<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20579
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
- ----- SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
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OR
- ----- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number : 1-7184
B. F. SAUL REAL ESTATE INVESTMENT TRUST
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(Exact name of registrant as specified in the charter)
Maryland 52-6053341
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8401 Connecticut Avenue,
Chevy Chase, Maryland 20815
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(Address of principal executive office) (Zip Code)
(301) 986-6000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirement for the past 90 days. Yes X No
--- ---
The number of Common Shares of Beneficial Interest, $1 Par Value,
outstanding as of February 9, 1999, was 4,826,910.
<PAGE>
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
(a) Consolidated Balance Sheets at December 31, 1998 and
September 30, 1998
(b) Consolidated Statements of Operations for the
three-month periods ended December 31, 1998 and 1997
(c) Consolidated Statements of Cash Flows for the
three-month periods ended December 31, 1998 and 1997
(d) Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations:
(a) Financial Condition
Real Estate
Banking
(b) Liquidity and Capital Resources
Real Estate
Banking
(c) Results of Operations
Three months ended December 31, 1998 compared
to three months ended December 31, 1997
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports On Form 8-K
<PAGE>
<TABLE>
Consolidated Balance Sheets
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
===================================================================================================================================
December 31 September 30
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(In thousands) 1998 1998
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<S> <C> <C>
ASSETS
Real Estate
Income-producing properties
Hotel $ 167,620 $ 165,805
Office and industrial 110,501 110,257
Other 3,895 3,889
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282,016 279,951
Accumulated depreciation (98,948) (96,072)
--------------- --------------
183,068 183,879
Land parcels 39,550 40,110
Construction in progress 15,475 8,694
Cash and cash equivalents 21,471 13,950
Other assets 71,313 76,799
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Total real estate assets 330,877 323,432
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Banking
Cash and due from banks 324,194 336,858
Interest-bearing deposits -- 499,598
Federal funds sold and securities purchased under agreements to resell 80,000 380,000
Loans held for sale 111,606 56,287
Loans held for securitization and sale -- 125,000
Trading securities 9,575 11,319
Investment securities (market value $44,371 and $44,528, respectively) 43,998 43,999
Mortgage-backed securities (market value $1,781,809 and $2,014,819, respectively) 1,795,552 2,025,817
Loans receivable (net of allowance for losses of $60,157 for both periods) 4,116,797 2,533,957
Federal Home Loan Bank stock 33,190 49,036
Real estate held for investment or sale (net of allowance for losses of $153,766 for both periods) 64,772 69,025
Property and equipment, net 287,560 285,916
Goodwill and other intangible assets, net 29,988 30,879
Interest only strips, net 11,350 13,508
Other assets 366,542 259,950
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Total banking assets 7,275,124 6,721,149
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TOTAL ASSETS $ 7,606,001 $ 7,044,581
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LIABILITIES
Real Estate
Mortgage notes payable $ 199,882 $ 198,874
Notes payable - secured 200,000 200,000
Notes payable - unsecured 48,287 50,335
Deferred gains - real estate 112,883 112,883
Accrued dividends payable - preferred shares of beneficial interest 35,403 34,049
Other liabilities and accrued expenses 32,306 39,895
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Total real estate liabilities 628,761 636,036
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Banking
Deposit accounts 5,180,975 4,888,230
Borrowings 499,940 492,184
Federal Home Loan Bank advances 634,960 352,027
Other liabilities 153,005 159,195
Capital notes -- subordinated 250,000 250,000
--------------- --------------
Total banking liabilities 6,718,880 6,141,636
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Commitments and contingencies
Minority interest held by affiliates 67,587 72,242
Minority interest -- other 218,306 218,306
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TOTAL LIABILITIES 7,633,534 7,068,220
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SHAREHOLDERS' DEFICIT
Preferred shares of beneficial interest, $10.50 cumulative, $1 par value, 90 million shares
authorized, 516,000 shares issued and outstanding, liquidation value $51.6 million 516 516
Common shares of beneficial interest, $1 par value, 10 million shares authorized,
6,641,598 shares issued 6,642 6,642
Paid-in surplus 92,943 92,943
Deficit (85,795) (81,936)
Net unrealized holding loss 9 44
--------------- --------------
14,315 18,209
Less cost of 1,814,688 common shares of beneficial interest in treasury (41,848) (41,848)
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TOTAL SHAREHOLDERS' DEFICIT (27,533) (23,639)
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TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 7,606,001 $ 7,044,581
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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 (Unaudited)
===================================================================================================================================
For the Three Months
Ended December 31
-------------------------------
(In thousands, except per share amounts) 1998 1997
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<S> <C> <C>
REAL ESTATE
Income
Hotels $ 18,062 $ 15,206
Office and industrial properties 5,941 5,518
Other 687 1,025
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Total income 24,690 21,749
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Expenses
Direct operating expenses:
Hotels 11,598 10,222
Office and industrial properties 1,870 1,911
Land parcels and other 388 399
Interest expense 10,194 10,114
Captalized interest (221) (32)
Amortization of debt expense 98 140
Depreciation 2,876 2,659
Advisory, management and leasing fees - related parties 2,260 2,043
General and administrative 305 384
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Total expenses 29,368 27,840
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Equity in earnings (losses) of unconsolidated entities 1,147 (1,339)
Loss on sale of property (1) --
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REAL ESTATE OPERATING LOSS $ (3,532) $ (7,430)
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BANKING
Interest income
Loans $ 75,943 $ 74,495
Mortgage-backed securities 28,888 26,607
Trading securities 569 472
Investment securities 615 402
Other 4,390 5,155
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Total interest income 110,405 107,131
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Interest expense
Deposit accounts 37,228 48,779
Borrowings 14,874 9,513
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Total interest expense 52,102 58,292
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Net interest income 58,303 48,839
Provision for loan losses (3,773) (35,062)
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Net interest income after provision for loan losses 54,530 13,777
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Other income
Servicing and securitization income 6,809 100,055
Credit card fees -- 13,758
Deposit servicing fees 15,895 11,757
Gain on sales of trading securities, net 665 557
Loss on real estate held for investment or sale, net (49) (4,914)
Gain on sales of loans, net 244 676
Other 5,953 6,744
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Total other income 29,517 128,633
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Continued on following page.
</TABLE>
<PAGE>
<TABLE>
Consolidated Statements of Operations (Continued)
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
===================================================================================================================================
For the Three Months
Ended December 31
-------------------------------
(In thousands, except per share amounts) 1998 1997
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<S> <C> <C>
BANKING (Continued)
Operating expenses
Salaries and employee benefits $ 40,796 $ 44,845
Loan 3,331 9,762
Property and equipment 6,223 6,680
Marketing 2,934 20,315
Data processing 4,325 10,549
Depreciation and amortization 8,044 7,830
Deposit insurance premiums 1,070 1,466
Amortization of goodwill and other intangible assets 851 798
Other 9,156 10,732
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Total operating expenses 76,730 112,977
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BANKING OPERATING INCOME $ 7,317 $ 29,433
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TOTAL COMPANY
Operating income $ 3,785 $ 22,003
Income tax provision 6 5,581
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Income before extraordinary item and minority interest 3,779 16,422
Extraordinary item:
Loss on early extinguishment of debt, net of taxes -- (266)
--------------- --------------
Income before minority interest 3,779 16,156
Minority interest held by affiliates 45 (2,971)
Minority interest -- other (6,329) (6,329)
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TOTAL COMPANY NET INCOME (LOSS) $ (2,505) $ 6,856
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NET INCOME (LOSS) AVAILABLE TO COMMON
SHAREHOLDERS $ (3,859) $ 5,502
NET INCOME (LOSS) PER COMMON SHARE
Income before extraordinary item and minority interest $ 0.50 $ 3.13
Extraordinary item:
Loss on early extinguishment of debt, net of taxes -- (0.06)
--------------- --------------
Income before minority interest 0.50 3.07
Minority interest held by affiliates 0.01 (0.62)
Minority interest -- other (1.31) (1.31)
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NET INCOME (LOSS) PER COMMON SHARE $ (0.80) $ 1.14
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The Notes to Consolidated Financial Statements are an integral part of these
statements.
</TABLE>
<PAGE>
<TABLE>
Consolidated Statements of Comprehensive Income and Changes in Shareholders' Deficit
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
===================================================================================================================================
For the Three Months
Ended December 31
-------------------------------
(Dollars in thousands, except per share amounts) 1998 1997
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<S> <C> <C>
COMPREHENSIVE INCOME
Net income (loss) $ (2,505) $ 6,856
Other comprehensive income:
Net unrealized holding gains (losses) (35) 299
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TOTAL COMPREHENSIVE INCOME (LOSS) $ (2,540) $ 7,155
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CHANGES IN SHAREHOLDERS' DEFICIT
PREFERRED SHARES OF BENEFICIAL INTEREST
Beginning and end of period (516,000 shares) $ 516 $ 516
--------------- --------------
COMMON SHARES OF BENEFICIAL INTEREST
Beginning and end of period (6,641,598 shares) 6,642 6,642
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PAID-IN SURPLUS
Beginning and end of period 92,943 92,943
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DEFICIT
Beginning of period (81,936) (142,642)
Net income (loss) (2,505) 6,856
Dividends:
Real Estate Trust preferred shares of beneficial interest:
Distributions payable ($2.62 per share and $2.62 per share, respectively) (1,354) (1,354)
--------------- --------------
End of period (85,795) (137,140)
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ACCUMULATED OTHER COMPREHENSIVE INCOME
Beginning of period 44 (396)
Net unrealized holding gains (losses) (35) 299
--------------- --------------
End of period 9 (97)
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TREASURY SHARES
Beginning and end of period (1,814,688 shares) (41,848) (41,848)
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TOTAL SHAREHOLDERS' DEFICIT $ (27,533) $ (78,984)
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The Notes to Consolidated Financial Statements are an integral part of these
statements.
</TABLE>
<PAGE>
<TABLE>
Consolidated Statements of Cash Flows
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
===================================================================================================================================
For the Three Months
Ended December 31
-------------------------------
(In thousands) 1998 1997
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Real Estate
Net loss $ (2,326) $ (5,027)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation 2,876 2,659
Early extinguishment of debt -- 266
(Increase) decrease in accounts receivable and accrued income 759 (1,397)
(Increase) decrease in deferred tax asset 5,358 (2,691)
Increase in accounts payable and accrued expenses (8,157) (7,209)
Amortization of debt expense 348 140
Equity in (earnings) losses of unconsolidated entities (1,147) 1,339
Other 18,004 2,632
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15,715 (9,288)
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Banking
Net income (179) 11,883
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization (accretion) of premiums, discounts and net deferred loan fees 3,576 7,998
Depreciation and amortization 8,044 7,889
Provision for loan losses 3,773 35,062
Capitalized interest on real estate under development (756) (499)
Proceeds from sales of trading securities 120,886 137,539
Net fundings of loans held for sale and/or securitization (185,506) (197,425)
Proceeds from sales of loans held for sale and/or securitization 10,854 783,646
Gain on sales of real estate held for sale (99) (332)
Provision for losses on real estate held for investment or sale -- 5,307
Gain on sales of trading securities, net (645) (557)
(Increase) decrease in interest-only strips 2,158 (33,553)
Decrease in servicing assets 3,341 6,930
(Increase) decrease in goodwill and other intangible assets 892 (23,068)
(Increase) decrease in other assets (109,875) 557
Increase (decrease) in other liabilities (13,465) 1,455
Minority interest held by affiliates (45) 2,971
Minority interest - other 2,438 2,438
Other (9,910) 3,940
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(164,518) 752,181
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Net cash provided by operating activities (148,803) 742,893
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CASH FLOWS FROM INVESTING ACTIVITIES
Real Estate
Capital expenditures - properties (8,255) (2,086)
Property acquisitions -- (26,124)
Equity investment in unconsolidated entities 1,500 1,327
Other 1 --
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(6,754) (26,883)
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Banking
Net proceeds from redemption of Federal Home Loan Bank stock 18,370 --
Net proceeds from sales of real estate 6,757 3,566
Net fundings of loans receivable (473,183) (691,629)
Principal collected on mortgage-backed securities 228,611 233,730
Purchases of Federal Home Loan Bank stock (2,524) --
Purchases of investment securities -- (34,010)
Purchases of loans receivable (978,848) (272,979)
Purchases of property and equipment (9,722) (13,253)
Disbursements for real estate held for investment or sale (2,483) (3,325)
Other 7 (1,830)
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(1,213,015) (779,730)
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Net cash used in investing activities (1,219,769) (806,613)
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Continued on following page.
</TABLE>
<PAGE>
<TABLE>
Consolidated Statements of Cash Flows (Continued)
B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)
===================================================================================================================================
For the Three Months
Ended December 31
-------------------------------
(In thousands) 1998 1997
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<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Real Estate
Proceeds from mortgage financing $ 3,705 $ 54,278
Principal curtailments and repayments of mortgages (2,697) (27,448)
Proceeds from sales of unsecured notes 1,174 2,587
Repayments of unsecured notes (3,222) (1,968)
Costs of obtaining financings (400) (818)
Loan prepayment fees -- (80)
--------------- --------------
(1,440) 26,551
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Banking
Proceeds from customer deposits and sales of certificates of deposit 10,547,746 6,181,097
Customer withdrawals of deposits and payments for maturing certificates of deposit (10,255,001) (6,080,308)
Net increase (decrease) in securities sold under repurchase agreements 26,125 8,768
Advances from the Federal Home Loan Bank 485,270 106,602
Repayments of advances from the Federal Home Loan Bank (202,337) (155,174)
Proceeds from other borrowings 5,588,128 2,385,502
Repayments of other borrowings (5,606,497) (2,389,177)
Cash dividends paid on preferred stock (2,438) (2,438)
Cash dividends paid on common stock (21,000) (3,500)
Other 5,275 1,037
--------------- --------------
565,271 52,409
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Net cash provided by financing activities 563,831 78,960
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Net increase (decrease) in cash and cash equivalents (804,741) 15,240
Cash and cash equivalents at beginning of period 1,230,406 670,139
--------------- --------------
Cash and cash equivalents at end of period $ 425,665 $ 685,379
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Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (net of amount capitalized) $ 70,830 $ 76,216
Income taxes paid (refunded) 92,319 1,826
Shares of Saul Centers, Inc. common stock 816 706
Limited partnership units of Saul Holdings Limited Partnership 1,471 --
Cash received during the year from:
Dividends on shares of Saul Centers, Inc. common stock 816 706
Distributions from Saul Holdings Limited Partnership 1,471 1,363
Supplemental disclosures of noncash activities:
Rollovers of notes payable - unsecured 2,088 1,204
Loans held for sale exchanged for trading securities 119,618 137,414
Loans receivable transferred to (from) loans held for sale and/or securitization (125,000) 697,547
Loans made in connection with the sale of real estate 906 3,624
Loans receivable transferred to real estate acquired in settlement of loans -- 1,222
Loans receivable exchanged for mortgage-backed securities held to maturity -- 2,786
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The Notes to Consolidated Financial Statements are an integral part of these
statements.
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. In the opinion of management, the consolidated financial statements reflect
all adjustments necessary for a fair presentation of the Trust's financial
position and results of operations. All such adjustments are of a normal
recurring nature. These financial statements and the accompanying notes should
be read in conjunction with the Trust's audited consolidated financial
statements included in its Form 10-K for the fiscal year ended September 30,
1998. The results of operations for interim periods are not necessarily
indicative of results to be expected for the year.
2. The accompanying financial statements include the accounts of B. F. Saul Real
Estate Investment Trust and its wholly owned subsidiaries (the "Real Estate
Trust"), which are involved in the ownership and development of income-producing
properties. The accounts of the Trust's 80%-owned banking subsidiary, Chevy
Chase Bank, F.S.B., and its subsidiaries ("Chevy Chase" or the "Bank") have also
been consolidated. Accordingly, the accompanying financial statements reflect
the assets, liabilities, operating results and cash flows for two business
segments: Real Estate and Banking. All significant intercompany balances and
transactions have been eliminated.
3. The Trust voluntarily terminated its qualification as a real estate
investment trust under the Internal Revenue Code during fiscal 1978. As a result
of the Trust's acquisition of an additional 20% equity interest in the Bank in
June 1990, the Bank became a member of the Trust's affiliated group filing
consolidated federal income tax returns. The current effect of the Trust's
consolidation of the Bank's operations into its federal income tax return
results in the use of the Trust's net operating losses and net operating loss
carryforwards to reduce the federal income taxes the Bank would otherwise owe.
<PAGE>
4. BANKING:
LOANS HELD FOR SALE:
Loans held for sale is composed of the following:
December 31, September 30,
(In thousands) 1998 1998
- ---------------------------------- ------------ -------------
Single-family residential $ 106,366 $ 49,502
Home improvement and related loans 5,240 6,785
------------ -------------
$ 111,606 $ 56,287
============ =============
LOANS HELD FOR SECURITIZATION AND SALE:
At September 30, 1998, loans held for securitization and sale totaled $125,000
and was composed of automobile loans. At December 31, 1998, there were no loans
held for securitization and sale.
LOANS RECEIVABLE:
December 31, September 30,
(In thousands) 1998 1998
- ---------------------------------- ------------ -------------
Single-family residential $ 2,835,334 $ 1,772,784
Home equity 215,457 135,122
Real estate construction and ground 253,178 209,247
Commercial real estate and multifamily 77,285 75,877
Commercial 370,830 279,416
Automobile 530,501 232,826
Home improvement and related loans 90,955 60,570
Overdraft lines of credit and
other consumer 32,106 33,484
------------ -------------
4,405,646 2,799,326
------------ -------------
Less:
Undisbursed portion of loans 243,310 207,921
Net deferred loan origination
costs (14,618) (2,709)
Allowance for loan losses 60,157 60,157
------------ -------------
288,849 265,369
------------ -------------
Total $ 4,116,797 $ 2,533,957
============ =============
<PAGE>
REAL ESTATE HELD FOR INVESTMENT OR SALE:
The Bank's real estate held for investment is carried at the lower of aggregate
cost or net realizable value. The Bank's real estate acquired in settlement of
loans is considered to be held for sale and is carried at the lower of cost or
fair value (less estimated selling costs).
Real estate held for investment or sale is composed of the following:
December 31, September 30,
(In thousands) 1998 1998
- ---------------------------------- ------------ -------------
Real estate held for investment $ 3,819 $ 3,819
Real estate held for sale 214,719 218,972
------------ -------------
Subtotal 218,538 222,791
------------ -------------
Less:
Allowance for losses on real estate
held for investment 202 202
Allowance for losses on real estate
held for sale 153,564 153,564
------------ -------------
Subtotal 153,766 153,766
------------ -------------
Total real estate held for
investment or sale $ 64,772 $ 69,025
============ =============
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The principal business conducted by the Trust and its wholly-owned
subsidiaries is the ownership and development of income-producing properties.
The Trust owns 80% of the outstanding common stock of Chevy Chase Bank, F.S.B.
("Chevy Chase" or the "Bank"). At December 31, 1998, the Bank's assets accounted
for approximately 96% of the Trust's consolidated assets. The Trust recorded a
net loss of $2.5 million for the three-month period ended December 31, 1998,
compared to net income of $6.9 million for the three-month period ended December
31, 1997.
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 and its subsidiaries, including Chevy Chase and
Chevy Chase's subsidiaries. "Real Estate Trust" refers to B.F. Saul Real Estate
Investment Trust and its subsidiaries, excluding Chevy Chase and Chevy Chase's
subsidiaries. The operations conducted by the Real Estate Trust are designated
as "Real Estate," while the business conducted by the Bank and its subsidiaries
is identified by the term "Banking."
FINANCIAL CONDITION
REAL ESTATE
The number of properties in the Real Estate Trust's investment portfolio
at December 31, 1998, which consisted primarily of hotels, office and industrial
projects, and land parcels, was unchanged from the number of properties at
September 30, 1998.
Space in the Real Estate Trust's commercial property portfolio was 97%
leased at December 31, 1998, compared to leasing rates of 100% and 99% at
September 30, 1998 and December 31, 1997, respectively. At December 31, 1998,
the Real Estate Trust's commercial property portfolio had a total gross leasable
area of 1.2 million square feet, of which 197,000 square feet (15.5%) and
178,000 square feet (14.0%) are subject to leases whose terms expire in the
balance of fiscal 1999 and in fiscal 2000, respectively.
The ten hotel properties owned by the Real Estate Trust throughout the
first fiscal quarters of 1999 and 1998 experienced average occupancy rates of
63.3% and 64.3%, respectively, and average room rates of $81.44 and $75.67,
respectively. Four of these hotels registered improved occupancy rates and nine
registered higher average room rates in the current period. Overall, the hotel
portfolio experienced an average occupancy rate of 62.1% and an average room
rate of $83.35 during the quarter ended December 31, 1998. On December 10, 1997,
the Real Estate Trust purchased a 308-room Holiday Inn hotel located in
Arlington, Virginia, near Washington National Airport and the Real Estate
Trust's Howard Johnsons hotel. On August 13, 1998, the Real Estate Trust opened
its newly-constructed 95-room Marriott TownePlace Suites hotel located near
Washington Dulles Airport.
<PAGE>
BANKING
General. The Bank recorded operating income of $7.3 million during the quarter
ended December 31, 1998, compared to operating income of $29.4 million in the
prior corresponding quarter. The decline in income for the current quarter
reflects the loss of revenues attributable to the Bank's credit card portfolio
which was sold on September 30, 1998. Decreases in credit card interest income,
credit card fees and servicing and securitization income during the current
quarter were partially offset by an increase in single-family loan interest
income and decreases in the provision for loan losses and operating expenses.
Servicing and securitization income decreased $93.2 million (or 93.2%) during
the current quarter and resulted primarily from decreased securitization
activity and decreased credit card servicing fees resulting from the sale of the
credit card portfolio. During the quarter ended December 31, 1997, the Bank
securitized and sold $335.0 million, $230.1 million and $161.7 million of credit
card, automobile and home equity loan receivables, respectively, and recognized
gains of $16.3 million, $9.0 million and $7.2 million, respectively, on these
transactions. The Bank did not securitize and sell any loan receivables during
the quarter ended December 31, 1998. In addition, credit card loan servicing
fees totaled $59.9 million for the quarter ended December 31, 1997.
At December 31, 1998, the Bank's tangible, core, tier 1 risk-based and total
risk-based regulatory capital ratios were 6.91%, 6.91%, 9.95% and 16.23%,
respectively. The Bank's regulatory capital ratios exceeded the requirements
under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
("FIRREA") as well as the standards established for "well-capitalized"
institutions under the prompt corrective action regulations issued pursuant to
the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA").
See "Capital."
During the quarter, the Bank declared out of the retained earnings of the Bank,
a dividend on its Common Stock in the amount of $2,300 per share. Of this
amount, $2,100 per share was paid in December 1998, and the remaining $200 per
share was paid in January 1999.
Under recent amendments to the OTS capital distribution regulation which will
take effect April 1, 1999, the Bank will be required to apply to the OTS for
approval to make any capital distribution regardless of size if the Bank does
not qualify for expedited treatment under the amended OTS regulations. If the
Bank qualifies for expedited treatment, an application will be required only if
the total amount of all of the Bank's capital distributions for the year
(including the proposed distribution) exceed the sum of the Bank's net income
for the year plus its retained net income for the previous two years. Because it
is a subsidiary of a holding company, the Bank will be required to provide the
OTS with advance notice of a proposed capital distribution even if an
application is not required. In considering an application or notice, the OTS
will not permit a capital distribution if (i) the Bank would be
"undercapitalized" following the distribution; (ii) the capital distribution
raises safety and soundness concerns; or (iii) the capital distribution violates
any statute, regulation, agreement with the OTS, or condition imposed by the
OTS. Dividends paid to preferred stockholders of Chevy Chase Preferred Capital
Corporation will not be treated as capital distributions for the purposes of
these regulations provided the Bank remains "well capitalized" after the
payment.
<PAGE>
Asset Quality. Non-Performing Assets. The following table sets forth
information concerning the Bank's non-performing assets at the dates
indicated. The figures shown are after charge-offs and, in the case of real
estate acquired in settlement of loans, after all valuation allowances.
<PAGE>
<TABLE>
Non-Performing Assets
(Dollars in thousands)
December 31, September 30, December 31,
1998 1998 1997
------------------- ---------------- ----------------
<S> <C> <C> <C>
Non-performing assets:
Non-accrual loans:
Residential $ 7,498 $ 8,106 $ 10,379
Consumer 7,262 4,501 5,875
------------------- ---------------- ----------------
Total non-accrual loans (1) 14,760 12,607 16,254
------------------- ---------------- ----------------
Real estate acquired in settlement of loans 214,719 218,972 228,985
Allowance for losses on real estate acquired in
settlement of loans (153,564) (153,564) (143,674)
------------------- ---------------- ----------------
Real estate acquired in settlement of loans, net 61,155 65,408 85,311
------------------- ---------------- ----------------
Total non-performing assets 75,915 78,015 101,565
Accruing credit card loans past due 90 days (2) (3) -- -- 26,357
------------------- ---------------- ----------------
Total non-performing assets and accruing credit card
loans past due 90 days $ 75,915 $ 78,015 $ 127,922
=================== ================ ================
Allowance for losses on loans $ 60,157 $ 60,157 $ 113,131
Allowance for losses on real estate held for investment 202 202 198
Allowance for losses on real estate acquired in settlement
of loans 153,564 153,564 143,674
------------------- ---------------- ----------------
Total allowances for losses $ 213,923 $ 213,923 $ 257,003
=================== ================ ================
Ratios:
Non-performing assets and accruing credit card loans past due
90 days, net to total assets (4) 0.21% 0.26% 0.24%
Allowance for losses on real estate loans to non-accrual
real estate loans (1) 220.74% 204.18% 95.41%
Allowance for losses on consumer loans to
non-accrual consumer loans (1) 469.86% 758.08% 136.94%
Allowance for losses on loans to non-accrual loans (1) 407.57% 477.17% 696.02%
Allowance for losses on loans to total loans receivable (5) 1.40% 2.17% 4.12%
(1) Before deduction of allowances for losses.
(2) The Bank sold its credit card portfolio and related operations on September
30, 1998.
(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 nonaccrual.
(4) Non-performing assets and accruing credit card loans past due 90 days, net
are presented after all allowances for losses on loans and real estate held for
investment or sale.
(5) Includes loans receivable and loans held for sale and/or securitization,
before deduction of allowance for losses.
</TABLE>
<PAGE>
Non-performing assets totaled $75.9 million, after valuation allowances on real
estate held for sale or real estate owned ("REO") of $153.6 million, at December
31, 1998, compared to $78.0 million, after valuation allowances on REO of $153.6
million, at September 30, 1998. In addition to the valuation allowances on REO,
the Bank maintained $7.3 million of valuation allowances on its non-accrual
loans at December 31, 1998. The $2.1 million decrease in non-performing assets
for the current quarter was attributable to net decreases in REO of $4.3 million
which was partially offset by net increases in non-accrual loans of $2.2
million. See "Non-accrual Loans" and "REO."
Non-accrual Loans. The Bank's non-accrual loans totaled $14.8 million at
December 31, 1998, as compared to $12.6 million at September 30, 1998. At
December 31, 1998, non-accrual loans consisted of $7.5 million of real estate
loans and $7.3 million of consumer loans compared to non-accrual real estate
loans of $8.1 million and non-accrual consumer loans of $4.5 million at
September 30, 1998. The $2.8 million increase in non-accrual consumer loans was
attributable to increased delinquencies in the Bank's sub-prime automobile loan
portfolio. Although management has taken steps designed to reduce losses in this
portfolio, including expansion of collection efforts and adjustments to
underwriting criteria, losses from the sub-prime automobile loan portfolio are
not expected to show improvement until the second half of fiscal 1999.
REO. At December 31, 1998, the Bank's REO totaled $61.2 million, after valuation
allowances on such assets of $153.6 million as set forth in the following table.
The principal component of REO consists of five planned unit developments (the
"Communities"), four of which are under active development. Only commercial
ground remains in two of the four active Communities. The fifth Community,
consisting of approximately 2,400 acres in Loudoun County, Virginia, is in the
pre-development stage.
Balance Balance
Before All After Percent
Number of Valuation Valuation Valuation of
Properties Allowances Allowances Allowances Total
(Dollars in thousands) ---------- ---------- ---------- ---------- -------
Communities 5 $ 197,104 $ 144,642 $ 52,462 85.8%
Residential ground 3 6,010 3,122 2,888 4.7%
Commercial ground 3 10,058 5,800 4,258 7.0%
Single-family
residential properties 12 1,547 - 1,547 2.5%
---------- ---------- ---------- ---------- -------
Total REO 23 $ 214,719 $ 153,564 $ 61,155 100.0%
========== ========== ========== ========== =======
During the three months ended December 31, 1998, REO decreased $4.3 million,
which was primarily attributable to additional sales in the Communities and
other properties, partially offset by additional capitalized costs.
During the three months ended December 31, 1998, the Bank received revenues of
$9.0 million from dispositions of 272 residential lots or units in the
communities ($7.4 million), approximately 1.25 acres of commercial land in one
of the Communities ($0.3 million) and various single-family residential
properties ($1.3 million).
At December 31, 1998, the Bank had an executed contract to sell one residential
ground property at its book value of $0.2 million.
<PAGE>
Delinquent Loans. At December 31, 1998, delinquent loans totaled $35.4 million
(or 0.8% of loans) compared to $20.7 million (or 0.7% of loans) at September 30,
1998. The following table sets forth information regarding the Bank's delinquent
loans at December 31, 1998.
Principal Balance
------------------------------------------
Total as a
Mortgage Non-Mortgage Percentage
Loans Loans Total of Loans (1)
(Dollars in thousands) ------------- ---------------- ----------- ------------
Loans delinquent for:
30-59 days.......... $ 5,687 $21,994 $27,681 0.6%
60-89 days.......... 1,747 6,008 7,755 0.2%
------------- ---------------- ----------- ------------
Total.................. $ 7,434 $28,002 $35,436 0.8%
============= ================ =========== ============
(1) Includes loans held for sale, before deduction of allowance for loan losses
and deferred loan origination costs.
Mortgage loans classified as delinquent 30-89 days consists entirely of
single-family permanent residential mortgage loans and home equity loans. Total
delinquent mortgage loans increased from $5.1 million at September 30, 1998 to
$7.4 million at December 31, 1998.
Non-mortgage loans delinquent 30-89 days increased to $28.0 million at December
31, 1998 from $15.6 million at September 30, 1998, primarily as a result of
increased delinquencies in the sub-prime segment of the automobile portfolio.
Troubled Debt Restructurings. At December 31, 1998 and September 30, 1998, loans
accounted for as troubled debt restructurings totaled $11.8 million, and
included one commercial permanent loan with a principal balance of $11.7 million
and one commercial collateralized loan with a principal balance of $0.1 million.
The Bank had commitments to lend $0.1 million of additional funds on loans that
have been restructured.
Real Estate Held for Investment. At December 31, 1998 and September 30, 1998,
real estate held for investment consisted of two properties with an aggregate
book value of $3.6 million, net of valuation allowances of $0.2 million.
Allowances for Losses. The following tables show loss experience by asset type
and the components of the allowance for losses on loans and the allowance for
losses on real estate held for investment or sale. These tables reflect
charge-offs taken against assets during the periods indicated and may include
charge-offs taken against assets which the Bank disposed of during such periods.
<PAGE>
<TABLE>
Analysis of Allowance for and Charge-offs of Loans
(Dollars in thousands)
Three Months Ended Year Ended
December 31, September 30,
------------------------------------------
1998 1997 1998
------------------ ------------------ ----------------------
<S> <C> <C> <C>
Balance at beginning of period $ 60,157 $ 105,679 $ 105,679
------------------ ------------------ ----------------------
Provision for loan losses 3,773 35,062 150,829
------------------ ------------------ ----------------------
Reduction due to sale of credit card portfolio -- -- (87,609)
------------------ ------------------ ----------------------
Charge-offs:
Single-family residential and home equity (208) (274) (1,629)
Credit card -- (26,442) (108,289)
Consumer (3,967) (3,972) (12,734)
------------------ ------------------ ----------------------
Total charge-offs (4,175) (30,688) (122,652)
------------------ ------------------ ----------------------
Recoveries:
Single-family residential 29 -- 49
Credit card -- 2,842 12,732
Consumer 373 236 1,129
------------------ ------------------ ----------------------
Total recoveries 402 3,078 13,910
------------------ ------------------ ----------------------
Charge-offs, net of recoveries (3,773) (27,610) (108,742)
------------------ ------------------ ----------------------
Balance at end of period $ 60,157 $ 113,131 $ 60,157
================== ================== ======================
Provision for loan losses to average loans (1) (2) 0.43% 5.45% 5.43%
Net loan charge-offs to average loans (1) (2) 0.43% 4.29% 3.92%
Ending allowance for losses on loans to total
loans (2) (3) 1.40% 4.12% 2.17%
(1) Annualized.
(2) Includes loans held for sale and/or securitization.
(3) Before deduction of allowance for losses.
</TABLE>
<PAGE>
<TABLE>
Components of Allowance for Losses on Loans by Type
(Dollars in thousands)
December 31, September 30,
------------------------------------------------------
1998 1997 1998
------------------------ ------------------------ ------------------------
Percent of Percent of Percent of
Loans to Loans to Loans to
Amount Total Loans Amount Total Loans Amount Total Loans
---------- ---------- ---------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance at end of period allocated
to:
Single-family residential $ 1,822 68.7 % $ 784 39.8 % $ 1,822 65.7 %
Home equity 676 5.0 757 5.1 676 4.9
Commercial real estate and
multifamily 10,828 1.8 7,781 2.2 10,828 2.7
Real estate construction and ground 3,225 3.4 581 2.1 3,225 3.9
Commercial 3,623 5.6 425 4.1 3,623 6.3
Credit card -- -- 94,758 36.8 -- --
Automobile 29,044 12.4 3,820 5.9 29,044 12.9
Home improvement and related loans 3,403 2.3 3,450 2.7 3,403 2.4
Overdraft lines of credit and
other consumer 1,674 0.8 775 1.3 1,674 1.2
Unallocated 5,862 -- - -- 5,862 --
---------- ---------- ---------
Total $ 60,157 $ 113,131 $ 60,157
========== ========== =========
</TABLE>
<PAGE>
<TABLE>
Real Estate Held for Investment or Sale
(Dollars in thousands)
Activity in Allowance for Losses:
Three Months Ended Year Ended
December 31, September 30,
----------------------------
1998 1997 1998
------------ ------------ -------------
<S> <C> <C> <C>
Balance at beginning of period:
Real estate held for investment $ 202 $ 198 $ 198
Real estate held for sale 153,564 140,738 140,738
------------ ------------ -------------
Total 153,766 140,936 140,936
------------ ------------ -------------
Provision for real estate losses:
Real estate held for investment -- -- 4
Real estate held for sale -- 5,307 18,856
------------ ------------ -------------
Total -- 5,307 18,860
------------ ------------ -------------
Charge-offs:
Real estate held for sale:
Ground -- (2,371) (6,030)
------------ ------------ -------------
Total charge-offs on real estate
held for investment or sale -- (2,371) (6,030)
------------ ------------ -------------
Balance at end of period:
Real estate held for investment 202 198 202
Real estate held for sale 153,564 143,674 153,564
------------ ------------ -------------
Total $ 153,766 $ 143,872 $ 153,766
============ ============ =============
</TABLE>
<TABLE>
Components of Allowance for Losses:
December 31, September 30,
----------------------------
1998 1997 1998
------------ ------------ -------------
<S> <C> <C> <C>
Allowance for losses on real estate
held for investment $ 202 $ 198 $ 202
Allowance for losses on real estate
held for sale:
Ground 153,564 143,674 153,564
------------ ------------ -------------
Total allowance for losses on real
estate held for investment or sale $ 153,766 $ 143,872 $ 153,766
============ ============ =============
</TABLE>
<PAGE>
At December 31, 1998 and September 30, 1998, the Bank's total valuation
allowances for losses on loans and real estate held for investment or sale was
$213.9 million. Although the amounts of delinquent and non-accrual non-mortgage
loans increased during the current quarter, the provision for loan losses for
the quarter equaled the amount of net charge-offs for the quarter, reflecting
management's determination that the overall level of the allowances remained
appropriate.
The allowance for losses on loans secured by real estate and real estate held
for investment or sale totaled $170.3 million at December 31, 1998, which
constituted 76.6% of total non-performing real estate assets, before valuation
allowances. During the three months ended December 31, 1998, the Bank provided
an additional $0.2 million of valuation allowances on loans secured by real
estate and real estate held for investment or sale and recorded net charge-offs
of $0.2 million on these assets. The allowance for losses on real estate held
for sale at December 31, 1998 is in addition to approximately $48.6 million of
cumulative charge-offs previously taken against assets remaining in the Bank's
portfolio at December 31, 1998.
At December 31, 1998, the combined allowance for losses on consumer loans
(automobile, home improvement and related loans, overdraft lines of credit and
other consumer loans) did not change from the level at September 30, 1998 of
$34.1 million. The ratios of the allowance for losses on consumer loans to
non-performing consumer loans and to outstanding consumer loans decreased to
469.9% and 5.2%, respectively, at December 31, 1998 from 758.1% and 7.4%,
respectively, at September 30, 1998.
Asset and Liability Management. The following table presents the interest rate
sensitivity of the Bank's interest-earning assets and interest-bearing
liabilities at December 31, 1998, 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 December 31, 1998 Real estate loans:
Adjustable-rate $ 455,026 $ 561,603 $ 93,385 $ 223 $ -- $ 1,110,237
Fixed-rate 84,033 74,696 282,802 234,973 1,239,023 1,915,527
Home equity credit lines and second
mortgages 233,027 2,112 7,467 6,090 24,631 273,327
Commercial 149,190 8,139 27,082 19,940 33,646 237,997
Consumer and other 126,069 102,014 265,179 126,530 20,074 639,866
Loans held for sale 111,606 -- -- -- -- 111,606
Loans held for securitization and sale -- -- -- -- -- --
Mortgage-backed securities 605,504 260,642 611,688 92,582 225,136 1,795,552
Trading securities 9,575 -- -- -- -- 9,575
Other investments 245,369 -- 43,998 -- -- 289,367
------------ ------------- -------------- -------------- ------------ ------------
Total interest-earning assets 2,019,399 1,009,206 1,331,601 480,338 1,542,510 6,383,054
Total non-interest earning assets -- -- -- -- 892,070 892,070
------------ ------------- -------------- -------------- ------------ ------------
Total assets $ 2,019,399 $ 1,009,206 $ 1,331,601 $ 480,338 $ 2,434,580 $ 7,275,124
============ ============= ============== ============== ============ ============
Deposits:
Fixed maturity deposits $ 956,217 $ 262,826 $ 205,356 $ 60,968 $ -- $ 1,485,367
NOW, statement and passbook accounts 1,685,479 43,720 145,616 99,110 211,215 2,185,140
Money market deposit accounts 1,071,103 -- -- -- -- 1,071,103
Borrowings:
Capital notes - subordinated -- -- -- -- 250,000 250,000
Other 1,052,134 460 9,087 13,934 59,285 1,134,900
------------ ------------- -------------- -------------- ------------ ------------
Total interest-bearing liabilities 4,764,933 307,006 360,059 174,012 520,500 6,126,510
Total non-interest bearing liabilities -- -- -- -- 736,370 736,370
Stockholders' equity -- -- -- -- 412,244 412,244
------------ ------------- -------------- -------------- ------------ ------------
Total liabilities & stockholders' equity $ 4,764,933 $ 307,006 $ 360,059 $ 174,012 $ 1,669,114 $ 7,275,124
============ ============= ============== ============== ============ ============
Gap $(2,745,534) $ 702,200 $ 971,542 $ 306,326 $ 1,022,010
Cumulative gap $(2,745,534) $ (2,043,334) $ (1,071,792) $ (765,466) $ 256,544
Adjustment for interest rate caps (1) $ 200,000 $ -- $ -- $ -- $ --
Adjusted cumulative gap $(2,545,534) $ (2,043,334) $ (1,071,792) $ (765,466) $ 256,544
Adjusted cumulative gap as a percentage
of total assets (35.0)% (28.1)% (14.7)% (10.5)% 3.5 %
(1) At December 31, 1998, the Bank had $200,000 notional amount of interest rate
caps. The adjustment reflects the average notional amount outstanding until the
cap expires June 30, 1999.
</TABLE>
<PAGE>
The interest sensitivity "gap" shown in the table represents the sum of all
interest-earning assets minus all interest-bearing liabilities subject to
repricing within the same period. The one-year gap, adjusted for the effect of
the Bank's interest rate caps, as a percentage of total assets, was a negative
28.1% at December 31, 1998 compared to a negative 16.6% at September 30, 1998.
The decline in the Bank's one-year gap during the quarter ended December 31,
1998 principally reflected the Bank's efforts to replace lower yielding
short-term assets acquired with the proceeds from the sale of the Bank's credit
card portfolio with higher yielding loans and investments of greater duration.
In addition, a significant portion of the growth in the Bank's assets during the
December 1998 quarter was concentrated in fixed-rate residential mortgage loans.
The Bank continues to consider a variety of strategies to manage its interest
rate risk position.
Tax Sharing Payments. During the December 1998 quarter, the Bank made a tax
sharing payment of $6.6 million to the Trust, which owns 80% of the Bank's
Common Stock.
Capital. At December 31, 1998, 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 December 31,
1998 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 $ 440,741
Minority interest in REIT Subsidiary (1) 144,000
Net unrealized holding gains (2) (15)
----------
584,726
Adjustments for tangible and core capital:
Intangible assets (61,448)
Non-allowable minority interest in
REIT Subsidiary (1) (18,877)
Non-includable subsidiaries (3) (3,908)
----------
Total tangible capital 500,493 6.91% $ 108,578 1.50% $ 391,915 5.41%
---------- ======== ========== ======== ========== =========
Total core capital (4) 500,493 6.91% $ 289,541 4.00% $ 210,952 2.91%
---------- ======== ========== ======== ========== =========
Tier 1 risk-based capital (4) 500,493 9.95% $ 205,020 4.00% $ 295,473 5.95%
---------- ======== ========== ======== ========== =========
Adjustments for total risk-based capital:
Subordinated capital debentures 250,000
Allowance for general loan losses 53,036
----------
Total supplementary capital 303,036
----------
Total available capital 803,529
Equity investments (3) (11,850)
----------
Total risk-based capital (4) $ 791,679 16.23% $ 410,039 8.00% $ 381,640 8.23%
========== ======== ========== ======== ========== =========
(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 $0.8 million representing the allowance for
general loan losses maintained against the Bank's equity investments and
non-includable subsidiaries which, pursuant to OTS guidelines, is available as a
"credit" against the deductions from capital otherwise required for such
investments.
(4) Under the OTS "prompt corrective action" regulations, the standards for
classification as "well capitalized" are a leverage (or "core capital") ratio of
at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0% and a total
risk-based capital ratio of at least 10.0%.
</TABLE>
<PAGE>
OTS capital regulations provide a five-year holding period (or such longer
period as may be approved by the OTS) for REO to qualify for an exception from
treatment as an equity investment. If an REO property is considered an equity
investment, its then-current book value is deducted from total risk-based
capital. In February 1998, the Bank received from the OTS an extension of the
holding periods for certain of its REO properties through February 17, 1999. The
Bank has submitted to the OTS a request for an additional one-year extension of
the holding periods for certain of its REO properties. At December 31, 1998, the
Bank's capital ratios would have remained above the levels required for well
capitalized institutions even if the book value of REO properties included in
the extension request had been deducted from total risk-based capital as of that
date. The following table sets forth the Bank's REO at December 31, 1998, after
valuation allowances of $153.6 million, by the fiscal year in which the property
was acquired through foreclosure.
Fiscal Year (In thousands)
------------------------- --------------
1990 (1) (2)............. $ 20,375
1991 (2)................. 32,973
1992 (2)................. 107
1993 .................... -
1994 .................... 219
1995 .................... 5,934
1996 .................... -
1997 .................... -
1998 .................... 1,360
1999 .................... 187
--------------
Total REO $ 61,155
==============
- -----------------------
(1) Includes REO with an aggregate net book value of $11.9 million, which the
Bank treats as equity investments for regulatory capital purposes.
(2) Includes REO, with an aggregate net book value of $41.6 million, for which
an extension of the holding periods through February 17, 1999.
<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 the balance of fiscal 1999 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.
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. In the first quarter of fiscal
1999, the Bank made a tax sharing payment of $6.6 million and a dividend payment
of $16.8 million to the Real Estate Trust. In January 1999, the Bank made a
dividend payment of $1.6 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 the 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.
<PAGE>
In fiscal 1994, the Real Estate 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
"1994 Notes"). In March 1998, the Real Estate Trust issued $200.0 million
aggregate principal amount of 9 3/4% Senior Secured Notes due 2008 (the "1998
Notes"). After providing for the retirement of the 1994 Notes, including a
prepayment premium of $10.0 million and debt issuance costs of approximately
$5.9 million, the Real Estate Trust realized approximately $9.1 million in new
funds. In addition, the Real Estate Trust received about $13.2 million in cash
which had been held as additional collateral by the indenture agent under the
1994 Notes. The 1998 Notes are secured by a first priority perfected security
interest in 8,000 shares (80%) of the issued and outstanding common stock of the
Bank, which constitute all of the Bank common stock held by the Real Estate
Trust. The 1998 Notes are nonrecourse obligations of the Real Estate Trust.
Through December 31, 1998, the Trust has purchased either in the open
market or through dividend reinvestment approximately 2.2 million shares of
common stock of Saul Centers (representing 17.0% of such company's outstanding
common stock). As of December 31, 1998, the market value of these unpledged
shares was approximately $34.2 million.
The Real Estate Trust sold Unsecured Notes, with a maturity ranging from
one to ten years, primarily to provide funds to repay maturing Unsecured Notes,
through January 31, 1999, when its current registration statement expired. The
Real Estate Trust plans to resume its program of selling Unsecured Notes when
its new registration becomes effective. 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.
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
initial 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 December 31, 1998, there were no borrowings under the
facility and unrestricted availability on that date was $8.3 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 a year. During fiscal 1998, the line of credit was
increased to $20.0 million and was extended for an additional year. Interest in
computed by reference to the floating rate index. At December 31, 1998, there
were no borrowings under the facility and unrestricted availability was $3.5
million.
<PAGE>
The maturity schedule for the Real Estate Trust's outstanding debt at
December 31, 1998 for the balance of fiscal 1999 and subsequent years is set
forth in the following table:
<TABLE>
Debt Maturity Schedule
(In thousands)
Notes Payable- Notes Payable-
Fiscal Year Mortgage Notes Secured Unsecured Total
- -------------------- ------------------ ------------------ ----------------- ------------------
<S> <C> <C> <C> <C>
1999 (1) $ 7,290 $ -- $10,839 $ 18,129
2000 10,098 -- 8,893 18,991
2001 8,369 -- 5,926 14,295
2002 14,117 -- 6,108 20,225
2003 11,501 -- 9,149 20,650
Thereafter 138,978 200,000 7,372 346,350
- -------------------- ------------------ ------------------ ----------------- ------------------
Total $190,353 $200,000 $48,287 $438,640
==================== ================== ================== ================= ==================
(1) January 1, 1999 - September 30, 1999
</TABLE>
Of the $190.4 million of mortgage debt outstanding at December 31, 1998,
$168.6 million was nonrecourse to Real Estate Trust.
As the owner, directly and through two wholly-owned subsidiaries, of a
limited partnership interest in Saul Holdings Limited Partnership ("Saul
Holdings"), 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 provides for quarterly cash distributions to the
partners out of net cash flow. During the three-month period ended December 31,
1998, the Real Estate Trust received a cash distribution of $1.5 million from
Saul Holdings. Beginning in April 1998, the Real Estate Trust has reinvested its
quarterly distributions and obtained additional partnership units in Saul
Holdings.
Development and Capital Expenditures. In September 1997, the Real Estate
Trust commenced development of a 95-unit extended stay hotel on a 3 acre parcel
located adjacent to its Hampton Inn and Holiday Inn near the Washington Dulles
International Airport in Sterling, Virginia. The new hotel was franchised as a
TownePlace Suites by Marriott and opened for business in August 1998.
Development costs were $5.8 million and were largely financed by a construction
loan of $4.5 million. The loan is for two years with two extension options for
two year and one year periods, respectively. The loan covered 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 the Washington National Airport and the
Real Estate Trust's Howard Johnson 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 $52.5 million. The new loans have a 15 year term, a fixed interest
rate of 7.57%, and amortization based on a 25 year schedule.
<PAGE>
During the quarter ended June 30, 1998, the Real Estate Trust commenced
development of four new extended stay hotels:
TownePlace Suites by Marriott containing 91 units located on a 2 acre
site owned by the Trust in Avenel Business Park in Gaithersburg,
Maryland.
Opening is scheduled for May 1, 1999.
TownePlace Suites by Marriott containing 91 units located on part of a 9
acre site owned by the Real Estate Trust in the Arvida Park of
Commerce in Boca Raton, Florida. Opening is scheduled for August
1, 1999.
SpringHill Suites by Marriott containing 146 units located on part of a
9 acre site owned by the Real Estate Trust in the Arvida Park of
Commerce in Boca Raton, Florida. Opening is scheduled for August
1, 1999.
TownePlace Suites by Marriott containing 95 units located on a 3 acre
site owned by the Real Estate Trust in Ft. Lauderdale Commerce
Center, Ft. Lauderdale, Florida. Opening is scheduled for
August 1, 1999.
The projected costs for the four hotels aggregate $32 million and will
largely be funded by the proceeds of a three year bank loan in the amount of
$25.9 million. The loan has two one-year renewal options.
During the quarter ended June 30, 1998, the Real Estate also began
development of a 78,000 square floor single-story office/research and
development building located on a 7 acre site owned by the Real Estate Trust in
Dulles North Corporate Park, Sterling, Virginia. This project is adjacent to the
Real Estate Trust's Dulles North office building and near three of the Real
Estate Trust's hotel properties. The development cost is $6.6 million with bank
financing of $6.5 million for a five-year term and a two-year extension option.
Leases for approximately 42% of the space have been signed.
During the quarter ended September 30, 1998, the Real Estate Trust began
the conversion of its two hotels located in Crystal City, Arlington, Virginia.
The present 308-room Crystal City Holiday Inn will be converted into a Holiday
Inn Crown Plaza, while the present 279-room Howard Johnsons will be converted
into a Holiday Inn. The new brands are expected to position the hotels to
generate higher room rates and revenues along with improved occupancy levels
consistent with the overall market. The renovations are largely an acceleration
of normal capital improvement work as well as some exterior and interior
signage, new marketing materials and a facade upgrade at the Howard Johnson
hotel. A restaurant, which had been operated by an unaffiliated company, will
also be renovated. The incremental costs for the two conversions will be funded
by the Real Estate Trust in part from its internal resources and in part from
its lines of credit.
The Real Estate Trust believes that the capital improvement costs for
its income-producing properties will be in range of $6.5 to $8.0 million per
year for the next several fiscal years.
<PAGE>
Year 2000 Statement - Pursuant to The Year 2000 Information and Readiness
Disclosure Act.
The Real Estate Trust has reviewed all its financial and accounting
systems for the purpose of assessing the impact of year 2000 on both internally
developed and externally provided systems. The Real Estate Trust currently uses
an IBM AS/400, which has been certified by the manufacturer to be year 2000
compliant. All software purchased over the past five years has been certified by
the various manufacturers to be Year 2000 compliant. All internally developed
software has been modified to make it Year 2000 compliant. Property management
systems for shopping centers, officer buildings, hotels, and construction and
development have been certified as Year 2000 compliant by applicable vendors. At
present, only one area of property management, apartments, has software which
requires replacement to meet Year 2000 compliance, and that replacement is
scheduled to be completed by May 1999. The Real Estate Trust has no information
which would suggest that its financial systems will not continue to function
effectively after the turn of the century.
Using the Building Owners and Manager Association's guidelines to
identify building systems and critical services that might be vulnerable to the
Year 2000 software problem, the Real Estate Trust has contacted the
manufacturer, supplier, or vendor supporting the system and requested
information regarding Year 2000 compliance. The majority of the replies have
indicated that the systems or services are Year 2000 compliant. We are presently
assessing whether any of the internal systems should be tested or whether
further investigation is necessary. The Real Estate Trust has no information
which would suggest that any system will not continue to function effectively
after the turn of the century. Except with regard to internally developed
software, all information regarding Year 2000 compliance is based on a
republication (as defined in The Year 2000 Information and Readiness Disclosure
Act) of Year 2000 statements of disclosures made by others.
The Real Estate Trust believes that there is risk that its operations
may be affected by vendors and tenants who are unable to perform as contracted
due to their own Year 2000 exposure. It is very difficult to identify the most
reasonable likely worst case scenario at this time. Although the Real Estate
Trust's potential exposure is widespread, there is no known major direct
exposure. The Real Estate Trust's commercial leases contain provisions
empowering it to take certain actions to enforce its right to the timely payment
of rent regardless of the tenants's Year 2000 exposure. While it is not possible
at this time to determine the likely impact of these potential problems, the
Real Estate Trust will continue to evaluate these areas and develop contingency
plans as appropriate. The Real Estate estimates that its incremental cost to
meet year 2000 compliance is less than $250,000.
<PAGE>
BANKING
Liquidity. The required liquidity level under OTS regulations at December 31,
1998 was 4.0%. The Bank's average liquidity ratio for the quarter ended December
31, 1998 was 14.3%, compared to 10.4% for the quarter ended September 30, 1998.
The Bank did not securitize and sell any loan receivables during the current
quarter. As part of its operating strategy, the Bank will continue to explore
opportunities to sell assets and to securitize and sell home equity, automobile
and home loan receivables to meet liquidity and other balance sheet objectives.
See Note 4 to the Consolidated Financial Statements.
The Bank is obligated under various recourse provisions (primarily related to
credit losses) related to the securitization and sale of receivables. As a
result of these recourse provisions, the Bank maintained restricted cash
accounts and overcollateralization of receivables amounting to $98.2 million and
$12.2 million, respectively, at December 31, 1998, and $110.2 million and $12.5
million, respectively, at September 30, 1998, both of which are included in
other assets in the Consolidated Balance Sheets. In addition, the Bank owned
subordinated automobile receivables-backed securities with carrying values of
$9.6 million and $11.3 million at December 31, 1998 and September 30, 1998,
respectively, which were classified as trading securities in the Consolidated
Balance Sheets.
The Bank is also obligated under various recourse provisions related to the swap
of single family residential loans for mortgage-backed securities issued by the
Bank. At December 31, 1998, recourse to the Bank under these arrangements was
$8.6 million, consisting of restricted cash accounts amounting to $4.1 million
and overcollateralization of receivables of $4.5 million.
There were no material commitments for capital expenditures at December 31,
1998. During fiscal 1998, the Bank leased 3.5 acres of land at 7501 Wisconsin
Avenue in Bethesda, Maryland, on which the Bank intends to develop and occupy an
office building to use as its new corporate headquarters. Construction on this
project is scheduled to begin in June 1999.
The Bank's liquidity requirements in fiscal 1999 and for years subsequent to
fiscal 1999 will continue to be affected both by the asset size of the Bank, the
growth of which will be constrained by capital requirements, and the composition
of the asset portfolio. Management believes that the Bank's primary sources of
funds, described above, will be sufficient to meet the Bank's foreseeable
long-term liquidity needs. The mix of funding sources utilized from time to time
will be determined by a number of factors, including capital planning
objectives, lending and investment strategies and market conditions.
YEAR 2000 ISSUES
As part of its Year 2000 program, the Bank charged $2.4 million and $2.3
million, respectively to expense during the three months ended December 31, 1998
and the year ended September 30, 1998 and expects that an additional $4.0
million and $1.0 million will be charged to expense during the remainder of
fiscal 1999 and fiscal 2000, respectively. The Bank also expects to invest an
additional $4.8 million in equipment purchases, which will be amortized to
expense over the estimated useful lives of the equipment. The Bank's cost
estimates are based on variables and assumptions that could cause actual results
to differ from these projections.
<PAGE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 1998 COMPARED TO
THREE MONTHS ENDED DECEMBER 31, 1997
REAL ESTATE
The Real Estate Trust recorded a loss before depreciation and
amortization of $558,000 and an operating loss of $3.5 million in the
three-month period ended December 31, 1998 (the "1999 quarter") compared to a
loss before depreciation and amortization of $4.6 million and an operating loss
of $7.4 million in the three-month period ended December 31, 1997, (the "1998
quarter"). The changes reflect improved results in operations of hotels and
office and industrial properties, and in the Real Estate Trust's equity in
earnings (losses) of unconsolidated entities.
Income after direct operating expenses from hotels increased $1,480,000
(29.7%) in the 1999 quarter over the level achieved in the 1998 quarter.
$608,000 of this increase reflected improved results from the ten hotels owned
throughout both quarters, and $872,000 reflected results from acquisition
properties. The increase in total revenue of $2,856,000 (18.8%) exceeded the
increase of $ 1,376,000 (13.5%) in direct operating expenses. For the ten hotels
owned throughout both periods, the increase in total revenue was $672,000 (4.5%)
and the increase in direct operating expenses was $64,000 (0.6%). The revenue
increase was attributable to improved market conditions which permitted the Real
Estate Trust to raise average room rates.
Income after direct operating expenses from office and industrial
properties increased $464,000 (12.9%) in the 1999 quarter over the 1998 quarter.
Gross income, increased $423,000 (7.7%), while expenses decreased $41,000
(2.1%), principally due to lower property taxes and repairs and maintenance. The
improvement was due to additional space leased in the current period and higher
turnover rents.
Interest expense increased $80,000 (0.8%) in the 1999 quarter because of
higher average borrowings. Average balances of the Real Estate Trust's
outstanding borrowings increased to $442.4 million for the 1999 quarter from
$404.0 million for the 1998 quarter. Average interest rates in the 1999 and 1998
quarters were 9.48% and 10.22%, respectively.
Capitalized interest increased $189,000 in the 1999 quarter due to the
higher level of development activity in the current period.
Amortization of debt expense decreased $42,000 (30.0%) in the 1999
quarter, primarily due to lower costs experienced in the renewal of lines of
credit.
Depreciation increased $217,000 (8.2%) in the 1999 quarter as a
result of new hotel assets placed in service.
Advisory, management and leasing fees paid to related parties increased
$217,000 (10.6%) in the 1999 quarter from their level in the 1998 quarter. The
monthly advisory fees were $337,000 in the 1999 quarter, compared to $317,000 in
the 1998 quarter, an increase aggregating $59,000 (6.2%). Management and leasing
fees increased $158,000 (14.5%) in the current quarter, reflecting both higher
hotel sales and office rents on which the fees are based.
<PAGE>
General and administrative expense decreased $79,000 (20.7%) in the 1999
quarter, primarily due to lower accounting and holding company expense
($69,000).
Equity in earnings (losses) of unconsolidated entities reflected
earnings of $1,147,000 in the 1999 quarter and a loss of $1,339,000 in the 1998
quarter. The loss was attributable to nonrecurring charges for losses on sales
of interest rate protection agreements and losses on early extinguishment of
debt.
BANKING
Overview. The Bank recorded operating income of $7.3 million for the three
months ended December 31, 1998 (the "1998 quarter"), compared to operating
income of $29.4 million for the three months ended December 31, 1997 (the "1997
quarter"). The decrease in income for the current quarter was primarily due to
the effects of the credit card sale on September 30, 1998. Although the credit
card program has historically been a significant source of earnings for the
Bank, management believes that the Bank will be able to maintain profitability
by relying on its core deposit franchise as a significant source of low-cost
funds, and investing those funds in assets that, although offering lower yields
than credit cards, involve less credit risk and overhead costs. Nevertheless,
implementation of this strategy is a gradual process and the Bank's earnings for
the current quarter have been adversely affected because the immediate loss of
earnings from the credit card program has not yet been fully offset by
corresponding reductions in operating expenses. Decreases in credit card
interest income ($37.8 million), credit card fees ($13.8 million) and servicing
and securitization income ($93.2 million) during the 1998 quarter were partially
offset by an increase in single-family loan interest income ($25.3 million) and
decreases in the provision for loan losses ($31.3 million) and operating
expenses ($36.2 million).
Net Interest Income. Net interest income, before the provision for loan losses,
increased $9.5 million (or 19.4%) in the 1998 quarter. The Bank would have
recorded additional interest income of $0.7 million for the 1998 quarter if the
Bank's non-accrual assets and restructured loans had been current in accordance
with their original terms. The Bank's net interest income in future periods will
continue to be adversely affected by the Bank's non-performing assets. See
"Financial Condition - Asset Quality - Non-Performing Assets."
The following table sets forth, for the periods indicated, information regarding
the total amount of income from interest-earning assets and the resulting
yields, the interest expense associated with interest-bearing liabilities,
expressed in dollars and rates, and the net interest spread and net yield on
interest-earning assets.
<PAGE>
<TABLE>
Net Interest Margin Analysis
(Dollars in thousands)
Three Months Ended December 31,
----------------------------------------------------------------------------
1998 1997
------------------------------------- -------------------------------------
Average Yield/ Average Yield/
Balances Interest Rate Balances Interest Rate
------------- ----------- --------- ------------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans receivable, net (1) $ 3,477,289 $ 75,943 8.74 % $ 2,574,477 $ 74,495 11.57 %
Mortgage-backed securities 1,926,088 28,888 6.00 1,892,345 26,607 5.62
Federal funds sold and securities
purchased under agreements to resell 93,218 1,181 5.07 213,924 3,027 5.66
Trading securities 30,207 569 7.53 27,597 472 6.84
Investment securities 43,998 615 5.59 27,804 402 5.78
Other interest-earning assets 254,390 3,209 5.05 168,592 2,128 5.05
------------- ----------- ------------- -----------
Total 5,825,190 110,405 7.58 4,904,739 107,131 8.74
----------- --------- ----------- ---------
Noninterest-earning assets:
Cash 231,488 206,274
Real estate held for investment or sale 66,853 94,013
Property and equipment, net 283,652 274,908
Goodwill and other intangible assets, net 30,478 21,230
Other assets 221,304 474,658
------------- -------------
Total assets $ 6,658,965 $ 5,975,822
============= =============
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits $ 1,058,278 3,197 1.21 $ 929,530 5,828 2.51
Savings deposits 1,016,707 5,719 2.25 992,692 8,531 3.44
Time deposits 1,512,870 19,399 5.13 1,791,592 24,775 5.53
Money market deposits 1,034,453 8,913 3.45 970,999 9,645 3.97
------------- --------- ------------- ---------
Total deposits 4,622,308 37,228 3.22 4,684,813 48,779 4.16
Borrowings 948,856 14,874 6.27 507,732 9,513 7.49
------------- ----------- ------------- -----------
Total liabilities 5,571,164 52,102 3.74 5,192,545 58,292 4.49
----------- --------- ----------- ---------
Noninterest-bearing items:
Noninterest-bearing deposits 435,667 231,583
Other liabilities 70,826 80,218
Minority interest 144,000 144,000
Stockholders' equity 437,308 327,476
------------- -------------
Total liabilities and stockholders' equity $ 6,658,965 $ 5,975,822
============= =============
Net interest income $ 58,303 $ 48,839
=========== ===========
Net interest spread (2) 3.84 % 4.25 %
========= =========
Net yield on interest-earning assets (3) 4.00 % 3.98 %
========= =========
Interest-earning assets to interest-bearing liabilities 104.56 % 94.46 %
========= =========
- -------------------------------------------------------------------------------------------------------------------------
(1) Includes loans held for sale and/or securitization. Interest on non-accruing
loans has been included only to the extent reflected in the Consolidated
Statements of Operations; however, the loan balance is included in the average
amount outstanding until transferred to real estate acquired in settlement of
loans.
(2) Equals weighted average yield on total interest-earning assets less weighted
average rate on total interest-bearing liabilities.
(3) Equals annualized net interest income divided by the average balances of
total interest-earning assets.
</TABLE>
<PAGE>
The following table presents certain information regarding changes in interest
income and interest expense of the Bank during the periods indicated. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to changes in volume (change in
volume multiplied by old rate); changes in rate (change in rate multiplied by
old volume); and changes in rate and volume.
<PAGE>
<TABLE>
Volume and Rate Changes in Net Interest Income
(Dollars in thousands)
Three Months Ended December 31, 1998
Compared to
Three Months Ended December 31, 1997
Increase (Decrease)
Due to Change in (1)
---------------------------------------
Total
Volume Rate Change
---------- ----------- -----------
<S> <C> <C> <C>
Interest income:
Loans (2) $ 86,902 $ (85,454) $ 1,448
Mortgage-backed securities 476 1,805 2,281
Federal funds sold and securities
purchased under agreements to resell (1,558) (288) (1,846)
Trading securities 47 50 97
Investment securities 302 (89) 213
Other interest-earning assets 1,081 -- 1,081
---------- ----------- -----------
Total interest income 87,250 (83,976) 3,274
---------- ----------- -----------
Interest expense:
Deposit accounts (644) (10,907) (11,551)
Borrowings 14,947 (9,586) 5,361
---------- ----------- -----------
Total interest expense 14,303 (20,493) (6,190)
---------- ----------- -----------
Increase in net interest income $ 72,947 $ (63,483) $ 9,464
========== =========== ===========
- ---------------------------------------------------------------------------------------
(1) The net change attributable to the combined impact of volume and rate has
been allocated in proportion to the absolute value of the change due to volume
and the change due to rate.
(2) Includes loans held for sale and/or securitization.
</TABLE>
<PAGE>
Interest income in the 1998 quarter increased $3.3 million (or 3.1%) from the
level in the 1997 quarter as a result of higher average balances of loans
receivable, which was offset by lower average yields on loans receivable. Higher
average balances of real estate loans, consumer loans and commercial loans more
than offset the $1.1 billion dollar decrease in average credit card loans.
The Bank's net yield on interest-earning assets increased slightly to 4.00% in
the 1998 quarter from 3.99% in the 1997 quarter. The increase in the net yield
primarily reflected increased average balances of earning assets which were
funded with proceeds received from the sale of the credit card portfolio and
related operations on September 30, 1998. Average interest-earning assets as a
percentage of average interest bearing liabilities increased to 104.56% for the
1998 quarter compared to 94.46% for the 1997 quarter.
Interest income on loans, the largest category of interest-earning assets,
increased by $1.4 million (or 1.9%) from the 1997 quarter primarily because of
higher average balances. The Bank did not securitize and sell any receivables in
the three months ended December 31, 1998, which contributed to the higher
average balances. Lower average yields earned on the loan portfolio (due to the
effect of the credit card sale) offset the positive effect of the higher average
balances.
Higher average balances of the Bank's single-family residential loans, which
increased $1.5 billion (or 156.7%), resulted in a $25.3 million (or 141.1%)
increase in interest income from such loans. Lower average yields on
single-family residential loans partially offset the effects of the higher
average balances. Average balances of home equity loans, commercial loans and
real estate construction loans increased $98.2 million, $73.9 million and $57.2
million, respectively, and contributed to a $1.3 million, $1.4 million and $1.2
million increase in interest income from such loans, respectively. Lower average
yields on these loans partially offset the effects of the higher average
balances. Average balances of automobile loans increased $167.1 million, which,
when coupled with an increase in its average yield, resulted in an $8.7 million
(or 97.3%) increase in interest income from such loans.
The average yield on the loan portfolio in the 1998 quarter decreased 283 basis
points (to 8.74% from 11.57%) from the average yield in the 1997 quarter. The
decline in the net yield for the current quarter resulted from the sale of the
credit card portfolio on September 30, 1998. During the 1997 quarter, average
credit card loans totaled $1.1 billion with an average yield of 14.0%.
Interest income on mortgage-backed securities increased $2.3 million (or 8.6%)
primarily because of higher average balances and average yields. The effect of
the higher average balances of $33.7 million was coupled with an increase in the
average interest rates on these securities from 5.62% to 6.00%.
Interest expense on deposits decreased $11.6 million (or 23.7%) during the
current quarter due to decreased average rates and balances. A shift in the
deposit mix from certificates of deposits to lower yielding demand deposits
contributed to the 94 basis point reduction in the average rate on deposits (to
3.22% from 4.16%). Also, as a result of decreased market rates, the Bank lowered
its rates paid on deposits during fiscal year 1998.
The decrease in interest expense on deposits was partially offset by an increase
in interest expense on borrowings. Higher average balances of Federal Home Loan
Bank advances ($200.4 million) and repurchase agreement transactions ($197.4
million) primarily resulted in a $5.4 million (or 56.4%) increase in interest
expense on borrowings. This amount was partially offset by a 122 basis point
reduction in the average rate on borrowings (to 6.27% from 7.49%).
<PAGE>
Provision for Loan Losses. The Bank's provision for loan losses decreased to
$3.8 million in the 1998 quarter from $35.1 million in the 1997 quarter. The
$31.3 million decrease was primarily due to the elimination of provisions for
losses on credit card loans resulting from the sale of the credit card portfolio
on September 30, 1998. See "Financial Condition - Asset Quality Allowances for
Losses."
Other Income. Other (non-interest) operating income decreased to $29.5 million
in the 1998 quarter from $128.6 million in the 1997 quarter. The $99.1 million
(or 77.1%) decrease was primarily attributable to a decrease in servicing and
securitization income. Also contributing to the decrease in other income was the
elimination of credit card fees. Partially offsetting these decreases were an
increase in deposit servicing fees and a decrease in loss on real estate held
for investment or sale.
Servicing and securitization income decreased $93.2 million (or 93.2%) during
the current quarter and resulted primarily from decreased securitization
activity. During the quarter ended December 31, 1997, the Bank securitized and
sold $335.0 million, $230.1 million and $161.7 million of credit card,
automobile and home equity loan receivables, respectively, and recognized gains
of $16.3 million, $9.0 million and $7.2 million, respectively, on these
transactions. The Bank did not securitize and sell any loan receivables during
the current quarter. In addition, credit card loan servicing fees amounting to
$59.9 million for the quarter ended December 31, 1997 were eliminated as a
result of the September 30, 1998 sale.
The $4.9 million (or 99.0%) decrease in loss on real estate held for investment
or sale was primarily attributable to a decrease of $5.3 million in the
provision for losses on such assets. See "Financial Condition - Asset Quality -
Allowances for Losses."
Deposit servicing fees increased $4.1 million (or 35.2%) during the 1998 quarter
primarily due to increased fees recognized for servicing deposit accounts and
fees generated through the Bank's ATM network.
Operating Expenses. Operating expenses for the 1998 quarter decreased $36.2
million (or 32.1%) from the level in the 1997 quarter. The sale of the Bank's
credit card operations was primarily responsible for decreases in marketing
expenses ($17.4 million), loan expenses ($6.4 million) and data processing
expenses ($6.2 million) during the current quarter. Salaries and employee
benefits decreased $4.0 million (or 9.0%) also as a result of the sale.
Partially offsetting the decrease within salaries and employee benefits, were
additions of staff to the Bank's consumer lending department and branch
operations.
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this Item is included in Item 2 " Management's
Discussion and Analysis of Financial Condition and Results of Operations."
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K are set forth below.
EXHIBITS DESCRIPTION
---------- ------------------------------------------------------------------
3. (a) Amended and Restated Declaration of Trust filed with the
Maryland State Department of Assessments and Taxation on June 22,
1990 as filed as Exhibit 3(a) to Registration Statement No.
33-34930 is hereby incorporated by reference.
(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 as filed as Exhibit
3(b) to Registration Statement No. 33-34930 is hereby
incorporated by reference.
(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 filed
as Exhibit 4(a) to Registration Statement No. 33-34930 is hereby
incorporated by reference.
(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 filed as Exhibit 4(b) to Registration Statement No.
33-34930 is hereby incorporated by reference.
(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.
<PAGE>
EXHIBITS DESCRIPTION
---------- ------------------------------------------------------------------
(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 25, 1998 between the Trust and Norwest
Bank Minnesota, National Association, as Trustee, with respect to
the Trust's 9 3/4% Series B Senior Secured Notes due 2008, as
filed as Exhibit 4(a) to Registration Statement No. 333-49937 is
hereby incorporated by reference.
(l) Second Supplemental Indenture dated as of January 13, 1999 with
respect to the Trust's Notes due from One to Ten Years from Date
of Issuance as filed as Exhibit 4(l) to Registration Statement
No. 333-70753 is hereby incorporated by reference.
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 filed
as Exhibit 10(c) to Registration Statement No. 33-34930 is hereby
incorporated by reference.
<PAGE>
EXHIBITS DESCRIPTION
---------- ------------------------------------------------------------------
(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 subsidiaries filed as Exhibit
10(d) to Registration Statement No. 33-34930 is hereby
incorporated by reference.
(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) Amendment 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) subsidiaries filed as
Exhibit 10(o) to Registration Statement No. 33-34930 is hereby
incorporated by reference.
(g) Advisory Contract between B.F. Saul Advisory Company and Dearborn
Corporation dated as of December 31, 1992 filed as Exhibit 10(p)
to Registration Statement No. 33-34930 is hereby incorporated by
reference.
(h) Commercial Property Leasing and Management Agreement between
Dearborn Corporation and Franklin Property Company dated as of
December 31, 1992 filed as Exhibit 10(q) to Registration Statement
No. 33-34930 is hereby incorporated by reference.
(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, 1995 is hereby incorporated by reference.
(1) Registration Rights Agreement dated as of March 25, 1998 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. 333-49937 is hereby
incorporated by reference.
(m) Bank Stock Registration Rights Agreement dated as of March 25,
1998 between the Trust and Norwest Bank Minnesota, National
Association, as Trustee, filed as Exhibit 4(d) to Registration
Statement No. 333-49937 is hereby incorporated by reference.
(n) Written Agreement dated September 30, 1991 between the Office of
Thrift Supervision and Chevy Chase Savings Bank, F.S.B. filed as
Exhibit 10(f) to Registration Statement No. 33-34930 is hereby
incorporated by reference.
(o) Amendment to Written Agreement dated October 29, 1993 between the
Office of Thrift Supervision and Chevy Chase Savings Bank, F.S.B.
filed as Exhibit 10(u) to Registration Statement No. 33-34930 is
hereby incorporated by reference.
*27. Financial Data Schedules.
- -------------------
*Filed herewith.
(b) The Registrant did not file any reports on Form 8-K during the
fiscal quarter covered by this report.
<PAGE>
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
B. F. SAUL REAL ESTATE INVESTMENT TRUST
-----------------------------------------------
(Registrant)
Date: February 16, 1999 Stephen R. Halpin, Jr.
----------------- -----------------------------------------------
Vice President and Chief Financial Officer
Date: February 16, 1999 Ross E. Heasley
----------------- -----------------------------------------------
Vice President and Principal Accounting Officer
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This schedule contains summary financial information extracted from financial
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qualified in its entirety by reference to such financial statements, schedules
and other disclosure.
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0
0
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<CGS> 0
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<OTHER-EXPENSES> 5220
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<INCOME-PRETAX> (3532)
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<EPS-PRIMARY> 0
<EPS-DILUTED> 0
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This schedule contains summary financial information extracted from financial
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and other disclosure.
</LEGEND>
<MULTIPLIER> 1000
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<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> DEC-31-1998
<CASH> 324194
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 80000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 43998
<INVESTMENTS-MARKET> 44371
<LOANS> 4228403
<ALLOWANCE> 60157
<TOTAL-ASSETS> 0
<DEPOSITS> 5180975
<SHORT-TERM> 332470
<LIABILITIES-OTHER> 153005
<LONG-TERM> 1052430
0
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<TOTAL-LIABILITIES-AND-EQUITY> 0
<INTEREST-LOAN> 75943
<INTEREST-INVEST> 30072
<INTEREST-OTHER> 4390
<INTEREST-TOTAL> 110405
<INTEREST-DEPOSIT> 37228
<INTEREST-EXPENSE> 52102
<INTEREST-INCOME-NET> 58303
<LOAN-LOSSES> 3773
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 76730
<INCOME-PRETAX> 7317
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 0
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<YIELD-ACTUAL> 4.00
<LOANS-NON> 14760
<LOANS-PAST> 0
<LOANS-TROUBLED> 11800
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 60157
<CHARGE-OFFS> 4175
<RECOVERIES> 402
<ALLOWANCE-CLOSE> 60157
<ALLOWANCE-DOMESTIC> 60157
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
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<ARTICLE> CT
<LEGEND>
This schedule contains summary financial information extracted from financial
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qualified in its entirety by reference to such financial statements, schedules
and other disclosure.
</LEGEND>
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<PERIOD-TYPE> 3-MOS
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<PERIOD-END> DEC-31-1998
<TOTAL-ASSETS> 7606001
516
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<COMMON> 6642
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<TOTAL-LIABILITY-AND-EQUITY> 7606001
<TOTAL-REVENUES> 0
<INCOME-TAX> 6
<INCOME-CONTINUING> 3779
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<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2505)
<EPS-PRIMARY> (0.80)
<EPS-DILUTED> (0.80)
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