross E. Heasley
Arthur Andersen, LLP VICE PRESIDENT
Washington, DC 20006 John R. Whitmore(E,N) Vice President, B.F. Saul
President and Chief Company, B.F. Saul Advisory Company,
INDENTURE TRUSTEE Executive Officer Franklin Property Company, and
Unsecured Notes The Bessemer Group, Saul Centers, Inc.
First Trust of New York, NA Incorporated
100 Wall Street Henry Ravenel, Jr.
New York, NY 10005 (A) Audit Committee Member VICE PRESIDENT
(E) Executive Committee Member Vice President, B.F. Saul Company,
INDENTURE TRUSTEE (N) Nominating Committee Member B.F. Saul Advisory Company and Saul
Senior Secured Notes Centers, Inc.
Norwest Bank Minnesota, NA
Minneapolis, MN 55479 William K. Albright
VICE PRESIDENT AND TREASURER
Vice President and Treasurer,
10-K REPORT TO SEC B.F. Saul Company, B.F. Saul
The Trust's Annual Report to the Advisory Company, Franklin
Securities and Exchange Commission Property Company, Vice President &
(Form 10-K), which includes a Assistant Treasurer, Saul Centers, Inc.
consolidated schedule of investment
properties, is available without
charge from the Secretary of the Trust
at the address and telephone number
indicated above.
</TABLE>
<PAGE>
EXHIBIT 21
B. F. SAUL REAL ESTATE INVESTMENT TRUST
LIST OF SUBSIDIARIES
Current
Site of Date of Principal
Incorporation Acquisition/ Business
Formation Activity
- -------------------------------------------------------------------------------
100% OWNED SUBSIDIARIES
Arlington Hospitality Corp. Virginia 1997 Hotel Owner
Auburn Hills Hotel Corporation Maryland 1994 Hotel Owner
Auburn Hills Land Corp. Maryland 1997 Land Owner
Avenel Executive Park Phase II, Inc. Maryland 1987 Real Estate
Investor
Commerce Center Development Corp. Florida 1980 Office Park
Owner
Crystal City Hospitality Corp. Virginia 1989 Hotel Owner
Dallas San Simeon Incorporated Texas 1993 Apartment
Project
Owner
Dearborn Corporation Delaware 1992 Land Owner
Dulles Airport Hotel Corporation Virginia 1989 Inactive
Dulles Hospitality Corp. Virginia 1997 Hotel Owner
Flagship Centre Corporation Maryland 1985 Land Owner
Herndon Hotel Corporation Virginia 1996 Hotel Owner
MHC Airport Inn. Inc. (a) New York 1980/1976 Hotel
Operator
MHC Corporation Maryland 1980/1974 Hotel
Operator
Metairie Office Towers, Inc. (b) Louisiana 1995 Office Bldg
Owner
NVA Development Corporation Virginia 1984 Gen'l Part/
Real Est.
P/ship
Peachtree / Northeast Corp. Georgia 1979 Land Owner
Pueblo Hotel Corp. Colorado 1985 Hotel Owner
Rochester Airport Hotel Corporation New York 1986 Inactive
Scope Hospitality Corp. Virginia 1989 Inactive
Sharonville Hotel Corporation Ohio 1986 Inactive
Sterling Hotel Corporation Virginia 1997 Hotel Owner
Tysons Corner Hospitality Corp. Virginia 1989 Inactive
Wheeler Road, Inc. Maryland 1992 Inactive
900 Corporation Georgia 1981 Office Bldg
Owner
1100 Corporation Georgia 1979 Office Bldg
Owner
1113 Corporation Florida 1984 Gen'l Part/
Real Est.
P/ship
- ---------------------------------------
(a) Subsidiary of MHC Corporation
(b) Subsidiary of Dearborn Corporation
<PAGE>
EXHIBIT 21 (Continued)
B. F. SAUL REAL ESTATE INVESTMENT TRUST
LIST OF SUBSIDIARIES (Continued)
<TABLE>
<CAPTION>
Date of Current
Site of Acquistion Principal Business
Note Corporation Formation/ Activity
- --------------------------------------------------------------------------------------------------------------------------------
80% OWNED SUBSIDIARIES
<S> <C> <C> <C> <C>
Ashburn Village Development Corporation (A) Maryland 1991 Real Estate Owned (REO)
Bailey's Corporation (sold property 11/95) (A) Maryland 1993 Inactive
Balmoral Golf Corporation (B) Maryland 1992 Inactive
B. F. Saul Mortgage Company (C) Maryland 1984 Residential Loan Origination
Bondy Way Development Corporation (A) Maryland 1990 REO
Brambleton Land Corporation (A) Maryland 1977 REO
Brooke Manor Land Corporation (sold
property 8/96) (A) Maryland 1990 Inactive
CCB Holding Corporation (C) Delaware 1994 Investments
CCRE, Inc. (D) Maryland 1984 Inactive
Cherrytree Corporation (A) Maryland 1993 REO
Chevy Chase Bank, F.S.B. United States 1969 Savings Bank
Chevy Chase Financial Services Corporation (C) Virginia 1996 Stock Ownership of CCIA and CCS
Chevy Chase Insurance Agency, Inc. ("CCIA") (E) Maryland 1985/1971 Insurance Agency
Chevy Chase Mortgage Company (F) Maryland 1972 Inactive
Chevy Chase Mortgage Company of Virginia (C) Virginia 1996 Inactive
Chevy Chase Preferred Capital Corporation (C) Maryland 1996 Real Estate Investment Trust (REIT)
Chevy Chase Real Estate Corporation (C) Virginia 1996 Holding Company
Chevy Chase Securities, Inc. ("CCS") (E) Maryland 1984 Securities
Consumer Finance Corporation (C) Virginia 1994 Consumer Loan Origination
Duvall Village Corporation (A) Maryland 1992 REO
First Balmoral Corporation (A) Maryland 1991 REO
Great Seneca Development Corporation (A) Maryland 1991 REO
Hamlets at Brambleton, Inc. (A) Virginia 1997 REO
Inglewood Corporation (sold property 11/95) (A) Maryland 1990 Inactive
Manor Holding Corporation (C) Virginia 1996 Inactive
Manor Investment Company (G) Maryland 1971 Real Estate Ownership / Development
Marbury I Corporation (A) Maryland 1991 REO
Marbury II Corporation (A) Maryland 1991 REO
NML Corporation (A) Maryland 1992 REO
North Ode Street Development Corporation (D) Maryland 1981 Real Estate Finance / Development
Oak Den, Inc. (sold remaining lots 10/94) (A) Maryland 1991 Inactive
Old Chapel Corporation (A) Maryland 1992 REO
Presley Corporation (C) Maryland 1993 Real Estate Ownership
Primrose Development Corporation (A) Maryland 1990 REO
Ridgeview Centre Corp. (A) Maryland 1992 REO
Ronam Corporation, Inc. (C) Maryland 1986 Real Estate Finance/Development
Sully Park Corporation (sold property 6/96) (A) Maryland 1990 Inactive
Sully Station Corporation (sold property 9/97) (A) Maryland 1990 Inactive
Sycolin - Leesburg Corporation (A) Maryland 1992 REO
Terminal Drive Properties Corporation (A) Maryland 1991 REO
</TABLE>
- -------------------------------------------
(A) Subsidiary of Chevy Chase Real Estate Corporation
(B) Subsidiary of First Balmoral Corporation
(C) Subsidiary of Chevy Chase Bank, F.S.B.
(D) Subsidiary of Manor Investment Company
(E) Subsidiary of Chevy Chase Financial Services Corporation
(F) Subsidiary of Chevy Chase Mortgage Company of Virginia
(G) Subsidiary of Manor Holding Company
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
by reference in this Post-Effective Amendment No. 9 to Registraton Statement No.
33-34930 of B.F. Saul Real Estate Investment Trust (the "Trust") on Form S-2 of
our reports dated December 9, 1997, included in Part III of the Trust's Form
10-K for the year ended September 30, 1997, and to all references to our Firm
included in this Registration Statement.
ARTHUR ANDERSEN LLP
Washington, D.C.
January 15, 1998
