____________________________________________________________________________________________

 

SECURITIES AND EXCHANGE COMMISSION

 

Washington, DC  20549

 

FORM 10-K

 

FOR ANNUAL AND TRANSITION REPORTS 

PURSUANT TO SECTION 13 OR 15(d) OF THE 

SECURITIES EXCHANGE ACT OF 1934

 

|   | [ X ] | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES |
|--------|-------|-----------------------------------------------------------------|

|   | EXCHANGE ACT OF 1934 |
|--------|----------------------|

 

| For the fiscal year ended:  December 31, 2007 |
|-----------------------------------------------|

OR

|   | [ | ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES |
|--------|---|---|---------------------------------------------------------------------|

|   | EXCHANGE ACT OF 1934 |
|--------|----------------------|

 

For the transition period from _______________________________to___________________________________

 

**Commission File Number: 001-12477**

 

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

(Exact name of registrant as specified in its charter)

 

|   | **Maryland** | **52-1998335** |
|--------|--------------|----------------|

|   | (State or other jurisdiction of | (I.R.S. Employer Identification No.) |
|--------|---------------------------------|--------------------------------------|

    Incorporation or organization)

 

**7501 Wisconsin Avenue**

**Bethesda, Maryland 20814**

(Address of principal executive office) (Zip Code)

 

**(301) 987-2265**

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of Act:

 

| Title of each class | Name of each exchange on which registered |
|---------------------|-------------------------------------------|

| 10 3/8% Noncumulative Exchangeable | New York Stock Exchange, Inc. |
|------------------------------------|-------------------------------|

Preferred Stock, Series A

 

Securities registered pursuant to Section 12(g) of the Act:

N/A

(Title of class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

| Yes[ | ] | No [ X ] |
|------|---|----------|

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

| Yes[ | ] | No [ X ] |
|------|---|----------|

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

| Yes[ X ] | No [ | ] |
|----------|------|---|

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

| Large accelerated filer[ | ] | Accelerated filer[ | ] | Non-accelerated filer[ X ] | Smaller reporting company  [ | ] |
|--------------------------|---|--------------------|---|----------------------------|------------------------------|---|

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).

| Yes[ | ] | No [ X ] |
|------|---|----------|

 

The number of shares outstanding of the registrant’s sole class of common stock was 100 shares, $1.00 par value per share, as of March 15, 2008.  All of such shares were owned by Chevy Chase Bank, F.S.B.; therefore, no common stock was held by non-affiliates.

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**TABLE OF CONTENTS**

 

|   | **PART I** | **Page** |
|--------|------------|----------|
|   |       |     |  
**Item 1.**

**BUSINESS**.......................................................................................................

1

 
 

General............................................................................................................

1

 
 

Dividend Coverage...............................................................................................

1

 
 

Mortgage Assets..................................................................................................

1

 
 

Loan Portfolio Composition..................................................................................

1

 
 

Investment Policy.............................................................................................

3

 
 

Loan Payable to Parent.......................................................................................

4 

 
 

Credit Risk Management Policies...........................................................................

4

 
 

Delinquencies..................................................................................................

4

 
 

Geographic Distribution......................................................................................

4

 
 

Servicing..........................................................................................................

5

 
 

Dividend Policy...................................................................................................

5

 
 

The Bank..........................................................................................................

6

 
 

The Advisor......................................................................................................

6

 
 

Capital and Leverage Policies..................................................................................

6

 
 

Recently Issued Accounting Standards........................................................................

7

 
 

Employees.........................................................................................................

7

 
 

Competition.......................................................................................................

8

 
 

Environmental Matters..........................................................................................

8

 
 

Tax Status of the Company.....................................................................................

8

 
**Item 1A.**

**RISK FACTORS**................................................................................................

9

 
**Item 1B.**

**DISCLOSURE OF OUTSTANDING COMMENTS**.....................................................

15

 
**Item 2.**

**PROPERTIES**....................................................................................................

15

 
**Item 3.**

**LEGAL PROCEEDINGS**.....................................................................................

15

 
**Item 4.**

**SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**........................

15

 
 

 

 

 
 

**PART II**

 

 
 

 

 

 
**Item 5.**

**MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED**

**STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**....

16

 
 

Description of Common Stock.................................................................................

16

 
 

General..........................................................................................................

16

 
 

Dividends.......................................................................................................

16

 
 

Voting Rights...................................................................................................

16

 
 

Rights Upon Liquidation.....................................................................................

16

 
 

Description of Series A Preferred Shares.....................................................................

17

 
 

Market Information and Dividends.........................................................................

17

 
 

General.........................................................................................................

17

 
 

Automatic Exchange..........................................................................................

17

 
 

Voting Rights....................................................................................................

18

 
 

Redemption.....................................................................................................

18

 
 

Rights Upon Liquidation.....................................................................................

18

 
 

Independent Director Approval..............................................................................

19

 
**Item 6.**

**SELECTED FINANCIAL DATA**...........................................................................

19

 
**Item 7.**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL**

**CONDITION AND RESULTS OF OPERATIONS**.....................................................

20

 
 

Financial Condition..............................................................................................

20

 
 

 

 

Critical Accounting Policies.................................................................................

20

 

Allowance for Loan Losses..................................................................................

20

 

Residential Mortgage Loans.................................................................................

20

 

Real Estate Acquired in Settlement of Loans..............................................................

21

 

Interest Rate Risk..............................................................................................

21

 

Significant Concentration of Credit Risk..................................................................

22

 

Liquidity and Capital Resources............................................................................

22

 

Results of Operations............................................................................................

23

 

Year 2007 Compared to Year 2006........................................................................

23

 

Year 2006 Compared to Year 2005........................................................................

24

**Item 7A.**

**QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**.........

25

**Item 8.**

**FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**....................................

F-1

**Item 9.**

**CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS**

**ON ACCOUNTING AND FINANCIAL DISCLOSURE**..............................................

26

**Item 9A.**

**CONTROLS AND PROCEDURES**........................................................................

26

**Item 9B.**

**OTHER INFORMATION**....................................................................................

26

 

 

 

 

**PART III**

 

 

 

 

**Item 10.**

**DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**..........................

26

 

Directors and Executive Officers..............................................................................

26

 

Code of Business Conduct......................................................................................

28

 

Audit Committee.................................................................................................

28

 

Section 16(a) Beneficial Ownership Reporting Compliance...............................................

28

**Item 11.**

**EXECUTIVE COMPENSATION**..........................................................................

29

**Item 12.**

**SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS**

**AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**.........................

29

**Item 13.**

**CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**...............................

29

**Item 14.**

**PRINCIPAL ACCOUNTING FEES AND SERVICES**................................................

30

 

 

 

 

**PART IV**

 

 

 

 

**Item 15.**

**EXHIBITS, FINANCIAL STATEMENT SCHEDULES**..............................................

31

 

**PART I**

 
 
**ITEM 1.**

**BUSINESS**

 

**GENERAL**

 

Chevy Chase Preferred Capital Corporation (the “Company”) is a Maryland corporation which acquires, holds and manages real estate mortgage assets (“Mortgage Assets”).  The Company has elected to be treated as a real estate investment trust (a “REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”), and generally will not be subject to federal income tax to the extent that it distributes its earnings to its stockholders and maintains its qualification as a REIT. All of the shares of the Company’s common stock, par value $1.00 per share (the “Common Stock”), are owned by Chevy Chase Bank, F.S.B., a federally chartered and federally insured stock savings bank (the “Bank”).  As of December 31, 2007, the Bank was in compliance with its regulatory capital requirements.  The Bank services the Company’s Residential Mortgage Loans(as defined below) and administers the day-to-day operations of the Company.  The Company has outstanding 3,000,000 shares of 10 3/8% Noncumulative Exchangeable Preferred Stock, Series A, par value $5.00 per share (the “Series A Preferred Shares”).  The Series A Preferred Shares are listed on the New York Stock Exchange (symbol CCP-PrA).

 

**DIVIDEND COVERAGE**

 

Based on the outstanding balance of the Company’s Residential Mortgage Loans (as defined below) at December 31, 2007, and the interest rates on those loans, the Company anticipates that annual income, net of interest expense and operating expenses, on the Company’s loan portfolio will be approximately 114.3% of the projected annual dividend of $15,562,500 on the Series A Preferred Shares.

 

**MORTGAGE ASSETS**

 

**Loan Portfolio Composition**

 

The Company’s current portfolio of Mortgage Assets consists of loans secured by first mortgages or deeds of trust (“Mortgage Loans”) on single-family residential real estate properties (“Residential Mortgage Loans”).  The following table sets forth information concerning the Company’s Residential Mortgage Loans as of December 31, 2007 and December 31, 2006. All of the Mortgage Loans were acquired from the Bank.  A description of the types of Residential Mortgage Loans included in the Company’s portfolio follows the table.

 

 

Residential Mortgage Loan Portfolio

 

December 31,

 

2007

 

2006

Type

Aggregate

Principal

Balance

 

Weighted Average Yield

 

Percent

to

Total

 

Aggregate

Principal Balance

 

Weighted Average

Yield 

 

Percent

to

Total

Payment Option ARMs

$ 15,364,697

 

7.98%

 

5.2%

 

$  33,880,718

 

8.12%

 

9.8%

One-Year ARMs

3,808,186

 

7.65%

 

1.3%

 

5,109,950

 

7.65%

 

1.5%

Three-Year ARMs

17,315,273

 

6.76%

 

5.8%

 

21,001,902

 

6.92%

 

6.1%

Five-Year ARMs

196,054,307

 

6.19%

 

66.3%

 

211,433,598

 

6.15%

 

61.0%

7/1 ARMs

2,025,360

 

7.86%

 

0.7%

 

2,512,271

 

7.93%

 

0.7%

10/1 ARMs

8,215,892

 

6.80%

 

2.8%

 

9,822,378

 

6.70%

 

2.8%

15 & 30 Year Fixed-Rate

52,951,803

 

6.41%

 

17.9%

 

62,610,120

 

6.40%

 

18.1%

 

295,735,518

 

6.40%

 

100%

 

346,370,937

 

6.48%

 

100.0%

Less:

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

160,000

 

 

 

 

 

40,333

 

 

 

 

Total

$295,575,518

 

 

 

 

 

$346,330,604

 

 

 

 

 

 

-1-

 

During the year ended December 31, 2007, the Company used principal collections totaling $70,956,034 to purchase $21,200,366 of Residential Mortgage loans from the Bank and to repay $47,700,000 of borrowings from the Bank.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Residential Mortgage Loans.”

 

Eighty-two percent of the Residential Mortgage Loans included in the Company’s portfolio at December 31, 2007 bear interest at adjustable rates.  The interest rate on an adjustable rate mortgage (“ARM”) resets periodically based on an index (such as the London Interbank Offered Rate (“LIBOR”) or the interest rate on United States Treasury Securities).  ARMs are typically subject to lifetime interest rate caps and may be subject to periodic interest rate adjustment caps.  As of December 31, 2007, the weighted average yield on the Residential Mortgage Loans included in the Company’s portfolio was 6.40%.  For the year ended December 31, 2007, the weighted average yield was 6.42%.

 

The interest rate on each type of ARM included in the Company’s portfolio adjusts at the time (the “Rate Adjustment Date”) and in the manner described below.  If specified in the related mortgage note, an ARM may be subject to lifetime interest rate adjustment caps, to minimum interest rates and to maximum periodic adjustment increases or decreases.  Information set forth below regarding interest rate adjustment caps and minimum interest rates applies to the current portfolio only.  Residential Mortgage Loans purchased by the Company after December 31, 2007 may be subject to different terms.

 

Each ARM bears interest at its initial interest rate until the first Rate Adjustment Date.  On each Rate Adjustment Date, the monthly payment on an ARM will be adjusted based on the ARM type.  For all ARMs other than those that provide the borrower with a variety of payment options (“Payment Option ARMs”), on each Rate Adjustment Date the payment is re-calculated to an amount that will fully amortize the then-outstanding principal balance of the loan over its remaining term to stated maturity.  Most Payment Option ARMs allow the borrower to make a minimum payment, which can be less than the amount of interest actually due.  This minimum payment is re-calculated when the loan reaches the maximum negative amortization threshold or on the dates specified in the note.  The minimum payment on some Payment Option ARMs is equal to the amount of interest due (interest-only payment) and changes each month. Certain ARMs contain an option, which may be exercised by the mortgagor, to convert the ARM into a fixed-rate loan for the remainder of the mortgage term.   If an ARM is converted into a fixed-rate loan, the interest rate on the fixed-rate loan will be determined at the time of conversion as specified in the mortgage note and will remain fixed at that rate for the remaining term of the loan.  The Company’s current policy is to retain these fixed-rate loans in its portfolio.  All Residential Mortgage Loans included in the portfolio allow the mortgagor to repay, at any time, some or all of the outstanding principal balance of the loan, although some loans provide for payment of a fee or penalty if prepaid in full up to three years after origination.

 

Payment Option ARMS.  Payment Option ARMs have interest rates that adjust monthly on each Rate Adjustment Date as specified in the related mortgage note to a rate equal to the sum (rounded as specified in the note) of the index and the related margin, subject to certain limitations.  The initial payment on each Payment Option ARM is based on an initial interest rate, which is lower, and may be significantly lower, than the sum of the index and the margin.  No Payment Option ARM contains a periodic interest rate adjustment cap; however, the interest rate may not exceed the maximum interest rate specified for such Payment Option ARM in the related mortgage note.  The amount of the minimum monthly payment due on most Payment Option ARMs adjusts, on the dates and in the manner specified in the related mortgage note, to an amount that would fully amortize the outstanding principalbalance of the mortgage loan over its remaining term to maturity at the interest rate applicable.  The minimum payment on some Payment Option ARMs is equal to the amount of interest due (interest-only payment) and changes each month.  The option to make an interest-only payment on these loans terminates with the 61st monthly payment, at which time the minimum payment adjusts to an amount that would fully amortize the outstanding principal balance of the mortgage loan over its remaining term to maturity at the then-current interest rate.

 

The Company’s Payment Option ARMs provide the borrower with a variety of monthly payment options.  At December 31, 2007, approximately $13.9 million of the Company’s Payment Option ARMs have a payment option that could result in interest being added to the principal of the loan, or “negative amortization.”  During 2007, the 

 

-2-

Company collected $0.4 million of deferred interest on its Payment Option ARMs.  At December 31, 2007, approximately $0.6 million of cumulative deferred interest was due on these loans.  Each loan contains terms which limit the amount of negative amortization to a percentage of the original loan amount, generally 10%.  The minimum payment required on the remaining $1.5 million of Payment Option ARMs is an interest only payment.

 

One-Year ARM.  Each one-year ARM bears interest at a rate that is fixed for the first twelve monthly payments and adjusts on the date specified in the related mortgage note, and annually thereafter, to a rate equal to the then-current applicable index plus the margin set forth in such mortgage note, subject to a maximum annual interest rate increase or decrease, and a lifetime interest rate adjustment cap.

 

Three-Year ARM.  Each three-year ARM bears interest at a rate that is fixed for the first 36 monthly payments and adjusts on the date specified in the related mortgage note, and periodically thereafter, to a rate equal to the then-current applicable index plus the margin set forth in such mortgage note, subject to a maximum periodic interest rate increase or decrease, and a lifetime interest rate adjustment cap.  Most of these loans allow the borrowers to make an interest-only payment during the fixed period.  

 

Five-Year ARM.  Each five-year ARM bears interest at a rate that is fixed for the first 60 monthly payments and adjusts on the date specified in the related mortgage note, and periodically thereafter, to a rate equal to the then-current applicable index plus the margin set forth in such mortgage note, subject to a maximum periodic interest rate increase or decrease, and a lifetime interest rate adjustment cap.  Most of these loans allow the borrowers to make an interest-only payment during the fixed period.  Certain of these loans contain an option, which may be exercised by the mortgagor, to convert the ARM into a fixed-rate loan for the remainder of the mortgage term.

 

Seven-Year Fixed-Rate Loan with Automatic Conversion to One-Year ARM.  The interest rate with respect to each seven-year fixed-rate loan with automatic conversion to a One-Year ARM (a “7/1 ARM”) is fixed for the first 84 monthly payments and adjusts on the date specified in the related mortgage note, and annually thereafter, to a rate equal to the then-current applicable index plus the margin set forth in such mortgage note, subject to a maximum annual interest rate increase or decrease, and a lifetime interest rate adjustment cap.  There is no ability to continue at a fixed rate after the first Rate Adjustment Date under the terms of this type of Residential Mortgage Loan.

 

Ten-Year Fixed-Rate Loan With Automatic Conversion to One-Year ARM.  The interest rate with respect to each ten-year fixed-rate loan with automatic conversion to a One-Year ARM (a “10/1 ARM”) is fixed for the first 120 monthly payments and adjusts on the date specified in the related mortgage note, and annually thereafter, to a rate equal to the then-current applicable index plus the margin set forth in such mortgage note, subject to a maximum annual interest rate increase or decrease, and a lifetime interest rate adjustment cap.  There is no ability to continue at a fixed rate after the first Rate Adjustment Date under the terms of this type of Residential Mortgage Loan. 

 

**Investment Policy**

 

General.  The Company currently intends to maintain at least 95% of its portfolio in Mortgage Assets consisting of either Residential Mortgage Loans or investment grade mortgage-backed securities representing interests in pools of Mortgage Loans (“Mortgage-Backed Securities”) and may invest up to 5% of its portfolio in Mortgage Loans secured by commercial real estate properties or multi-family properties (“Commercial Mortgage Loans”) or in other assets eligible to be held by a REIT, cash and cash equivalents.  The Company’s current policy prohibits the acquisition of any Mortgage Loan or any interest in a Mortgage Loan (other than an interest resulting from the acquisition of Mortgage-Backed Securities) if the Mortgage Loan (i) is delinquent in the payment of principal and interest; (ii) is or was at any time during the preceding 12 months (a) classified,(b) in nonaccrual status or (c) renegotiated due to the financial deterioration of the borrower; or (iii) has been, more than once during the preceding 12 months, more than 30 days past due in the payment of principal or interest.  Loans that are in “non-accrual status” are generally loans that are past due 90 days or more in principal or interest, and “classified” loans are generally troubled loans which are deemed substandard or doubtful with respect to collectibility.

 

The Company may, from time to time, acquire both conforming and nonconforming Residential Mortgage Loans.  Conventional conforming Residential Mortgage Loans comply with the requirements for inclusion in a loan 

 

-3-

guarantee program sponsored by either Freddie Mac or the Fannie Mae.  The nonconforming Residential Mortgage Loans that the Company purchases will be nonconforming generally because they have original principal balances which exceed the limits for Freddie Mac or Fannie Mae programs.

 

Mortgage-Backed Securities.  While no Mortgage-Backed Securities are included in the current Mortgage Asset portfolio, the Company may, from time to time, acquire fixed-rate or variable-rate Mortgage-Backed Securities.  A portion of any Mortgage-Backed Securities that the Company may purchase may have been originated by the Bank by exchanging pools of Mortgage Loans for the Mortgage-Backed Securities. The Mortgage Loans underlying the Mortgage-Backed Securities will be secured by single-family residential properties.

 

The Company currently intends to acquire only investment grade Mortgage-Backed Securities issued by agencies of the Federal government or government sponsored agencies, such as Freddie Mac, Fannie Mae and Ginnie Mae.  The Company does not currently intend to acquire any interest-only or principal-only Mortgage-Backed Securities.

 

Commercial Mortgage Loans.  While no Commercial Mortgage Loans are included in the current portfolio, the Company may, from time to time, acquire Commercial Mortgage Loans secured by industrial and warehouse properties, recreational facilities, office buildings, retail space and shopping malls, hotels and motels, hospitals, nursing homes or senior living centers.

 

**Loan Payable to Parent**

 

On December 20, 2004, the Company borrowed $75,000,000 from the Bank.  The Company used the proceeds to purchase Residential Mortgage Loans from the Bank.  The loan was secured by a portion of the Residential Mortgage Loan portfolio.  Interest on the loan adjusted monthly based on one-month LIBOR plus a specified margin and was payable monthly.

 

During the year ended December 31, 2007, the Company repaid the remaining balance of $47,700,000 on the loan.

 

**Credit Risk Management Policies**

 

The Company intends that each Mortgage Loan it acquires will represent a first lien position and will be originated in the ordinary course of the originator’s real estate lending activities based on the underwriting standards generally applied (at the time of origination) for the originator’s own account.  The Company also intends that all Mortgage Loans held by the Company will be serviced pursuant to the servicing agreement between the Company and the Bank (the “Servicing Agreement”).  See “Servicing.”

 

**Delinquencies**

 

When a borrower fails to make a required payment on a Mortgage Loan, the loan is considered delinquent and, after expiration of the applicable cure period, the borrower is charged a late fee, which is retained by the Servicer (as defined below).  The Bank and the Company follow practices customary in the banking industry in attempting to cure delinquencies and in pursuing remedies upon default.

 

**Geographic Distribution**

 

Residential Mortgage Loans secured by residential real estate properties located in the Washington, DC metropolitan area comprised 54.5% of total loans at December 31, 2007.  In addition, 12.0% of the Residential Mortgage Loans are secured by residential real estate properties located in California.  Consequently, adverse economic, political, or business developments in the Washington, DC metropolitan area and California may affect the Company’s loan portfolio to a greater degree than a more diversified portfolio.  See “Risk Factors – Continued deteriorating conditions in the U.S. housing markets may lead to increased losses on loans.”

 

-4-

**SERVICING**

 

The Residential Mortgage Loans owned by the Company are serviced by the Bank (the “Servicer”) pursuant to the terms of the Servicing Agreement.  The Company pays a servicing fee to the Bank equal to 0.250% of the outstanding loan balance.  See “Certain Relationships and Related Transactions.”

 

The Servicing Agreement requires the Servicer to service the Company’s Mortgage Loans in a manner generally consistent with accepted secondary market practices, with any servicing guidelines promulgated by the Company and, in the case of Residential Mortgage Loans, with Fannie Mae and Freddie Mac guidelines and procedures.  The Servicing Agreement requires the Servicer to service these loans solely with a view toward the interests of the Company and without regard to the interests of the Bank or any of the Bank’s affiliates.  The Servicer collects and remits principal and interest payments, administers mortgage escrow accounts, submits and pursues insurance claims and initiates and supervises foreclosure proceedings on the loans it services.  The Servicer also provides accounting and reporting services required by the Company for such loans.  The Servicing Agreement requires the Servicer to followsuch collection procedures as are customary in the industry, including contacting delinquent borrowers and supervising foreclosures and property disposition in the event of unremedied defaults in accordance with servicing guidelines promulgated by the Company.  The Servicer may, in its discretion, arrange with a defaulting borrower a schedule for the liquidation of delinquencies, provided that, in the case of Residential Mortgage Loans, no primary mortgage guaranty insurance coverage is adversely affected.

 

The Servicer is entitled to retain any ancillary fees, including, but not limited to, late payment charges, prepayment fees, penalties and assumption fees collected in connection with the Mortgage Loans serviced by it.  In addition, the Servicer is entitled to receive any benefit derived from interest earned on collected principal and interest payments between the date of collection and the date of remittance to the Company and from interest earned on tax and insurance impound funds with respect to Mortgage Loans serviced by the Servicer.

 

The Servicer is required to pay all expenses related to the performance of its duties under the Servicing Agreement.  The Servicer is required to make advances of taxes and required insurance premiums that are not collected from borrowers with respect to any Mortgage Loan serviced by it, unless it determines that such advances are not recoverable from the mortgagor, insurance proceeds or other sources with respect to such Mortgage Loan.

 

The Company can terminate the Servicing Agreement without cause, provided it gives at least sixty days’ notice to the Servicer and pays a termination fee.

 

**DIVIDEND POLICY**

 

The Company expects to pay an aggregate amount of dividends each year with respect to its outstanding shares of stock equal to approximately 100% of the Company’s “REIT taxable income” for such year.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations.”

 

Dividends are declared at the discretion of the Board of Directors of the Company after considering the Company’s distributable funds, financial requirements, tax considerations and other factors.  The Company’s distributable funds consist primarily of interest payments received on its Mortgage Assets. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Interest Rate Risk.”

 

Under Office of Thrift Supervision (“OTS”) regulations, the Bank is 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 OTS regulations.  Dividends on the Series A Preferred Shares are not treated as capital distributions for the purposes of these regulations, provided the Bank remains “well capitalized” after the payment.  At December 31, 2007, the Bank’s capital ratios exceeded the ratios established for “well capitalized” institutions under OTS regulations.

 

 

-5-

**THE BANK**

 

The Bank is a federally chartered and federally insured stock savings bank which, at December 31, 2007, was conducting business from 288 full-service offices, including 54 grocery store banking centers, and over 1,000 automated teller machines in Maryland, Virginia, Delaware and the District of Columbia.  The Bank’s home office is located in McLean, Virginia and its executive offices are located in Bethesda, Maryland, both suburban communities of Washington, DC.  The Bank either directly or through a wholly-owned subsidiary also maintains two commercial loan production offices located in Baltimore, Maryland and Northern Virginia and nine mortgage loan production offices in the mid-Atlantic region.  At December 31, 2007, the Bank had total assets of $15.3 billion, total deposits of $11.1 billion and total stockholders’ equity of $826.7 million.  Based on total assets at December 31, 2007, the Bankis the largest full-service bank headquartered in the Washington, DC metropolitan area.

 

The Company is a subsidiary of the Bank and, therefore, federal regulatory authorities have the right to examine the Company and its activities.  Payment of dividends on the Series A Preferred Shares could be subject to regulatory limitations if after the payment the Bank was not “well capitalized” under OTS regulations.  See “Risk Factors – Our ability to pay dividends could be affected by regulatory restrictions on our operations.”

 

**THE ADVISOR**

 

In 1996, the Company entered into an advisory agreement (the “Advisory Agreement”) with the Bank (the “Advisor”) to administer the day-to-day operations of the Company.  The Advisor is principally responsible for: (i) monitoring the credit quality of the Mortgage Assets held by the Company, (ii) advising the Company with respect to the acquisition, management and financing of the Company’s Mortgage Assets, and (iii) maintaining the custody of the documents related to the Company’s Mortgage Loans.  The Advisor may from time to time subcontract all or a portion of its obligations under the Advisory Agreement to one or more of its affiliates involved in the business of managing Mortgage Assets.

 

The Advisor and its affiliates have substantial experience in the mortgage lending industry, both in the origination and in the servicing of mortgage loans.  At December 31, 2007, the Advisor and its affiliates owned approximately $8.3 billion of residential mortgage loans, including all of the Company’s Residential Mortgage Loans.  In their residential mortgage loan business, the Advisor and its affiliates originate and purchase residential mortgage loans.  A portion of those loans are sold to investors, primarily in the secondary market, generally on a servicing retained basis.  The Advisor and its affiliates may purchase servicing rights on residential mortgage loans.  Including loans serviced for its own portfolio and loans serviced for the Company, the Advisor and its affiliates serviced residential mortgage loans having an aggregate principal balance of approximately $21.2 billion as of December 31, 2007.

 

The Advisory Agreement had an initial term of three years and is renewed automatically for additional one-year periods unless notice of nonrenewal is delivered to the Advisor by the Company.  The Advisory Agreement may be terminated by the Company at any time upon sixty days’ prior written notice.  As long as any Series A Preferred Shares remain outstanding, any decision by the Company either to not renew the Advisory Agreement or to terminate the Advisory Agreement must be approved by a majority of the Board of Directors, as well as by a majority of the Independent Directors (as defined below under “Market for Registrant’s Common Equity and Related Stockholder Matters”).  The Advisor is entitled to receive an annual advisory fee equal to $200,000, payable in equal quarterly installments, with respect to the advisory and management services provided to the Company.  See “CertainRelationships and Related Transactions.”

 

**CAPITAL AND LEVERAGE POLICIES**

 

To the extent that the Board of Directors determines that additional funding is required, the Company may raise those funds through additional equity offerings, debt financing or retention of cash flow (after consideration of provisions of the Code requiring the distribution by a REIT of a certain percentage of taxable income and taking into account taxes that would be imposed on undistributed taxable income, including capital gains), or a combination of these methods.

 

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At December 31, 2007, the Company had no debt outstanding.  The Company does not currently intend to incur additional indebtedness, however, the organizational documents of the Company do not contain any limitation on the amount or percentage of debt, funded or otherwise, that the Company might incur.  The Company may not, without the approval of a majority of the Independent Directors, incur debt for borrowed money in excess of 25% of the Company’s total stockholders’ equity, including intercompany advances made by the Bank to the Company.

 

The Company may also issue additional series of Preferred Stock (as defined below under “Market for Registrant’s Common Equity and Related Stockholder Matters”).  However, the Company does not currently intend to issue any additional series of Preferred Stock unless it simultaneously receives additional capital contributions from the Bank equal to the sum of the aggregate offering price of such additional Preferred Stock and the Company’s expenses in connection with the issuance of such additional shares of Preferred Stock.  Prior to its issuance of additional shares of Preferred Stock, the Company will take into consideration the Bank’s regulatory capital requirements and the cost of raising and maintaining that capital at the time.

 

The Company may redeem its Series A Preferred Shares subject to payment of a redemption premium which declines annually over each of the next four years.  See “Redemption.”

 

**RECENTLY ISSUED ACCOUNTING STANDARDS**

 

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”).   SFAS 159 is effective for fiscal years beginning after November 15, 2007, but early adoption is permitted.  Upon adoption, SFAS 159 allows entities to make a one-time irrevocable election to measure certain existing financial assets and liabilities at fair value and report the unrealized gains and losses on those items in earnings at each subsequent reporting date.  When adopting SFAS 159, entities must also adopt SFAS 157, “Fair Value Measurements,” issued in September 2006, which defines fair value and outlines the hierarchy of inputs that should be used when calculating fair value.  The Company did not elect fair value treatment for any assets.  

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).  SFAS 157 eliminates the diversity in practice that exists due to the different definitions of fair value and the limited guidance for applying those definitions that are dispersed among the many accounting pronouncements that require fair value measurements.  SFAS 157 clarifies the definition of fair value as an exit price and defines the exit price as the price in an orderly transaction between market participants to sell an asset or to settle a liability in the principal or most advantageous market for the asset or liability.  Furthermore, SFAS 157 establishes a three-level fair value hierarchy that distinguishes between (i) market participant assumptions developed from independent and observable inputs and (ii) the reporting entity’s own assumptions about market participant assumptionsdeveloped from unobservable inputs.  SFAS 157 is effective for fiscal years beginning after November 15, 2007.  Management does not expect the adoption of SFAS 157 to have a material impact on the Company’s financial condition or results of operations.

 

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”).  FIN 48 clarifies the requirements of SFAS No. 109, “Accounting for Income Taxes,” relating to the recognition of income tax benefits.  FIN 48 provides a two-step approach to recognizing and measuring tax benefits when realization of the benefits is uncertain.  The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%.  FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The adoption of FIN 48 on January 1, 2007, had no impact on the Company's financial condition or results of operations.

 

**EMPLOYEES**

 

The Company has eight officers.  The executive officers of the Company are described further below under “Directors and Executive Officers of the Registrant – Directors and Officers.”  The Company does not anticipate that it will require any additional employees because it has retained the Advisor to administer the day-to-day 

 

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activities of the Company pursuant to the Advisory Agreement.  Each officer of the Company currently is also an officer and/or director of the Bank and/or affiliates of the Bank.  The Company maintains corporate records and obtains audited financial statements that are separate from those of the Bank or any of the Bank’s other affiliates.

 

**COMPETITION**

 

The Company does not anticipate that it will engage in the business of originating Residential Mortgage Loans.  It does anticipate that it will purchase Mortgage Assets in addition to those in the current loan portfolio and that all such Mortgage Assets will be purchased from the Bank or affiliates of the Bank.  Accordingly, the Company does not expect to compete with mortgage conduit programs, investment banking firms, savings and loan associations, banks, finance companies, mortgage bankers or insurance companies in acquiring its Mortgage Assets.  However, the Bank and its affiliates face competition with these types of entities in originating the residential mortgage loans that the Company purchases from the Bank. The Bank’s major competition comes from local, regional, national and international financial institutions and other providers of financial services. 

 

**ENVIRONMENTAL MATTERS**

 

In the event that the Company is forced to foreclose on a defaulted Mortgage Loan to recover its investment in such Mortgage Loan, the Company may be subject to environmental liabilities in connection with the underlying real property which could exceed the value of the real property.  See “Risk Factors – Environmental liabilities could reduce the value of the properties securing a defaulted Mortgage Loan, which could require us to make significant expenditures or make it difficult or impossible to sell the properties.”

 

**TAX STATUS OF THE COMPANY**

 

The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Code.  As a REIT, the Company generally will not be subject to federal income tax on its net income (excluding capital gains) provided that it distributes annually 100% of its REIT taxable income to its stockholders, meets certain organizational, stock ownership and operational requirements and meets certain income and asset tests. To remain qualified as a REIT, the Company must (a) distribute each year at least 90% of its “REIT taxable income” (not including capital gains) for that year to stockholders, (b) meet certain income tests, (c) meet certain asset tests and (d) meet certain ownership tests.  If in any taxable year the Company fails to qualify as a REIT, the Company would not be allowed a deduction for distributions to stockholders in computing its taxable income and would be subject to federal and stateincome tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates.  In addition, the Company would be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost.

 

On March 11, 2008, the Company’s Board of Directors declared a cash dividend of $1,896.60 per share of Common Stock, which was paid out of retained earnings of the Company and which was treated, for tax purposes, as a distribution made for 2007.  Including this dividend, the Company will have distributed 100% of its REIT taxable income to its stockholders in 2007.  During the year ended December 31, 2006, the Company distributed over 100% of its REIT taxable income to its stockholders.

 

There are two income tests that must be satisfied for each taxable year.
 
 

**•**

At least 75% of the Company’s gross income (excluding income from certain prohibited transactions) must be from interest on obligations secured by mortgages on real property or on interests in real property, gains from the sale or other disposition of real property (including interests in mortgages on real property), and certain other sources;
  
 

**•**

At least 95% of the Company’s gross income (excluding income from prohibited transactions) must be from income included under the 75% income test, other interest, dividends, and gains from the sale or other disposition of certain stocks and securities.
 
 

 

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There are three relevant asset tests that must be satisfied at the close of each quarter of the Company’s taxable year.
 
 

**•**

At least 75% of the value of the Company’s total assets must be represented by real estate assets, cash, cash items, and government securities;
  
 

**•**

Not more than 25% of the Company’s total assets may be represented by securities other than those in the 75% asset class; and
  
 

**•**

The value of any one issuer’s securities included in the 25% asset class may not exceed 5% of the value of the Company’s total assets and the Company may not own more than 10% of the total voting power or value of the outstanding securities of any one issuer.
 
 

The stock ownership test has two components.  At least 100 persons must hold shares of capital stock for at least 335 days of the year and no more than 50% of the Company’s capital stock may be owned directly or indirectly by five or fewer individuals during the final six months of the calendar year.

 

During 2007, the Company met the requirements of each test.

 
 
**ITEM 1A.**

**RISK FACTORS**

 

***Continued deteriorating conditions in the U.S. housing markets and the general economy may lead to increased losses on loans.***

 

Deteriorating conditions in the U.S. housing market and the general economy during recent periods have resulted in increased balances of non-accrual loans and increased levels of losses reported by owners of mortgage loans.  The combination of lower volumes of home sales transactions, longer marketing periods, growing inventories of unsold homes and increased foreclosure rates has exerted downward pressure on housing prices in many parts of the country, including markets such as the Washington, DC area and California in which the Company has a significant concentration of its residential mortgage loans.  As a result, property values have declined in most markets.  Faced with these conditions, and increases in their monthly payments due to interest rate or other adjustments to their loans, some borrowers have been unable to either refinance or sell their properties and consequently have defaulted on theirloans.  In addition, as lenders tighten underwriting guidelines for loan products offered and adjust loan pricing to reflect market conditions, refinancing is made more difficult.  Although these conditions have thus far had only a relatively minor effect on the Company, if market conditions in the U.S. housing market continue to deteriorate, our financial results could be adversely impacted.

 

***If our allowance for losses is not sufficient to absorb losses in our loan portfolio, it will adversely affect our financial condition and results of operations and may affect our ability to pay dividends.***

 

Some borrowers may not repay loans that we make to them.  We record on our financial statements an allowance for possible losses from our loan portfolio, which reflects management’s best estimates of losses, both known and inherent, in the portfolio.  However, we cannot predict losses with certainty.  It is possible that we will suffer losses in excess of our allowance for losses, or that future evaluations of our asset portfolio will require significant increases in the allowance for losses as a result of changes in economic conditions, regulatory examinations or our own internal review process.  In this event, our financial condition and results of operations will be adversely affected, and our ability to pay dividends may also be affected.

 

***Our ability to pay dividends could be affected by regulatory restrictions on our operations.***

 

Because we are a subsidiary of the Bank, federal regulators have the right to examine us and our activities.  Under certain circumstances, including if they make a determination that the Bank’s relationship to us results in an unsafe and unsound banking practice, those regulators have the authority to restrict our ability to transfer assets, to make distributions to our stockholders (including dividends to the holders of Series A Preferred Shares, as described below), or to redeem the Series A Preferred Shares, or even to require the Bank to sever its relationship with or divest its ownership of us.  Those actions also could potentially result in our failure to qualify as a REIT.

 

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Payment of dividends on the Series A Preferred Shares could also be subject to regulatory limitations if after the payment the Bank were not “well capitalized” for purposes of the OTS prompt corrective action regulations, which is currently defined as having a total risk-based capital ratio of less than 10.0%, a Tier 1 risk-based capital ratio of less than 6.0% and a core capital (or leverage) ratio of less than 5.0%, and not being subject to a regulatory action requiring maintenance of a specific capital level.  At December 31, 2007, the Bank’s total risk-based capital ratio was 10.97%, its Tier 1 risk-based capital ratio was 8.84% and its core capital (or leverage) ratio was 5.88%, and the Bank was not subject to any such regulatory action.  The Bank’s ability to maintain well-capitalized status depends on a number of factors, many of which, such as general economic conditions, arebeyond its control.

 

If the Automatic Exchange (as discussed in Item 5 “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities”) occurs, the Bank would likely be prohibited from paying dividends on the Bank Preferred Shares.  In all circumstances following the Automatic Exchange, the Bank’s ability to pay dividends would be subject to various restrictions under OTS regulations and certain contractual provisions.

 

Furthermore, in the event the Bank is placed into conservatorship or receivership (whether before or after the Automatic Exchange), the Bank would be unable to pay dividends on the Bank Preferred Shares. In addition, in the event of a liquidation of the Bank, the claims of the Bank’s depositors and of its secured, senior, general and subordinated creditors would be entitled to a priority of payment over the dividend and other claims of holders of equity interests such as the Bank Preferred Shares issued pursuant to the Automatic Exchange.  

 

***Because our dividends are not cumulative, we cannot assure you that you will receive dividends each quarter or at historical rates.***

 

Dividends on the Series A Preferred Shares are not cumulative.  Consequently, if our Board of Directors does not declare a dividend on the Series A Preferred Shares for any quarterly period, the holders of the Series A Preferred Shares would not be entitled to recover that dividend whether or not funds are or subsequently become available.  The Board of Directors may determine, in its business judgment, that it would be in our best interests to pay less than the full amount of the stated dividends on the Series A Preferred Shares or no dividends for any quarter notwithstanding that funds are available.  Factors that would be considered by the Board of Directors in making this determination are our financial condition and capital needs, the impact of legislation and regulations as then in effect or as may be proposed, economic conditions, and such other factors as the Board may deem relevant.Notwithstanding the foregoing, to remain qualified as a REIT, we must distribute annually at least 90% of our “REIT taxable income” (not including capital gains) to stockholders.

 

***The concentration of our mortgage loans in certain geographic areas makes our income more susceptible to the effects of weaker economic conditions in those areas.***

 

Certain geographic regions of the United States may from time to time experience natural disasters or weaker regional economic conditions and housing markets, and, consequently, may experience higher rates of loss and delinquency on Mortgage Loans generally.  Any concentration of the Mortgage Loans in such a region may present risks in addition to those present for Mortgage Loans generally.  Residential Mortgage Loans secured by properties located in the Washington, DC metropolitan area equaled 54.5% of total loans at December 31, 2007.  In addition, 12.0% of the Residential Mortgage Loans are secured by properties located in California.  Consequently, these Mortgage Assets may be subject to a greater risk of default than other comparable Mortgage Assets in the event of adverse economic, political or business developments or natural hazards that may affect those regions and the ability of property owners inthose regions to make payments of principal and interest on the underlying mortgages.

 

***Because our income consists primarily of interest payments on our Mortgage Assets, a decline in interest rates could reduce our income and affect our ability to pay dividends.***

 

Our income consists primarily of interest payments on the Mortgage Assets we hold.  A majority (or 82.1%) of our Mortgage Assets bear interest at adjustable rates.  If there is a decline in interest rates (as measured by the indices 

 

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upon which the interest rates of the Mortgage Assets are based), then we may experience a decrease in income available to be distributed to our stockholders.  In such an interest rate environment, we may experience an increase in prepayments on our Mortgage Assets and may find it difficult to purchase additional Mortgage Assets bearing rates sufficient to support payment of dividends on our Series A Preferred Shares.  In addition, certain Mortgage Asset products which we may purchase may permit the borrower to convert an adjustable rate mortgage to a fixed rate mortgage.  Borrowers may be more likely to exercise this right in a low interest rate environment in order to “lock in” a low fixed interest rate.  Because the rate at which dividends, if, when and as declared, are payable on the Series A Preferred Shares is fixed, a significant decline in interest rates could adversely affect our abilityto pay dividends on the Series A Preferred Shares.

 

***We have not obtained credit enhancements or special hazard insurance for our Mortgage Loans, and thus are subject to risks that are not covered by standard hazard insurance.***

 

The Servicer is required to ensure that standard hazard and, where required, flood insurance is maintained on the Mortgage Loans.  We have not obtained credit enhancements such as mortgagor bankruptcy insurance or special hazard insurance for our Mortgage Loans.  Accordingly, during the time we hold Mortgage Loans for which these credit enhancements are not obtained, we will be subject to risks of borrower defaults and bankruptcies and special hazard losses that are not covered by standard hazard insurance (such as those occurring from earthquakes).  In addition, in the event of a default on any of our Mortgage Loans resulting from declining property values or worsening economic conditions, among other factors, we would bear the risk of loss of principal to the extent of any deficiency between (i) the value of the related mortgaged property, plus any payments from an insurer (or guarantor in the case ofCommercial Mortgage Loans) and (ii) the amount owing on the Mortgage Loan.

 

***Our operations and financial condition could be adversely affected by a number of factors affecting the value of real estate.***

 

The results of our operations are affected by various factors, many of which are beyond our control, such as:

 

 

**•**

local and other economic conditions affecting real estate values,

 

**•**

the ability of borrowers to make mortgage payments; and

 

**•**

interest rate levels and the availability of credit to refinance such loans at or prior to maturity.

 

The results of our operations depend on, among other things, the level of interest income generated by our Mortgage Assets, the market value of such Mortgage Assets and the supply of and demand for such Mortgage Assets.  Further, there can be no assurance that the values of the Mortgage Assets included in our portfolio, or the values of properties securing such Mortgage Assets, have remained or will remain at the levels existing on the dates of origination of such Mortgage Assets.

 

***Our “payment option” mortgage loans subject us to additional risks.***

 

Some of our loans permit borrowers to defer payment of principal and/or interest.  Some of these loans also have a payment option that could result in interest being added to the principal of the loan, or “negative amortization.”  Others allow the borrower to make an interest only payment.  These features, coupled with the adjustable interest rates on these loans, could cause borrowers’ payments to increase substantially.  In the absence of offsetting factors, such as higher wages or rising property values, those increased payments could result in higher defaults and require increases in our allowance for loan losses.  If all borrowers with payment option ARMs choose to pay only the minimum payment, approximately 25 loans with aggregate outstanding balances of $5.1 million, would reach their payment recast ceiling during 2008 (assuming LIBOR rates remain unchanged from levels at December 31,2007) and, as a result, the payment amount would increase to a fully amortizing payment.  In addition, approximately 40 payment option ARMs, with aggregate outstanding balances of $16.8 million, will reach their payment recast date during 2008 and, as a result, the payment amount would increase to a fully amortizing payment.  The potential for significant increases in the payments required to be made by these borrowers, coupled with the relative complexity of these products when compared to traditional mortgage loans, could subject us to increased litigation risk, particularly in an environment of rising interest rates and declining property values.  

 

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These loans also can result, under certain circumstances, in our recognition as interest income payments that have not yet been made by the borrowers, which may lead to future losses if the borrowers ultimately fail to make those payments.  At December 31, 2007, cumulative deferred interest totaled $0.6 million, but this amount could increase in the future.

 

***We may experience delays in liquidating defaulted Mortgage Loans which may affect our financial condition.***

 

Even assuming that the mortgaged properties underlying our Mortgage Loans provide adequate security for those Mortgage Loans (an assumption which may not be accurate in many situations under current market conditions), substantial delays could be encountered in connection with the liquidation of defaulted Mortgage Loans, with corresponding delays in the receipt of related proceeds by us.  An action to foreclose on a mortgaged property securing a Mortgage Loan is regulated by state statutes and rules and is subject to many of the delays and expenses of other lawsuits if defenses or counterclaims are asserted, which can sometimes require several years to complete.  Furthermore, in some states (not including Washington, DC, Maryland or Virginia) an action to obtain a deficiency judgment is not permitted following a nonjudicial sale of a mortgaged property.  In the event of a default by a mortgagor, theserestrictions, among other things, may impede our ability to foreclose on or sell the mortgaged property or to obtain proceeds sufficient to repay all amounts due on the related Mortgage Loan.  In addition, the Servicers of our Mortgage Loans will be entitled to deduct from collections received all expenses reasonably incurred in attempting to recover amounts due and not yet repaid on liquidated Mortgage Loans, including legal fees and costs of legal action, real estate taxes and maintenance and preservation expenses, thereby reducing amounts available to us.

 

***Our business is highly regulated and we are subject to complex legal restrictions, the violation of which may adversely affect our financial condition and results of operations.***

 

Applicable state laws generally regulate interest rates and other charges and require certain disclosures to borrowers.  In addition, most states have other laws, public policy and general principles of equity relating to the protection of consumers, unfair and deceptive practices and practices which may apply to the servicing and collection of the Mortgage Loans. Depending on the provisions of the applicable law and the specific facts and circumstances involved, violations of these laws, policies and principles may limit our ability to collect all or part of the principal of or interest on the Mortgage Loans, may entitle the borrower to a refund of amounts previously paid and, in addition, could subject us to damages and administrative sanctions.

 

***Environmental liabilities could reduce the value of the properties securing a defaulted Mortgage Loan, which could require us to make significant expenditures or make it difficult or impossible to sell the properties.***

 

In the event that we are forced to foreclose on a defaulted Mortgage Loan to recover our investment in such Mortgage Loan, we may be subject to environmental liabilities in connection with the underlying real property which could exceed the value of the real property.  Although we intend to exercise due diligence to discover potential environmental liabilities prior to the acquisition of any property through foreclosure, hazardous substances or wastes, contaminants, pollutants or sources thereof (as defined by state and federal laws and regulations) may be discovered on properties during our ownership or after a sale thereof to a third party.  If such hazardous substances are discovered on a property which we have acquired through foreclosure or otherwise, we may be required to remove those substances and clean up the property.  There can be no assurance that in such a case we would not incur full recourseliability for the entire costs of any removal and clean-up, that the cost of such removal and clean-up would not exceed the value of the property or that we could recoup any of such costs from any third party.  We may also be liable to tenants and other users of neighboring properties.  In addition, we may find it difficult or impossible to sell the property prior to or following any such clean-up.

 

***Failure to qualify as a REIT would cause us to be taxed as a corporation, which would substantially reduce funds available for payment of distributions.***

 

We operate so as to qualify as a REIT under the Code.  Although we believe that we are owned and organized and operate in such a manner, no assurance can be given that we will be able to continue to operate in such a manner 

 

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so as to remain qualified as a REIT.  Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations.  The determination of various factual matters and circumstances, not entirely within our control, may affect our ability to remain qualified as a REIT.  Although we are not aware of any proposal in Congress to amend the tax laws in a manner that would materially and adversely affect our ability to operate as a REIT, no assurance can be given that new legislation or new regulations, administrative interpretations or court decisions will not significantly change the tax laws in the future with respect to qualification as a REIT or the federal income tax consequences of such qualification.

 

If in any taxable year we fail to qualify as a REIT, we would not be allowed a deduction for distributions to stockholders in computing our taxable income and would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates.  As a result, the amount available for distribution to our stockholders, including the holders of the Series A Preferred Shares, would be reduced for the year or years involved.  In addition, unless entitled to relief under certain statutory provisions, we would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost. 

 

***We are dependent on the Bank as Advisor and Servicer.***

 

We depend on the diligence and skill of officers and employees of the Advisor to select, structure and monitor our Mortgage Assets.  In addition, we depend on the expertise of the Servicer for the servicing of the Mortgage Loans.  The Advisor may subcontract all or a portion of its obligations under the Advisory Agreement, and the Servicer of the Mortgage Loans may subcontract all or a portion of its obligations under the Servicing Agreement, to one or more affiliates, and under certain conditions to non-affiliates, involved in the business of managing Mortgage Assets.  In the event the Advisor or the Servicer subcontracts its obligations in such a manner, we will be dependent upon the subcontractor to provide services. Any failure by the Bank or any subcontractor to perform its services in a satisfactory manner could have an adverse affect on our operating performance.

 

***We have substantial relationships with the Bank and its affiliates and their interests may not always be aligned with our interests.***

 

The Bank and its affiliates are involved in virtually every aspect of our existence.  The Bank is the sole holder of our Common Stock and administers our day-to-day activities in its role as Advisor under the Advisory Agreement.  The Bank acts as Servicer of our Mortgage Loans under the Servicing Agreement.  In addition, other than the Independent Directors, all of our officers and directors are also officers and/or directors of the Bank and/or affiliates of the Bank.  As the holder of all of our outstanding voting stock, the Bank will have the right to elect all of our directors, including the Independent Directors.

 

The Bank and its affiliates may have interests which are not identical to ours.  Consequently, conflicts of interest may arise with respect to transactions, including without limitation, future acquisitions of Mortgage Assets from the Bank and/or affiliates of the Bank; servicing of Mortgage Loans; future dispositions of Mortgage Loans to the Bank or affiliates of the Bank; and the modification of the Advisory Agreement or the Servicing Agreement.  It is our intention and the intention of the Bank that any agreements and transactions between us, on the one hand, and the Bank and/or its affiliates, on the other hand, are fair to all parties and consistent with market terms, including the prices paid and received for Mortgage Assets, including those in our current portfolio, on their acquisition or disposition by us or in connection with the servicing of Mortgage Loans.  The requirement in the ArticlesSupplementary establishing the Series A Preferred Shares that certain of our actions be approved by a majority of the Independent Directors is also intended to ensure fair dealings between us and the Bank and its affiliates.  However, there can be no assurance that such agreements or transactions will be on terms as favorable to us as those that could have been obtained from unaffiliated third parties.

 

 

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***We may change our policies and strategies at any time without shareholder approval.***

 

The Board of Directors has established our investment policies and operating policies and strategies.  These policies may be amended or revised from time to time at the discretion of the Board of Directors (in certain circumstances subject to the approval of a majority of the Independent Directors) without a vote of our stockholders, including holders of the Series A Preferred Shares.  We cannot assure you that any change in our policies and strategies will have a positive effect on holders of Series A Preferred Shares. 

 

***Because we have not obtained third party valuations of Mortgage Assets we have purchased and we have not engaged in arms’-length negotiations with the Bank or its affiliates, we cannot assure that the purchase prices paid do not differ from the fair value of the Mortgage Assets purchased.***

 

We, along with the Bank, intend that the fair value of the Mortgage Assets we purchase from the Bank to be approximately equal to the amount that we paid for such assets.  However, no third party valuations of the Mortgage Assets constituting the portfolio were obtained, and there can be no assurance that the fair value of the portfolio does not differ from the purchase price we paid.  In addition, we do not anticipate obtaining third party valuations in connection with future acquisitions and dispositions of Mortgage Assets even in circumstances where one of our affiliates is selling the Mortgage Assets to, or purchasing the Mortgage Assets from, us.  Accordingly, although we and the Bank intend that future acquisitions or dispositions of Mortgage Assets be on a fair value basis, there can be no assurance that the consideration to be paid (or received) by us to (or from) the Bank or any of its affiliatesin connection with future acquisitions or dispositions of Mortgage Assets will not differ from the fair value of such Mortgage Assets.

 

***Upon the occurrence of the Exchange Event, your investment in us will be converted to an investment in the Bank and thus, you will subject to risks related to owning interests in the Bank.***

 

Our Series A Preferred Shares will be exchanged automatically on a one-for-one basis for Bank Preferred Shares upon the occurrence of the Exchange Event.  Consequently, an investment in Series A Preferred Shares could be replaced by an investment in Bank Preferred Shares at a time when the Bank’s financial condition is deteriorating or when the Bank has been placed into conservatorship or receivership.  In addition, although the Series A Preferred Shares are listed on the NYSE, the Bank has not applied and does not intend to apply for listing of the Bank Preferred Shares, for which the Series A Preferred Shares will be exchanged automatically on a one-for-one basis upon the occurrence of the Exchange Event, on any national securities exchange or for quotation of the Bank Preferred Shares through the National Association of Securities Dealers Automated Quotation System.  Consequently, there can be noassurance as to the liquidity of the trading markets for the Bank Preferred Shares, if issued, or that an active public market for the Bank Preferred Shares would develop or be maintained.  Potential investors in the Series A Preferred Shares, therefore, should carefully consider the risks related to an investment in the Bank summarized below and more fully described in the Bank’s Annual Report on Form 10-K for the fiscal year ended September 30, 2007 filed with the Office of Thrift Supervision including, but not limited to, the following:

 

 

**•**

risks related to the current turmoil in the mortgage markets;

 

**•**

risks related to the continued deteriorating conditions in the U.S. housing markets;

 

**•**

risks related to changes in interest rates and other market conditions including risks relating to the valuation of the Bank’s interest-only strips and mortgage servicing rights, which are based on various assumptions concerning prepayment and default rates;

 

**•**

risks related to the Bank’s “payment option” and interest-only adjustable rate mortgage loans;

 

**•**

risks related to the Bank’s dependence on asset securitizations for additional liquidity;

 

**•**

risks related to legislative and regulatory actions and restrictions, including restrictions on the payment of dividends and the Bank’s ability to satisfy regulatory capital requirements;

 

**•**

risks related to increased competition in the financial services industry and in the Bank’s local markets;

 

**•**

risks related to the Bank’s reliance on non-interest income, including gains from securitization transactions, for a significant portion of its revenue; 

 

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**•**

risks related to the sufficiency of the Bank’s allowance for losses;

 

**•**

risks related to the Bank’s shareholders, including its tax sharing arrangement with B. F. Saul Real Estate Investment Trust; and

 

**•**

risks related to the Bank’s concentration of business in the Washington, DC metropolitan area.
 
 

**ITEM 1B.**

**DISCLOSURE OF OUTSTANDING COMMENTS**

 

None.

 

**ITEM 2.**

**PROPERTIES**

 

None.

 

**ITEM 3.**

**LEGAL PROCEEDINGS**

 

The Company is not involved in any material litigation.

 

**ITEM 4.**

**SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matter was submitted to a vote of security holders of the Company during the fourth quarter of the year ended December 31, 2007.

 

-15-

**PART II**

 
 
**ITEM 5.**

**MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER**

**MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

**DESCRIPTION OF COMMON STOCK**

 

**General**

 

In connection with the formation of the Company in 1996, the Company issued 100 shares of Common Stock to the Bank for $1,000.  There is no established public trading market for the Common Stock.  As of March 15, 2008, there were 100 issued and outstanding shares of Common Stock held by one stockholder, the Bank.

 

**Dividends**

 

The following table reflects the distributions declared by the Company on the Common Stock for the two most recent years.  For a discussion of the Company’s distribution policy with respect to the Common Stock, see “Business – Dividend Policy.”

 

Period

 

Distributions

 

Payment Date

January 1, 2006 to March 31, 2006

 

$              230,104

 

April 17, 2006

April 1, 2006 to June 30, 2006

 

-

 

N/A

July 1, 2006 to September 30, 2006

 

-

 

N/A

October 1, 2006 to December 31, 2006

 

6,000,000

 

January 16, 2007

January 1, 2007 to March 31, 2007

 

-

 

N/A

April 1, 2007 to June 30, 2007

 

-

 

N/A

July 1, 2007 to September 30, 2007

 

-

 

N/A

October 1, 2007 to December 31, 2007

 

2,300,000

 

January 15, 2008

 

Holders of Common Stock are entitled to receive dividends when, if and as declared by the Board of Directors out of funds legally available.  If the Company fails to declare and pay full dividends on the Series A Preferred Shares in any dividend period, the Company may not make any dividend or other distributions with respect to the Common Stock until such time as dividends on all outstanding Series A Preferred Shares have been (i) declared and paid for three consecutive dividend periods and (ii) declared and paid or declared and a sum sufficient for the payment thereof has been set apart for payment for the fourth consecutive dividend period.  To remain qualified as a REIT, the Company must distribute each year at least 90% of its annual “REIT taxable income” (not including capital gains) to stockholders.  See “Business – Tax Status of the Company.”

 

**Voting Rights**

 

Subject to the rights, if any, of the holders of any class or series of Preferred Stock (as defined below), all voting rights are vested in the Common Stock.  The holders of Common Stock are entitled to one vote per share.

 

**Rights Upon Liquidation**

 

In the event of the liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, after paying or setting aside the full preferential amounts to which such holders of all series of Preferred Stock are entitled, the holders of Common Stock will be entitled to share equally and ratably in any assets remaining after the payment of all debts and liabilities.

 

-16-

**DESCRIPTION OF SERIES A PREFERRED SHARES**

 

**Market Information and Dividends**

 

The Series A Preferred Shares are listed on the New York Stock Exchange under the trading symbol “CCP-PrA.”  As of February 13, 2008, there were 3,000,000 issued and outstanding Series A Preferred Shares held by approximately 130 holders of record.  The following table reflects the respective high and low sales prices for the Series A Preferred Shares for each quarter during the two most recent years.  The table also indicates the distributions declared by the Company during these periods.  For a discussion of the Company’s distribution policy with respect to the Series A Preferred Shares, see “Business – Dividend Policy.”

 

 

 

Price

 

 

 

 

Period

 

High

 

Low

 

Distributions

 

Payment Date

January 1, 2006 to March 31, 2006

 

$    56.25

 

$    53.50

 

$       3,890,625

 

April 17, 2006

April 1, 2006 to June 30, 2006

 

54.48

 

52.50

 

3,890,625

 

July 17, 2006

July 1, 2006 to September 30, 2006

 

55.05

 

52.75

 

3,890,625

 

October 16, 2006

October 1, 2006 to December 31, 2006

 

54.55

 

52.60

 

3,890,625

 

January 16, 2007

January 1, 2007 to March 31, 2007

 

54.89

 

52.59

 

3,890,625

 

April 16, 2007

April 1, 2007 to June 30, 2007

 

54.81

 

52.92

 

3,890,625

 

July 16, 2007

July 1, 2007 to September 30, 2007

 

54.10

 

51.81

 

3,890,625

 

October 15, 2007

October 1, 2007 to December 31, 2007

 

53.40

 

50.12

 

3,890,625

 

January 15, 2008

 

Holders of Series A Preferred Shares are entitled to receive, if, when and as declared by the Board of Directors of the Company out of assets of the Company legally available, cash dividends at the rate of 10 3/8% per annum of the liquidation preference (equivalent to $5.1875 per share per annum).

 

The right of holders of Series A Preferred Shares to receive dividends is noncumulative.  Accordingly, if the Board of Directors fails to declare a dividend on the Series A Preferred Shares for a quarterly dividend period, then holders of the Series A Preferred Shares will have no right to receive a dividend for that period, and the Company will have no obligation to pay a dividend for that period, whether or not dividends are declared and paid for any future period with respect to either the Series A Preferred Shares or the Common Stock.

 

**General**

 

The Company may issue, from time to time, one or more series of preferred stock with rights, preferences and limitations determined by the Company’s Board of Directors.  The holders of the Series A Preferred Shares have no preemptive rights with respect to any shares of the capital stock of the Company or any other securities of the Company convertible into or carrying rights or options to purchase any such shares.  The Series A Preferred Shares are not subject to any sinking fund or other obligation of the Company for their repurchase or retirement.  The Series A Preferred Shares will be exchanged automatically on a one-for-one basis for Bank Preferred Shares (as defined below) upon the occurrence of the Exchange Event (as defined below).

 

**Automatic Exchange**

 

Each Series A Preferred Share will be exchanged automatically (an “Automatic Exchange”) for one newly issued Series B preferred share of the Bank (“Bank Preferred Share”) if the appropriate federal regulatory agency of the Bank directs in writing (the “Directive”) an exchange of the Series A Preferred Shares for Bank Preferred Shares because (i) the Bank becomes “undercapitalized” under prompt corrective action regulations established pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991, as amended, (ii) the Bank is placed into conservatorship or receivership or (iii) the appropriate federal regulatory agency, in its sole discretion and even if the Bank is not “undercapitalized,” anticipates the Bank becoming “undercapitalized” in the near term (the “Exchange Event”).  Upon the Exchange Event, each holder ofSeries A Preferred Shares will be unconditionally obligated to surrender to the Bank any and all certificates representing any and all Series A Preferred Shares 

 

-17-

owned by such holder, and the Bank will be unconditionally obligated to issue to such holder in exchange for each such Series A Preferred Share a certificate representing an equal number of Bank Preferred Shares.  Absent the occurrence of the Exchange Event, no Bank Preferred Shares will be issued.

 

Holders of Series A Preferred Shares cannot exchange their Series A Preferred Shares for Bank Preferred Shares voluntarily.  In addition, absent the occurrence of the Automatic Exchange, holders of Series A Preferred Shares will have no dividend, voting, liquidation preference or other rights with respect to any security of the Bank; such rights as are conferred by the Series A Preferred Shares exist solely as to the Company.

 

**Voting Rights**

 

Except as expressly required by applicable law, or except as indicated below, the holders of the Series A Preferred Shares will not be entitled to vote.  In the event the holders of Series A Preferred Shares are entitled to vote as indicated below, each Series A Preferred Share will be entitled to one vote on matters on which holders of the Series A Preferred Shares are entitled to vote.

 

If, at the time of any annual meeting of the Company’s stockholders for the election of directors, the Company has failed to pay or declare and set aside for payment a quarterly dividend during any of the four preceding quarterly dividend periods on any series of Preferred Stock of the Company, including the Series A Preferred Shares, the number of directors then constituting the Board of Directors of the Company will be increased by two (if not already increased by two due to a default in preference dividends), and the holders of the Series A Preferred Shares, voting together with the holders of all other series of Preferred Stock as a single class, will be entitled to elect such two additional directors to serve on the Company’s Board of Directors at each such annual meeting.  Each director elected by the holders of shares of the Preferred Stock shall continue to serve as such director until thelater of (i) the expiration of the full term for which he or she shall have been elected or (ii) the payment of four quarterly dividends on the Preferred Stock, including the Series A Preferred Shares.

 

**Redemption**

 

The Series A Preferred Shares are redeemable at the option of the Company, in whole or in part, at any time at the following per share redemption prices plus accrued and unpaid dividends:

 

If redeemed during the

12-month period

beginning January 15,

 

 

Redemption

Price

2007

 

$       52.594

2008

 

52.075

2009

 

51.556

2010

 

51.038

2011

 

50.519

2012 and thereafter

 

50.000

 

Any such redemption must comply with the prompt corrective action and capital distribution regulations of the OTS, which may prohibit a redemption and will require the OTS’ prior written approval.

 

The Company will also have the right at any time, upon the occurrence of certain tax events and with the prior written approval of the OTS, to redeem the Series A Preferred Shares, in whole (but not in part) at a redemption price of $50.00 per share, plus the quarterly accrued and unpaid dividend to the date of redemption, if any, thereon.

 

**Rights Upon Liquidation**

 

In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company, the holders of the Series A Preferred Shares at the time outstanding will be entitled to receive out of assets of the Company 

 

-18-

available for distribution to stockholders, before any distribution of assets is made to holders of Common Stock or any other class of stock ranking junior to the Series A Preferred Shares upon liquidation, liquidating distributions in the amount of $50.00 per share, plus the quarterly accrued and unpaid dividend thereon, if any, to the date of liquidation.

 

**Independent Director Approval**

 

As long as any Series A Preferred Shares are outstanding, certain actions by the Company must be approved by a majority of the independent directors who are not officers or employees of the Company and are not directors, officers, or employees of the Bank or any of its affiliates (the “Independent Directors”).  Any members of the Board of Directors of the Company elected by holders of Preferred Stock, including the Series A Preferred Shares, will be deemed to be Independent Directors for purposes of approving actions requiring the approval of a majority of the Independent Directors.  

 
 
**ITEM 6.**

**SELECTED FINANCIAL DATA**

 

The selected financial data of the Company herein has been derived from the financial statements of the Company.  The data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements included elsewhere herein.

 

 

 

As of or for the year ended

December 31,

 

 

2007

 

2006

 

2005

 

2004

 

2003

OPERATING DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$   20,184,783

 

$   23,668,932

 

$   22,469,755

 

$   17,394,530

 

$   17,035,160

Interest expense

 

(936,692)

 

(4,124,514)

 

(3,153,396)

 

(81,500)

 

-

Net interest income 

 

19,248,091

 

19,544,418

 

19,316,359

 

17,313,030

 

17,035,160

Provision for loan losses

 

(226,353)

 

(13,540)

 

-

 

-

 

-

Net interest income after 

provision for loan losses

 

19,021,738

 

19,530,878

 

19,316,359

 

17,313,030

 

17,035,160

Operating expenses

 

(1,189,415)

 

(1,299,934)

 

(1,245,429)

 

(1,020,672)

 

(1,103,037)

Net income

 

$   17,832,323

 

$   18,230,944

 

$   18,070,930

 

$   16,292,358

 

$   15,932,123

Earnings available to common    

Stockholders

 

$     2,269,823

 

$     2,668,444

 

$     2,508,430

 

$        729,858

 

$        369,623

Earnings per common share

 

$     22,698.23

 

$     26,684.44

 

$     25,084.30

 

$       7,298.58

 

$       3,696.23

 

 

 

 

 

 

 

 

 

 

 

DIVIDENDS DECLARED:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividends on common stock

 

$     2,300,000

 

$     6,230,104

 

$     2,300,000

 

$        742,614

 

$        350,000

Dividends on preferred stock

 

$   15,562,500

 

$   15,562,500

 

$   15,562,500

 

$   15,562,500

 

$   15,562,500

 

 

 

 

 

 

 

 

 

 

 

BALANCE SHEET DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage loans, net

 

$ 295,575,518

 

$ 346,330,604

 

$ 376,814,496

 

$ 374,458,643

 

$ 296,062,742

Total assets

 

$ 306,180,428

 

$ 354,543,864

 

$ 381,735,069

 

$ 379,720,055

 

$ 304,266,967

Loan payable to parent

 

$                    -

 

$   47,700,000

 

$   75,000,000

 

$   75,000,000

 

$                    -

Total stockholders’ equity

 

$ 299,969,823

 

$ 296,653,637

 

$ 300,215,297

 

$ 300,006,867

 

$ 300,019,623

Number of preferred shares

Outstanding

 

3,000,000

 

3,000,000

 

3,000,000

 

3,000,000

 

3,000,000

Number of common shares 

Outstanding

 

100

 

100

 

100

 

100

 

100

Average yield on residential

mortgage loans

 

6.42%

 

6.42%

 

6.01%

 

5.71%

 

5.90%

 

 

-19-
 
**ITEM 7.**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**
 
 

**FINANCIAL CONDITION**

 

**Critical Accounting Policies**

 

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different outcomes under different assumptions and conditions.  The Company’s significant accounting policies are described in Note 2 in the Notes to the Financial Statements.  Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates; however, the Company’s policy on estimation of allowance for loan losses could be deemed to be critical within the Securities and Exchange Commission (the “SEC”) definition.

 

**Allowance for Loan Losses**

 

Management reviews the loan portfolio to establish an allowance for estimated losses if deemed necessary.  Management performs a quarterly analysis to determine whether an allowance for loan loss is required, and an allowance is provided after considering such factors as historical loss performance, delinquency status, current economic conditions and geographical concentrations.  The allowance for loan losses is based on estimates, and ultimate losses may vary from current estimates.  As adjustments to the allowance become necessary, provisions for loan losses are reported in operations.  Based on a review of delinquent and nonaccrual loans, management increased the allowance for loan losses to $160,000 during the year ended December 31, 2007 by recording a provision of $119,667 in excess of charge-offs.  During the year ended December 31, 2006, the Company recorded a provision equal to its charge-offs of$13,540 on a loan secured by a property in Michigan for which the Company agreed to accept repayment in an amount less than its recorded balance.  

 

The activity in the allowance for loan losses is shown in the following table.

 

 

 

Year Ended

 

 

December 31,

 

 

2007

 

2006

Beginning Balance

 

$      40,333

 

$       40,333

Provision for loan losses

 

226,353

 

13,540

Charge-offs

 

(106,686)

 

(13,540)

Ending Balance

 

$    160,000

 

$       40,333

 

**Residential Mortgage Loans**

 

At December 31, 2007, the Company had $295,575,518 invested in Residential Mortgage Loans compared to $346,330,604 at December 31, 2006.  During the year ended December 31, 2007, the Company used principal collections totaling $70,956,034 to purchase $21,200,366 of Residential Mortgage Loans from the Bank and to repay $47,700,000 of borrowings from the Bank.  The decision to reduce the Company’s Residential Mortgage Loan portfolio through repayment of the Bank’s loan was based on management’s determination that interest rates had returned to a level sufficient to provide adequate coverage without the need to maintain the portfolio beyond its historical level.  Management intends to continue to reinvest proceeds received from repayments of loans by purchasing additional Residential Mortgage Loans from either the Bank or its subsidiaries.

 

At December 31, 2007, the Company had five non-accrual loans (loans contractually past due 90 days or more or with respect to which other factors indicate that full payment of principal and interest is unlikely) with an aggregate principal balance of $1,815,511 (or 0.61% of loans).  At December 31, 2006, the Company had five non-accrual loans with an aggregate principal balance of $1,119,642 (or 0.32% of loans).  

 

-20-

At December 31, 2007, the Company had nine delinquent loans (loans delinquent 30-89 days) with an aggregate principal balance of $3,822,833 (or 1.29% of loans).  At December 31, 2006, the Company had six delinquent loans with an aggregate principal balance of $1,304,688 (or 0.38% of loans).  

 

**Real Estate Acquired in Settlement of Loans**

 

At December 31, 2007, the Company’s real estate acquired in settlement of loans (“REO”) totaled $656,948 and consisted of four properties.  There were no REO properties at December 31, 2006.  The increase during the year is a result of increasing foreclosures due to continued softening in the housing market.

 

**Interest Rate Risk**

 

The Company’s income consists primarily of interest payments on Residential Mortgage Loans.  If there is a decline in interest rates, then the Company will experience a decrease in income available to be distributed to its stockholders.  Certain Residential Mortgage Loans which the Company holds allow borrowers to convert an ARM to a fixed-rate mortgage, thus “locking in” a fixed interest rate at a time when interest rates have declined.  In addition, when interest rates decline, holders of fixed-rate mortgages are more likely to prepay such mortgages.  In recent periods, primarily as a result of a decline in interest rates, the Company has experienced an increase in prepayments on its Residential Mortgage Loans.  See “Risk Factors – Because our income consists primarily of interest payments on our Mortgage Assets, a decline in interest rates could reduce our income and affect ourability to pay dividends.”

 

Based on the outstanding balance of the Company’s Residential Mortgage Loans at December 31, 2007, and the interest rates on such loans, anticipated annual interest income on the Company’s loan portfolio at December 31, 2007, net of operating expenses, was approximately 114.3% of the projected annual dividend of $15,562,500 on the Series A Preferred Shares. 

 

As a result of a decline in market interest rates and in order to increase the funds available to pay dividends on the Series A Preferred Shares, the Company borrowed $75,000,000 from the Bank in December 2004, and used the proceeds to purchase Residential Mortgage Loans from the Bank.  The loan was secured by a portion of the Residential Mortgage Loan portfolio and the interest rate on the loan adjusts monthly based on changes in one-month LIBOR.  During the year ended December 31, 2007, the Company repaid the remaining balance of $47,700,000 on the loan.

 

An interest rate environment in which there is a decline in market interest rates could adversely affect the Company’s ability to pay dividends on the Series A Preferred Shares or the Common Stock.  The Company, to date, has not used any derivative instruments to manage its interest rate risk.

 

-21-

The following table stratifies the Company’s loan portfolio by type and calendar year based on the earlier of the next interest rate adjustment or estimated principal payments, including both contractual and anticipated prepayment amounts.  Prepayment rates are assumed for the Company’s loans based on recent actual and market experience.  Fair value is estimated using discounted cash flow analyses based on contractual repayment and estimated prepayment schedules.  The discount rates used in these analyses are based either on the interest rates paid on U.S. Treasury securities of comparable maturities adjusted for credit risk and non-interest earning operating costs, or the interest rates currently offered for loans with similar terms to borrowers of similar credit quality.  Because fair value is estimated as of the balance sheet date, the amount which would actually be realized or paid uponsettlement could be significantly different.

 

Expected Maturity/Repricing Date

(Dollars in thousands)

 

 

 

Year Ending December 31,

 

 

 

Fair Value at December 31, 2007

 

 

2008

 

2009

 

2010

 

2011

 

2012

 

Thereafter

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Payment Option ARMs

 

$  15,365

 

$          -

 

$          -

 

$          -

 

$          -

 

$          -

 

$  15,365

 

$   15,459

Average Yield 

 

7.98%

 

-

 

-

 

-

 

-

 

-

 

7.98%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One-Year ARMs

 

3,808

 

-

 

-

 

-

 

-

 

-

 

3,808

 

3,963

Average Yield 

 

7.65%

 

-

 

-

 

-

 

-

 

-

 

7.65%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three-Year ARMs

 

13,627

 

3,448

 

240

 

-

 

-

 

-

 

17,315

 

17,675

Average Yield 

 

6.76%

 

6.43%

 

6.30%

 

-

 

-

 

-

 

6.76%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Five-Year ARMs

 

58,815

 

34,302

 

58,581

 

41,276

 

3,080

 

-

 

196,054

 

196,020

Average Yield 

 

6.45%

 

6.01%

 

5.87%

 

6.39%

 

6.28%

 

-

 

6.19%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7/1 ARMs

 

2,025

 

-

 

-

 

-

 

-

 

-

 

2,025

 

2,043

Average Yield 

 

7.86%

 

-

 

-

 

-

 

-

 

-

 

7.86%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10/1 ARMs

 

4,408

 

3,808

 

-

 

-

 

-

 

-

 

8,216

 

8,219

Average Yield 

 

6.93%

 

6.63%

 

-

 

-

 

-

 

-

 

6.80%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

15 & 30-Year 

Fixed Rate

 

5,664

 

5,274

 

4,803

 

4,350

 

3,943

 

28,918

 

52,952

 

53,120

Average Yield 

 

6.44%

 

6.44%

 

6.44%

 

6.44%

 

6.44%

 

6.39%

 

6.41%

 

 

 

**Significant Concentration of Credit Risk**

 

Concentration of credit risk arises when a number of customers engage in similar business activities, or activities in the same geographical region, or have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions.  Concentration of credit risk indicates the relative sensitivity of the Company’s performance to both positive and negative developments affecting a particular industry or geographic location.  The Company’s exposure to geographic concentrations directly affects the credit risk of the Residential Mortgage Loans within the portfolio.  See “Risk Factors – The concentration of our mortgage loans in certain geographic areas makes our income more susceptible to the effects of weaker economic conditions in those areas.”

 

**Liquidity and Capital Resources**

 

The objective of liquidity management is to ensure the availability of sufficient cash flows to meet all of the Company’s financial commitments.  In managing liquidity, the Company takes into account various legal limitations placed on a REIT as discussed in “Business - Tax Status of the Company.”

 

-22-

The Company’s principal liquidity needs are to fund the acquisition of additional Mortgage Assets as Mortgage Assets held by the Company are repaid and to pay dividends on the Series A Preferred Shares.  The acquisition of Mortgage Assets will be funded with the proceeds of principal repayments on the Company’s current portfolio of Mortgage Assets.  The Company does not anticipate that it will have any material capital expenditures.  The Company believes that cash generated from the payment of principal and interest on its Mortgage Asset portfolio will provide sufficient funds to meet its operating requirements and to pay dividends in accordance with the requirements to be treated as a REIT for income tax purposes for the foreseeable future.  The Company may borrow as it deems necessary.

 

**RESULTS OF OPERATIONS**

 

**Year 2007 Compared to Year 2006**

 

The Company reported net income of $17,832,323 and $18,230,944 for the years ended December 31, 2007 and 2006, respectively.  The decrease in net income is due primarily to a decrease in interest income on Residential Mortgage Loans, which was mostly offset by a decrease in interest expense.

 

Total interest income was $20,184,783 and $23,668,932 for the years ended December 31, 2007 and 2006, respectively.  Interest income on Residential Mortgage Loans totaled $20,163,157 and $23,644,671 for the years ended December 31, 2007 and 2006, respectively.  The decrease in interest income on Residential Mortgage Loans was due to a decrease in the average balance of Residential Mortgage Loans to $314,079,364 for 2007 from $368,520,011 for 2006 resulting from the Company’s decision to reduce the size of the loan portfolio.  The Company would have recorded an additional $74,725 and $54,338 in interest income for the years ended December 31, 2007 and 2006, respectively, had its non-accrual loans been current in accordance with their original terms.

 

Other interest income of $21,626 and $24,261 was recognized on the Company’s interest bearing deposits during the years ended December 31, 2007 and 2006, respectively.

 

The Company incurred interest expense of $936,692 for 2007 and $4,124,514 for 2006.  The decrease was due to the Company’s repayments of the remaining balance of the loan from the Bank during the year ended December 31, 2007.

 

During the year ended December 31, 2007, the Company recorded a provision for loan losses of $226,353 compared to a provision for loan losses of $13,540 during the year ended December 31, 2006.  The increased provision reflected an increase in charge-offs as well as management’s review of delinquent and non-accrual loans.  

 

Operating expenses totaling $1,189,415 and $1,299,934 for the years ended December 31, 2007 and 2006, respectively, were comprised of loan servicing fees paid to parent, advisory fees paid to parent, directors’ fees, other loan expenses and general and administrative expenses.  Loan servicing fees paid to parent were $763,928 and $904,068 for the years ended December 31, 2007 and 2006, respectively, and were based on a servicing fee rate of 0.250% per annum of the outstanding principal balances of residential mortgage loans, pursuant to the Servicing Agreement.  The decrease in servicing fees paid in 2007 resulted from a decrease in the average balance of the Residential Mortgage loan portfolio.  Advisory fees paid to parent for the years ended December 31, 2007 and 2006 totaled $200,000 for each period.  Directors’ fees paid were $32,000 for the years ended December 31, 2007 and 2006 andrepresent compensation to the two independent members of the Board of Directors.  General and administrative expenses totaled $193,487 and $163,866 for the years ended December 31, 2007 and 2006, respectively.  The increase in general and administrative expenses is largely due to an increase in rating agency and independent auditor fees.

 

During the year ended December 31, 2007, the Company’s Board of Directors declared cash dividends of $15,562,500, representing $5.1875 per share on the outstanding shares of Series A Preferred Shares, out of the retained earnings of the Company.

 

-23-

Also during the year ended December 31, 2007, the Company’s Board of Directors declared cash dividends of $2,300,000, representing $23,000.00 per share of Common Stock, all of which was paid out of the retained earnings of the Company.

 

**Year 2006 Compared to Year 2005**

 

The Company reported net income of $18,230,944 and $18,070,930 for the years ended December 31, 2006 and 2005, respectively.  The increase in net income is due primarily to an increase in interest income on Residential Mortgage Loans partially offset by an increase in interest expense.

 

Total interest income was $23,668,932 and $22,469,755 for the years ended December 31, 2006 and 2005, respectively.  Interest income on Residential Mortgage Loans totaled $23,644,671 and $22,444,739 for the years ended December 31, 2006 and 2005, respectively.  The increase in interest income on Residential Mortgage Loans was due to an increase in the average yield on Residential Mortgage Loans to 6.42% for 2006 from 6.01% for 2005.  The Company would have recorded an additional $54,338 and $11,033 in interest income for the years ended December 31, 2006 and 2005, respectively, had its non-accrual loans been current in accordance with their original terms.

 

Other interest income of $24,261 and $25,016 was recognized on the Company’s interest bearing deposits during the years ended December 31, 2006 and 2005, respectively.

 

The Company incurred interest expense of $4,124,514 for 2006 and $3,153,396 for 2005.  The increase was due to an increase in the average rate paid on the $75,000,000 loan to 5.87% in 2006 from 4.14% in 2005.  This was partially offset by a decrease in the average balance of the loan to $68,150,000 in 2006 from $75,000,000 in 2005.

 

During the year ended December 31, 2006, the Company recorded a provision equal to its charge-offs of $13,540 on a loan secured by a property in Michigan for which the Company agreed to accept repayment for an amount less than its recorded balance.  There were no provisions for loan losses during the year ended December 31, 2005.

 

Operating expenses totaling $1,299,934 and $1,245,429 for the years ended December 31, 2006 and 2005, respectively, were comprised of loan servicing fees paid to parent, advisory fees paid to parent, directors’ fees, other loan expenses and general and administrative expenses.  Loan servicing fees paid to parent were $904,068 and $911,577 for the years ended December 31, 2006 and 2005, respectively, and were based on a servicing fee rate of 0.250% per annum of the outstanding principal balances of residential mortgage loans, pursuant to the Servicing Agreement.  The decrease in servicing fees paid in 2006 resulted from a decrease in the average balance of the Residential Mortgage loan portfolio.  Advisory fees paid to parent for the years ended December 31, 2006 and 2005 totaled $200,000 for each period.  Directors’ fees paid were $32,000 for the years ended December 31, 2006 and 2005 andrepresent compensation to the two independent members of the Board of Directors.  General and administrative expenses totaled $163,866 and $101,852 for the years ended December 31, 2006 and 2005, respectively.  The increase in general and administrative expenses is largely due to an increase in rating agency and independent auditor fees.

 

During the year ended December 31, 2006, the Company’s Board of Directors declared cash dividends of $15,562,500, representing $5.1875 per share on the outstanding shares of Series A Preferred Shares, out of the retained earnings of the Company.

 

Also during the year ended December 31, 2006, the Company’s Board of Directors declared cash dividends of $6,230,104, representing $62,301.40 per share of Common Stock, $2,883,841 of which was paid out of the retained earnings of the Company and $3,346,363 of which was treated as a return of capital.  On January 16, 2007, the Bank made a $3,346,363 capital contribution to the Company.

 

 

 

-24-
 
**ITEM 7A.**

**QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**
 
 

Information required by this item is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Risk.”

 

-25-
 
**ITEM 8.**

**FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

 

CONTENTS

 

 

 

 

Page

 
 

 

 

(a)

Report of Independent Registered Public Accounting Firm....................................................

F-2

 

 

 

(b)

Statements of Financial Condition at December 31, 2007 and 2006..........................................

F-3

 

 

 

(c)

Statements of Operations for the Years Ended December 31, 2007, 2006 and 2005.......................

F-4

 

 

 

(d)

Statements of Stockholders’ Equity for the Years Ended December 31, 2007, 2006 and 2005..........

F-5

 

 

 

(e)

Statements of Cash Flows for the Years Ended December 31, 2007, 2006 and 2005.....................

F-6

 

 

 

(f)

Notes to Financial Statements......................................................................................

F-7

 

 

 

 

 

F-1

 

 

 

**Report of Independent Registered Public Accounting Firm**

 

The Board of Directors of Chevy Chase Preferred Capital Corporation:

 

We have audited the accompanying statements of financial condition of Chevy Chase Preferred Capital Corporation (the “Company,”) as of December 31, 2007 and 2006, and the related statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2007.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits. 

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  We were not engaged to perform an audit of the Company’s internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company at December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.

 

/s/ ERNST & YOUNG, LLP

McLean, Virginia

February 29, 2008

 

F-2

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**STATEMENTS OF FINANCIAL CONDITION**

 

 

 

 

 

 

 

 

 

December 31,

 

2007

 

2006

 

 

 

 

**ASSETS**

 

 

 

 

Cash and interest-bearing deposits

$        6,916,334

 

$        5,753,475

Residential mortgage loans (net of allowance

for loan losses of $160,000 and $40,333, respectively)

295,575,518

 

346,330,604

Real estate acquired in settlement of loans

656,948

 

-

Accounts receivable from parent

1,773,030

 

983,467

Accrued interest receivable

1,226,515

 

1,436,651

Prepaid expenses

32,083

 

39,667

 

 

 

 

Total assets

$     306,180,428

 

$    354,543,864

 

 

 

 

**LIABILITIES AND STOCKHOLDERS’ EQUITY**

 

 

 

 

Loan payable to parent

$                   -

 

$      47,700,000

Accounts payable to others and accrued expenses 

19,980

 

14,212

Accrued interest payable to parent

-

 

285,390

Dividends payable to parent

2,300,000

 

6,000,000

Dividends payable to others

3,890,625

 

3,890,625

 

 

 

 

Total liabilities

6,210,605

 

57,890,227

 

 

 

 

Preferred Stock, 10,000,000 shares authorized:

10 3/8% Noncumulative Exchangeable Preferred Stock,

$5 par value, 3,000,000 shares issued and outstanding

(liquidation value of $150,000,000 plus accrued and

unpaid dividends)

15,000,000

 

15,000,000

Common Stock, $1 par value 1,000 shares authorized,

100 shares issued and outstanding 

100

 

100

Capital contributed in excess of par

284,999,900

 

281,653,537

Retained (Deficit) Earnings

(30,177)

 

-

Total stockholders’ equity

299,969,823

 

296,653,637

 

 

 

 

Total liabilities and stockholders’ equity

$     306,180,428

 

$    354,543,864

 

 

 

 

 

 

 

 

 

 

The accompanying Notes to Financial Statements are an integral part of these statements.

 

F-3

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**STATEMENTS OF OPERATIONS**

 

 

Year Ended December 31,

 

 

2007

 

2006

 

2005

**Interest income:**

 

 

 

 

 

 

Residential mortgage loans

 

$       20,163,157

 

$       23,644,671

 

$       22,444,739

Other

 

21,626

 

24,261

 

25,016

Total interest income

 

20,184,783

 

23,668,932

 

22,469,755

 

 

 

 

 

 

 

Interest expense

 

936,692

 

4,124,514

 

3,153,396

 

 

 

 

 

 

 

Net interest income

 

19,248,091

 

19,544,418

 

19,316,359

Provision for loan losses

 

226,353

 

13,540

 

-

Net interest income after

provision for loan losses

 

19,021,738

 

19,530,878

 

19,316,359

 

 

 

 

 

 

 

**Operating expenses:**

 

 

 

 

 

 

Loan servicing fees-parent

 

763,928

 

904,068

 

911,577

Advisory fees-parent

 

200,000

 

200,000

 

200,000

Directors’ fees

 

32,000

 

32,000

 

32,000

General and administrative

 

193,487

 

163,866

 

101,852

Total operating expenses

 

1,189,415

 

1,299,934

 

1,245,429

 

 

 

 

 

 

 

**NET INCOME**

 

**$       17,832,323**

 

**$       18,230,944**

 

**$       18,070,930**

 

 

 

 

 

 

 

**PREFERRED STOCK  DIVIDENDS**

 

15,562,500

 

15,562,500

 

15,562,500

 

 

 

 

 

 

 

**EARNINGS AVAILABLE TO**

 

 

 

 

 

 

**COMMON STOCKHOLDER**

 

$         2,269,823

 

$         2,668,444

 

$         2,508,430

 

 

 

 

 

 

 

**AVERAGE COMMON SHARES**

 

100

 

100

 

100

 

 

 

 

 

 

 

**EARNINGS PER COMMON  SHARE**

 

$         22,698.23

 

$         26,684.44

 

$         25,084.30

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying Notes to Financial Statements are an integral part of these statements.

 

F-4

 

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**STATEMENTS OF STOCKHOLDERS’ EQUITY**

 

 

 

 

 

 

 

 

 

 

 

Preferred Stock

 

Common Stock

 

Capital Contributed

in Excess

of Par

 

Retained Earnings

 

Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2004

$  15,000,000

 

$             100

 

$    284,999,900

 

$           6,867

 

$   300,006,867

 

 

 

 

 

 

 

 

 

 

Net income

-

 

-

 

-

 

18,070,930

 

18,070,930

Dividends on 10 3/8%

 

 

 

 

 

 

 

 

 

Noncumulative Exchangeable

 

 

 

 

 

 

 

 

 

Preferred Stock, Series A

-

 

-

 

-

 

(15,562,500)

 

(15,562,500)

Dividends on common stock

-

 

-

 

-

 

(2,300,000)

 

(2,300,000)

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2005

15,000,000

 

100

 

284,999,900

 

215,297

 

300,215,297

 

 

 

 

 

 

 

 

 

 

Net income

-

 

-

 

-

 

18,230,944

 

18,230,944

Dividends on 10 3/8%

 

 

 

 

 

 

 

 

 

Noncumulative Exchangeable

 

 

 

 

 

 

 

 

 

Preferred Stock, Series A

-

 

-

 

-

 

(15,562,500)

 

(15,562,500)

Dividends on common stock

-

 

-

 

(3,346,363)

 

(2,883,741)

 

(6,230,104)

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2006

15,000,000

 

100

 

281,653,537

 

-

 

296,653,637

 

 

 

 

 

 

 

 

 

 

Net income

-

 

-

 

-

 

17,832,323

 

17,832,323

Dividends on 10 3/8%

 

 

 

 

 

 

 

 

 

Noncumulative Exchangeable

 

 

 

 

 

 

 

 

 

Preferred Stock, Series A

-

 

-

 

-

 

(15,562,500)

 

(15,562,500)

Dividends on common stock

-

 

-

 

-

 

(2,300,000)

 

(2,300,000)

 

Capital contribution from parent

-

 

-

 

3,346,363

 

-

 

3,346,363

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2007

$  15,000,000

 

$             100

 

$    284,999,900

 

$       (30,177)

 

$   299,969,823

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying Notes to Financial Statements are an integral part of these statements.

 

F-5

 

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**STATEMENTS OF CASH FLOWS**

 
 

 

Year Ended December 31,

 
 

2007

 

2006

 

2005

 
**Cash flows from operating activities:**

 

 

 

 

 

 
 

 

 

 

 

 

 
Net income

$     17,832,323

 

$     18,230,944

 

$     18,070,930

 
 

 

 

 

 

 

 
Adjustments to reconcile net income to net cash

provided by (used in) operating activities:

 

 

 

 

 

 
Provision for loan losses

226,353

 

13,540

 

-

 
(Increase) decrease in accounts receivable from parent

(789,563)

 

475,092

 

132,987

 
(Increase) decrease in accrued interest receivable   

210,136

 

107,065

 

(196,952)

 
(Increase) decrease in prepaid expenses

7,584

 

(34,667)

 

-

 
Increase (decrease) in accounts payable to others and 

accrued expenses

5,768

 

4,588

 

(31,439)

 
Increase (decrease) in accrued interest payable to parent

(285,390)

 

(34,133)

 

238,023

 
 

 

 

 

 

 

 
**Net cash provided by operating activities**

17,207,211

 

18,762,429

 

18,213,549

 
 

 

 

 

 

 

 
**Cash flows from investing activities:**

 

 

 

 

 

 
 

 

 

 

 

 

 
Purchases of residential mortgage loans

(21,200,366)

 

(63,675,650)

 

(151,039,626)

 
Repayments of residential mortgage loans

70,956,034

 

94,146,002

 

148,683,773

 
Net proceeds from sale of real estate

116,117

 

-

 

-

 
 

 

 

 

 

 

 
**Net cash provided by (used in) investing activities**

49,871,785

 

30,470,352

 

(2,355,853)

 
 

 

 

 

 

 

 
**Cash flows from financing activities:**

 

 

 

 

 

 
 

 

 

 

 

 

 
Repayment of loan payable to parent

(47,700,000)

 

(27,300,000)

 

-

 
Capital contribution from parent

3,346,363

 

-

 

-

 
Dividends paid on preferred stock

(15,562,500)

 

(15,562,500)

 

(15,562,500)

 
Dividends paid on common stock

(6,000,000)

 

(2,530,104)

 

(700,000)

 
 

 

 

 

 

 

 
**Net cash used in financing activities**

(65,916,137)

 

(45,392,604)

 

(16,262,500)

 
 

 

 

 

 

 

 
**Net increase (decrease) in cash and cash equivalents**

1,162,859

 

3,840,177

 

(404,804)

 
 

 

 

 

 

 

 
**Cash and cash equivalents at beginning of year**

5,753,475

 

1,913,298

 

2,318,102

 
 

 

 

 

 

 

 
**Cash and cash equivalents at end of year**

$       6,916,334

 

$       5,753,475

 

$       1,913,298

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
 

 

 

 

 

 

 
The accompanying Notes to Financial Statements are an integral part of these statements.

 

F-6

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**NOTES TO FINANCIAL STATEMENTS**

**DECEMBER 31, 2007, 2006 and 2005**

 

**NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION:**

 

Chevy Chase Preferred Capital Corporation (the “Company”) is a Maryland corporation which acquires, holds and manages real estate assets. Chevy Chase Bank, F.S.B. (the “Bank”), a federally insured stock savings bank, owns all of the Company’s Common Stock (as defined below).  The Bank is in compliance with its regulatory capital requirements.

 

**NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:**

 

***Use of Estimates:***

 

The financial statements have been prepared in conformity with accounting principles generally accepted in the United States.  In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities as of the date of the statements of financial condition and income and expenses for the reporting periods.  Actual results could differ from those estimates.

 

***Cash and Cash Equivalents:***

 

For purposes of reporting cash flows, cash and cash equivalents include cash and interest-bearing deposits.

 

***Residential Mortgage Loans:***

 

Residential mortgage loans are carried at amortized cost.  Interest income is accrued and recognized based on the terms of each loan.  

 

Loans are reviewed on a monthly basis and are placed on non-accrual status when, in the opinion of management, the full collection of principal and interest has become unlikely.  When a loan is placed on non-accrual, the amount of accrued interest receivable then due is charged against current period income and no further interest income is recognized while on non-accrual status.  The Company had non-accrual loans at December 31, 2007 and 2006 totaling $1,815,511 and $1,119,642, respectively.  The Company would have recorded an additional $74,725 and $54,338 in interest income for the years ended December 31, 2007 and 2006, respectively, had its non-accrual loans been current in accordance with their original terms.

 

***Allowance for Loan Losses:***

 

On a quarterly basis, management reviews the loan portfolio and adjusts the allowance for estimated losses if deemed necessary.  An allowance is provided after considering such factors as the economy in lending areas, delinquency statistics and past loss experience.  The allowance for loan losses is based on estimates and ultimate losses may vary from current estimates.  As adjustments to the allowance become necessary, provisions for losses are reported in operations in the periods they are determined to be necessary.

 

***Real Estate Acquired in Settlement of Loans***

 

Real estate acquired in settlement of loans (“REO”) is carried at the lower of cost or fair value (less estimated selling costs).  Costs relating to the development and improvement of property, including interest, are capitalized, whereas costs relating to the holding of property are expensed.  REO totaled $656,948 at December 31, 2007.  There were no REO properties at December 31, 2006.

 

 

 

F-7

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**NOTES TO FINANCIAL STATEMENTS**

**DECEMBER 31, 2007, 2006 and 2005**

 

**NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):**

 

***Concentrations of Credit:***

 

Residential Mortgage Loans secured by residential real estate properties located in the Washington, DC metropolitan area equaled 54.5% of total residential loans at December 31, 2007.  In addition, 12.0% of the Residential Mortgage Loans are secured by residential real estate properties located in California.  Consequently,

adverse economic, political, or business developments in Washington DC, Maryland, Virginia and California may affect the Company’s loan portfolio to a greater degree than a more diversified portfolio.

 

***Accounts Receivable from Parent:***

 

Accounts receivable from parent represents principal and interest payments received from borrowers by the Bank as servicer of the mortgage loans.  These payments are being held by the servicer in a custodial account pending remittance to the Company.  The Company receives remittances from the servicer on a weekly basis.  See Note 8.

 

***Dividends:***

 

Preferred Stock.  Dividends on the Series A Preferred Shares are payable at a rate of 10 3/8% per annum of the liquidation preference (an amount equal to $5.1875 per annum per share), if, when and as declared by the Board of Directors of the Company.  Dividends are not cumulative and, if declared, are payable quarterly in arrears on the fifteenth day of January, April, July and October or the next business day when the fifteenth falls on a weekend or holiday.

 

Common Stock.  The stockholder is entitled to receive dividends if, when and as declared by the Board of Directors out of funds legally available after all preferred dividends have been paid.

 

***Earnings Per Common Share:***

 

Dividends on preferred stock are deducted from earnings in the computation of earnings per common share when declared by the Company’s Board of Directors.  Because there are no dilutive securities, basic earnings per common share is equal to diluted earnings per common share.

 

***Income Taxes:***

 

The Company has elected, for Federal income tax purposes, to be treated as a Real Estate Investment Trust (“REIT”) and intends to comply with the provisions of the Internal Revenue Code of 1986, as amended (the “Code”).  Accordingly, the Company is generally not subject to Federal corporate income taxes on its net income (excluding capital gains) to the extent it distributes at least 100% of its annual REIT taxable income to stockholders and as long as certain asset, income and stock ownership tests are met in accordance with the IRC.  To remain qualified as a REIT, the Company must (a) distribute each year at least 90% of its “REIT taxable income” (not including capital gains) for that year to stockholders (b) meet certain income tests (c) meet certain asset tests and (d) meet certain ownership tests. Because management of the Company believes it qualifies as a REIT forFederal income tax purposes and it generally intends to fully remit its earnings to the extent of REIT taxable income to its shareholders, no provision for income tax is included in the accompanying financial statements.

 

On March 11, 2008, the Company’s Board of Directors declared a cash dividend of $1,896.60 per share of Common Stock, which was paid out of retained earnings of the Company and which was treated, for tax purposes, as a distribution made for 2007.  Including this dividend, the Company will have distributed 100% of its REIT taxable income to its stockholders in 2007.  During the year ended December 31, 2006, the company distributed over 100% of its REIT taxable income to its stockholders.

 

F-8

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**NOTES TO FINANCIAL STATEMENTS**

**DECEMBER 31, 2007, 2006 and 2005**

 

**NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):**

 

***Income Taxes (Continued):***

 

There are two income tests that must be satisfied for each taxable year.

 

**•**

At least 75% of the Company’s gross income (excluding income from certain prohibited transactions) must be from interest on obligations secured by mortgages on real property or on interests in real property, gains from the sale or other disposition of real property (including interests in mortgages on real property), and certain other sources;

 
;
 

**•**

At least 95% of the Company’s gross income (excluding income from prohibited transactions) must be from income included under the 75% income test, other interest, dividends, and gains from the sale or other disposition of certain stocks and securities.

 

There are three relevant asset tests that must be satisfied at the close of each quarter of the Company’s taxable year.

 

**•**

At least 75% of the value of the Company’s total assets must be represented by real estate assets, cash, cash items, and government securities;

 

 

**•**

Not more than 25% of the Company’s total assets may be represented by securities other than those in the 75% asset class; and

 

 

**•**

The value of any one issuer’s securities included in the 25% asset class may not exceed 5% of the value of the Company’s total assets and the Company may not own more than 10% of the total voting power or value of the outstanding securities of any one issuer.

 

The stock ownership test has two components.  At least 100 persons must hold shares of capital stock for at least 335 days of the year and no more than 50% of the Company’s capital stock may be owned directly or indirectly by five or fewer individuals during the final six months of the calendar year.

 

During 2007, the Company met the requirements of each test.

 

***Recently Issued Accounting Standards:***

 

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”).   SFAS 159 is effective for fiscal years beginning after November 15, 2007, but early adoption is permitted.  Upon adoption, SFAS 159 allows entities to make a one-time irrevocable election to measure certain existing financial assets and liabilities at fair value and report the unrealized gains and losses on those items in earnings at each subsequent reporting date.  When adopting SFAS 159, entities must also adopt SFAS 157, “Fair Value Measurements,” issued in September 2006, which defines fair value and outlines the hierarchy of inputs that should be used when calculating fair value.  The Company did not elect fair value treatment for any assets.  

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).  SFAS 157 eliminates the diversity in practice that exists due to the different definitions of fair value and the limited guidance for applying those definitions that are dispersed among the many accounting pronouncements that require fair value measurements.  SFAS 157 clarifies the definition of fair value as an exit price and defines the exit price as the price in an orderly transaction between market participants to sell an asset or to settle a liability in the principal or most advantageous market for the asset or liability.  Furthermore, SFAS 157 establishes a three-level fair value hierarchy that distinguishes between (i) market participant assumptions developed from independent and observable inputs and (ii) the reporting entity’s own assumptions about market participant assumptionsdeveloped from unobservable inputs.  SFAS 157 is effective for fiscal years beginning after November 15, 2007.  Management does not expect the adoption of SFAS 157 to have a material impact on the Company’s financial condition or results of operations.

 

F-9

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**NOTES TO FINANCIAL STATEMENTS**

**DECEMBER 31, 2007, 2006 and 2005**

 

**NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):**

 

***Recently Issued Accounting Standards (Continued):***

 

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”).  FIN 48 clarifies the requirements of SFAS No. 109, “Accounting for Income Taxes,” relating to the recognition of income tax benefits.  FIN 48 provides a two-step approach to recognizing and measuring tax benefits when realization of the benefits is uncertain.  The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%.  FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The adoption of FIN 48 on January 1, 2007, had no impact on the Company's financial condition or results of operations.

 

**NOTE 3 – RESIDENTIAL MORTGAGE LOANS:**

 

Residential mortgage loans consist of adjustable-rate mortgages (“ARMs”) and 15 and 30 year fixed-rate mortgages.  The ARMs have interest rates which are fixed for an initial period (one month, one year, three years, five years, seven years or ten years) and which adjust thereafter based on the margin, index and frequency, subject to interest rate adjustment caps, all as specified in the related mortgage note.  

 

The following table shows the residential mortgage loan portfolio by type at the dates indicated: 

 

 

December 31,

 

2007

 

2006

Payment Option ARMs

$           15,364,697

 

$           33,880,718

One-Year ARMs

3,808,186

 

5,109,950

Three-Year ARMs

17,315,273

 

21,001,902

Five-Year ARMs

196,054,307

 

211,433,598

7/1 ARMs

2,025,360

 

2,512,271

10/1 ARMs

8,215,892

 

9,822,378

15 & 30 Year Fixed-Rate

52,951,803

 

62,610,120

Subtotal

295,735,518

 

346,370,937

Less:

 

 

 

Allowance for loan losses

160,000

 

40,333

Total

$         295,575,518

 

$         346,330,604

 

Each of the mortgage loans is secured by a mortgage, deed of trust or other security instrument which created a first lien on the residential dwellings located in their respective jurisdictions.

 

**NOTE 4 - ALLOWANCE FOR LOAN LOSSES:**

 

During the year ended December 31, 2007, the Company recorded a provision of $226,353.  During the year ended December 31, 2006, the Company recorded a provision equal to its charge-offs of $13,540 on a loan secured by a property in Michigan for which the Company agreed to accept repayment for an amount less than its recorded balance.  

 

 

 

 

F-10

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**NOTES TO FINANCIAL STATEMENTS**

**DECEMBER 31, 2007, 2006 and 2005**

 

**NOTE 4 - ALLOWANCE FOR LOAN LOSSES (Continued):**

 

The balance of the allowance for loan losses was $160,000 and $40,333 at December 31, 2007 and 2006, respectively.  The activity in the allowance for loan losses is shown in the following table.  

 

 

 

Year Ended

 

 

December 31,

 

 

2007

 

2006

Beginning Balance

 

$      40,333

 

$       40,333

Provision for loan losses

 

226,353

 

13,540

Charge-offs

 

(106,686)

 

(13,540)

Ending Balance

 

$    160,000

 

$       40,333

 

**NOTE 5 – LOAN PAYABLE TO PARENT:**

 

The Company borrowed $75,000,000 from the Bank on December 20, 2004, and used the proceeds to purchase Residential Mortgage Loans from the Bank.  The loan is secured by a portion of the Residential Mortgage Loan portfolio, and the interest rate on the loan adjusts monthly based on changes in one-month LIBOR.  

 

During the year ended December 31, 2007, the Company repaid the remaining balance of $47,700,000 on the loan.  

 

**NOTE 6 - PREFERRED STOCK:**

 

On December 3, 1996, the Company sold $150 million of Series A Preferred Shares, $5.00 par value and received net cash proceeds of $144 million.  Cash dividends on the Series A Preferred Shares, if, when and as declared by the Board of Directors, are payable quarterly in arrears at an annual rate of 10 3/8%.  The liquidation value of each Series A Preferred Share is $50 plus accrued and unpaid dividends.  Except under certain circumstances, the holders of the Series A Preferred Shares have no voting rights.  The Series A Preferred Shares are automatically exchangeable for a new series of preferred stock of the Bank upon the occurrence of certain events.

 

The Series A Preferred Shares are redeemable at the option of the Company at any time, in whole or in part, at the following per share redemption prices plus accrued and unpaid dividends:
 
If redeemed during the

12-month period

beginning January 15,

 

 

Redemption

Price

2007

 

$       52.594

2008

 

52.075

2009

 

51.556

2010

 

51.038

2011

 

50.519

2012 and thereafter

 

50.000

 

**NOTE 7 - DIVIDENDS:**

 

During the year ended December 31, 2007, the Company’s Board of Directors declared $15,562,500 of preferred stock dividends out of retained earnings of the Company.  The Company's Board of Directors also declared $2,300,000 of common stock dividends, all of which were paid out of the retained earnings of the Company.  

 

Of these amounts, preferred stock dividends of $3,890,625 and common stock dividends of $2,300,000 were paid subsequent to December 31, 2007. 

 

F-11

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**NOTES TO FINANCIAL STATEMENTS**

**DECEMBER 31, 2007, 2006 and 2005**

 

**NOTE 8 - RELATED PARTY TRANSACTIONS:**

 

The Company has entered into an advisory agreement (the “Advisory Agreement”) with the Bank (the “Advisor”).  The Advisor provides advice to the Board of Directors and manages the operations of the Company as defined in the Advisory Agreement.  The Advisory Agreement has an initial term of three years commencing on December 3, 1996 and is automatically renewed for additional one-year periods unless the Company delivers a notice of nonrenewal to the Advisor.  The Advisory Agreement may be terminated by the Company at any time upon sixty days’ prior written notice.  The advisory fee is $200,000 per annum payable in equal quarterly installments.

 

The Company also entered into a servicing agreement with the Bank for the servicing of its residential mortgage loans (the “Servicing Agreement”).  Pursuant to the Servicing Agreement, the Bank performs the servicing of the loans owned by the Company, in accordance with normal industry practice.  The Servicing Agreement can be terminated without cause upon sixty days’ notice to the servicer and payment of a termination fee.  Servicing fees are payable at the annual rate of 0.250% and totaled $763,928, $904,068 and $911,577 for the years ended December 31, 2007, 2006 and 2005, respectively.

 

The Company purchased Residential Mortgage Loans from the Bank totaling $21,200,366 and $63,675,650 for the years ended December 31, 2007 and 2006, respectively.

 

The Company borrowed $75,000,000 from the Bank on December 20, 2004, and used the proceeds to purchase Residential Mortgage Loans from the Bank.  The loan was secured by a portion of the Residential Mortgage Loan portfolio and the interest rate on the loan adjusted monthly based on changes in one-month LIBOR.  During the year ended December 31, 2007, the Company repaid the remaining balance of $47,700,000 on the loan.  During the years ended December 31, 2007, 2006 and 2005 the Company incurred $936,692, $4,124,514 and $3,153,396, respectively, of interest expense on these borrowings.

 

The Company had cash balances of $6,916,334 and $5,753,475 as of December 31, 2007 and 2006, respectively, held in various deposit accounts with the Bank.  Interest earned on these accounts was $21,626, $24,261 and $25,016 for the years ended December 31, 2007, 2006 and 2005, respectively.

 

F-12

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**NOTES TO FINANCIAL STATEMENTS**

**DECEMBER 31, 2007, 2006 and 2005**

 

**NOTE 9 – ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS:**

 

The majority of the Company’s assets are financial instruments; however, certain of these financial instruments lack an available trading market.  Significant estimates, assumptions and present value calculations were therefore used for the purposes of deriving the fair values of the Company’s financial instruments, resulting in a degree of subjectivity inherent in the indicated fair value amounts.  Because fair value is estimated as of the balance sheet date, the amount which would actually be realized or paid upon settlement could be significantly different.  Comparability among REITs may be difficult due to the range of permitted valuation techniques and the numerous estimates and assumptions which must be made.

 

The estimated fair values of the Company’s financial instruments at December 31, 2007 and 2006 are as follows:

 

 

December 31, 2007

 

Carrying

Amount

 

Fair

Value

Financial assets:

 

 

 

Cash and interest-bearing deposits

$       6,916,334

 

$         6,916,334

Residential mortgage loans, net

295,575,518

 

296,499,000

 

 

 

 

 

 

 

 

 

December 31, 2006

 

Carrying

Amount

 

Fair

Value

Financial assets:

 

 

 

Cash and interest-bearing deposits

$       5,753,475

 

$         5,753,475

Residential mortgage loans, net

346,330,604

 

349,952,000

 

 

 

 

Financial liabilities

 

 

 

Loan payable to parent

$     47,700,000

 

$       47,700,000

 

The following methods and assumptions were used to estimate the fair value amounts at December 31, 2007 and 2006.

 

***Cash and interest-bearing deposits*****:**

 

Carrying amount approximates fair value.

 

***Residential mortgage loans*****:**

 

Fair value is estimated using discounted cash flow analyses based on contractual repayment and anticipated prepayment schedules.  The discount rates used in these analyses are based on either the interest rates paid on U.S. Treasury securities of comparable maturities adjusted for credit risk and non-interest operating costs, or the interest rates currently offered for loans with similar terms to borrowers of similar credit quality.

 

***Loan payable to parent*****:**

 

The carrying amount of the loan payable to the Bank approximates fair value because the interest rate on the loan changes monthly based on market rates.

 

 

F-13

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**NOTES TO FINANCIAL STATEMENTS**

**DECEMBER 31, 2007, 2006 and 2005**

 

**NOTE 10 – QUARTERLY FINANCIAL DATA (Unaudited):**

 

The quarterly financial data of the Company herein has been derived from the unaudited quarterly financial statements of the Company.  The data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements included elsewhere herein.

 

 

 

2007

For the quarter ended

 
 

 

March 31

 

June 30

 

September 30

 

December 31

 

OPERATING DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$        5,482,064

 

$      5,131,321

 

$    4,827,946

 

$    4,743,452

 

Interest expense

 

(617,721)

 

(291,412)

 

(27,559)

 

-

 

Net interest income

 

4,864,343

 

4,839,909

 

4,800,387

 

4,743,452

 

Provision for loan losses

 

(119,736)

 

(13,960)

 

-

 

(92,657)

 

Net interest income after

provision for loan losses

 

4,744,607

 

4,825,949

 

4,800,387

 

4,650,795

 

Operating expenses

 

(311,551)

 

(309,440)

 

(280,077)

 

(288,347)

 

Net income

 

$        4,433,056

 

$      4,516,509

 

$    4,520,310

 

$    4,362,448

 

Preferred Stock dividends

 

$        3,890,625

 

$      3,890,625

 

$    3,890,625

 

$    3,890,625

 

Earnings available to common

stockholders

 

$           542,431

 

$         625,884

 

$       629,685

 

$       471,823

 

Average common shares

 

100

 

100

 

100

 

100

 

Earnings per common share

 

$          5,424.31

 

$        6,258.84

 

$      6,296.85

 

$      4,718.23

 

 

 

 

 

2006

For the quarter ended

 
 

 

March 31

 

June 30

 

September 30

 

December 31

 

OPERATING DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$        5,906,598

 

$      5,962,626

 

$    6,066,531

 

$    5,733,177

 

Interest expense

 

(1,008,177)

 

(1,106,436)

 

(1,147,388)

 

(862,513)

 

Net interest income

 

4,898,421

 

4,856,190

 

4,919,143

 

4,870,664

 

Provision for loan losses

 

-

 

-

 

-

 

(13,540)

 

Net interest income after

provision for loan losses

 

4,898,421

 

4,856,190

 

4,919,143

 

4,857,124

 

Operating expenses

 

(327,764)

 

(327,012)

 

(329,384)

 

(315,774)

 

Net income

 

$        4,570,657

 

$      4,529,178

 

$    4,589,759

 

$    4,541,350

 

Preferred Stock dividends

 

$        3,890,625

 

$      3,890,625

 

$    3,890,625

 

$    3,890,625

 

Earnings available to common

stockholders

 

$           680,032

 

$         638,553

 

$       699,134

 

$       650,725

 

Average common shares

 

100

 

100

 

100

 

100

 

Earnings per common share

 

$          6,800.32

 

$        6,385.53

 

$      6,991.34

 

$      6,507.25

 

 

 

F-14
 
**ITEM 9.**

**CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON**

 

**ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM 9A.**

**CONTROLS AND PROCEDURES**

 

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chairman and Chief Executive Officer and its Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2007.  In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Based on the foregoing, the Company’s Chairman and Chief Executive Officer and its Executive Vice President and Chief Financial Officer concluded that theCompany’s disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2007.  

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. With our participation, an evaluation of the effectiveness of our internal control over financial reporting was conducted as of December 31, 2007, based on the framework and criteria established in *Internal Control – Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on this evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2007. 

 

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

 

During the three months ended December 31, 2007, there were no changes in the Company’s internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 
 
**ITEM 9B.**

**OTHER INFORMATION**

 

None.

 

**PART III**

 
 
**ITEM 10.**

**DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

**DIRECTORS AND EXECUTIVE OFFICERS**

 

The Company’s Board of Directors currently consists of six members, two of whom are Independent Directors.  Each director was elected to serve for a term of one year and until his successor shall have been duly elected and qualified.  The Board of Directors is elected by the Bank, which is the sole holder of common stock of the Company.  The holders of the Series A Preferred Shares may elect directors only under certain limited circumstances.  See Description Of Series A Preferred Shares – Voting Rights.  The Board of Directors met four times during 2007 and all of its members attended at least 80% of the meetings.  The Company currently has eight officers.  The Company has no other employees and does not anticipate that it will require additional employees.

 

-26-

The following persons are the Company’s current directors and/or executive officers.

 

Name

 

Age

 

Position and Offices Held

B. Francis Saul II

 

75

 

Chairman of the Board, President and Chief Executive Officer

 

 

 

 

 

Alexander R. M. Boyle

 

70

 

Director

 

 

 

 

 

Stephen R. Halpin, Jr.

 

52

 

Executive Vice President, Chief Financial Officer, Treasurer and Director

 

 

 

 

 

Thomas H. McCormick

 

57

 

Executive Vice President, General Counsel and Director

 

 

 

 

 

N. Alexander MacColl, Jr.

 

73

 

Director

 

 

 

 

 

H. Gregory Platts

 

60

 

Director 

 

The following is a summary of the experience of the executive officers and/or directors of the Company:

 

B. FRANCIS SAUL II has served as Chairman of the Board and Chief Executive Officer of the Company since its formation in 1996.  He also serves as Chairman of the Board and Chief Executive Officer of the Bank. He also has been President and Chief Operating Officer of B.F. Saul Company since 1969.  Mr. Saul has served as the Chairman of B.F. Saul Real Estate Investment Trust since 1969 and as a trustee since 1964.  He is also a director of Derwood Investment Corporation.  At December 31, 2006, B.F. Saul Real Estate Investment Trust and Derwood Investment Corporation owned of record 80% and 16%, respectively, of the Bank’s outstanding common stock.  Mr. Saul is also Chairman of the Board of Directors of B. F. Saul Advisory Company and Chevy Chase Property Company Limited.  He serves as Chairman of the Board and Chief Executive Officer of Saul Centers, Inc., a public real estate investment trust.  Mr. Saulis the father of B. Francis Saul III, a director of the Bank.  Mr. Saul serves as a Trustee of the National Geographic Society and the Johns Hopkins Medicine Board.  He also serves as a member of the Trustees Council of the National Gallery of Art and is an Honorary Trustee of the Brookings Institute.  In addition, Mr. Saul is Director Emeritus of Colonial Williamsburg Hotel Properties, Inc., a member of the Folger Shakespeare Library and the Board of Visitors and Governors of Washington College.

 

ALEXANDER R. M. BOYLE has been a Director of the Company since its formation in 1996.  He also has been Vice Chairman of the Board of Directors of the Bank since 1985.  Prior to beginning service in this position, Mr. Boyle was the President and a member of the Board of Directors of Government Services Savings and Loan, Inc. from 1975 until its merger with the Bank in 1985.  He is also a Trustee of the B. F. Saul Employees Profit Sharing Retirement Trust.  Mr. Boyle has served as a director of the U. S. League of Savings Institutions and as chairman of the Maryland League of Financial Institutions.  He currently serves as a Director of the American Bankers Association and has been appointed to a two-year term on the Thrift Institutions Advisory Council of the Federal Reserve Board.  He is also a member of the Rotary Club of Bethesda-Chevy Chase.

 

STEPHEN R. HALPIN, JR. has served as Director, Executive Vice President and Chief Financial Officer of the Company since its formation in 1996.  Mr. Halpin has also served as Executive Vice President and Chief Financial Officer of the Bank since 1995.  Mr. Halpin is also the Chief Financial Officer for the B.F. Saul Company and B.F. Saul Real Estate Investment Trust.  He is a Trustee of the B.F. Saul Employees Profit Sharing Retirement Trust.  In addition, Mr. Halpin is a Trustee for Hospice Caring, Inc.  Before joining the Bank in 1983, Mr. Halpin was with a public accounting firm.

 

THOMAS H. MCCORMICK has served as Director, Executive Vice President and General Counsel of the Company since 2006.  He joined the Bank in February 2005 as Executive Vice President and General Counsel.  Mr. McCormick is also Senior Vice President and General Counsel and a Director of B. F. Saul Company and Senior Vice President and General Counsel of Saul Centers, Inc.  In addition, he is a Trustee of the B. F. Saul Employees Profit Sharing Retirement Trust.  Prior to joining the Bank, Mr. McCormick was a senior partner with the law firm Shaw Pittman, LLP, now known as Pillsbury Winthrop Shaw Pittman LLP.  He also served as the Chair of Shaw Pittman’s managing board and its Corporate and Securities group.

 

-27-

N. ALEXANDER MACCOLL, JR. has been a Director of the Company since its formation in 1996.  Mr. MacColl was a Senior Vice President of the Union Trust Company Loan Production Office from 1982 until 1990 when he retired.  He served as Corporate Vice President of Colonial Bancorp. from 1977 until 1981.  Prior to his position at Colonial Bancorp., he served as Second Vice President of the National Bank of Detroit from 1962 until 1977.

 

H. GREGORY PLATTS has been a Director since 2003.  Mr. Platts currently serves as Senior Vice President and Treasurer of the National Geographic Society.  Prior to joining the National Geographic Society in 1980, Mr. Platts served as a trust investment officer with the Union Trust Company and First American Bank in Washington, DC from 1972 until 1978.  Mr. Platts currently serves on the board of the Center for the Study of the Presidency, on the advisory board of Decatur House, and the investment committee of St. Albans School. He has served as a director and president of the Washington Society of Investment Analysts, chairman of the American Red Cross Blood Services mid-Atlantic region, and trustee of Westmoreland Congregational Church in Bethesda.  He has also served on the boards of the National Presbyterian School, the Edes Home in Georgetown, the Friends of Fort Dupont, and the Bulldog Hockey Club.

 

**CODE OF BUSINESS CONDUCT**

 

The Company does not have employees and, accordingly, has not adopted a code of business conduct applicable exclusively to the Company.  However, the officers of the Company, including the principal executive, financial and accounting officers of the Company, are employees of the Bank and, as such, are bound by the Bank’s Code of Business Conduct.  The Bank’s Code of Business Conduct will be made available to any person who writes the Company requesting a copy.

 

**AUDIT COMMITTEE**

 

The Company’s audit committee reviews the engagement of independent accountants and reviews their independence.  The audit committee also reviews the adequacy of the Company’s internal accounting controls.  The audit committee is comprised of the Company’s Independent Directors, H. Gregory Platts and N. Alexander MacColl, Jr. The audit committee met four times during 2007.

 

The Company’s Board of Directors has not designated any member of the audit committee as an “audit committee financial expert.”  The Board of Directors believes that the Company’s business of acquiring, holding and managing Mortgage Assets does not generate accounting issues of sufficient complexity to require the designation of a member of the audit committee as an “audit committee financial expert.”

 

**SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE**

 

Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the Company’s officers, directors and persons who own more than ten percent of either the Common Stock or the Series A Preferred Shares to file reports of ownership on Form 3 and changes in ownership on Form 4 or 5 with the SEC and the New York Stock Exchange.  Such officers, directors and ten percent shareholders are also required by SEC rules to furnish the Company with copies of all Section 16(a) forms that they file.

 

Based solely on its review of copies of such reports received or representations from certain reporting persons, the Company believes that, during the year ended December 31, 2007, all of its officers, directors and ten percent shareholders complied with all Section 16(a) filing requirements applicable to them with respect to transactions during fiscal 2007.

 

-28-
 
**ITEM 11.**

**EXECUTIVE COMPENSATION**

 

Since the Company’s inception on November 5, 1996, no compensation has been awarded to, earned by or paid to any of the Company’s directors (other than its Independent Directors), officers or employees.  The Company does not intend to pay any compensation to any of its directors (other than its Independent Directors), officers or employees.  The Company pays the Independent Directors annual compensation of $10,000, plus a fee of $750 for attendance (in person or by telephone) at each meeting of the Board of Directors and each meeting of the Audit Committee.  In 2007, each of the Independent Directors earned $6,000 for attending four meetings of the Board of Directors and four meetings of the Audit Committee.

 
 
**ITEM 12.**

**SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**
 
 

The Company had no compensation plan under which its equity securities are authorized for issuance.  The following table sets forth, as of March 15, 2008, the number and percentage of outstanding shares of Common Stock and Series A Preferred Shares beneficially owned by (i) all persons known by the Company to own more than five percent of such shares; (ii) each director of the Company; (iii) each executive officer of the Company; and (iv) all executive officers and directors of the Company as a group.  The persons or entities named in the table have sole voting and sole investment power with respect to each of the shares beneficially owned by such person or entity.  The calculations were based on a total of 100 shares of Common Stock and 3,000,000 Series A Preferred Shares outstanding as of March 15, 2008.

 

**Names and Address of**

**Beneficial Owner (1)**

 

**Amount of Beneficial**

**Ownership**

 

**Percent of Class of**

**Outstanding Shares**

Chevy Chase Bank, F.S.B.

 

100

 

Common - 100%

 

 

 

 

 

B. Francis Saul II (2)(3)(4)

 

100

 

Common - 100%

 

 

 

 

 

Alexander R. M. Boyle (2)

 

0

 

0%

 

 

 

 

 

Stephen R. Halpin, Jr. (2)(3)

 

1,000

 

Preferred - 0.033%

 

 

 

 

 

Thomas H. McCormick (2)(3)

 

0

 

0%

 

 

 

 

 

N. Alexander MacColl, Jr. (2)

 

0

 

0%

 

 

 

 

 

H. Gregory Platts (2)

 

0

 

0%

 

 

 

 

 

All directors and executive officers

as a group (6 persons)

 

1,000

 

Preferred - 0.033%

 

(1) The address of each beneficial owner is 7501 Wisconsin Avenue, Bethesda, Maryland 20814.

(2) Indicates a director of the Company.

(3) Indicates an executive officer of the Company.

(4) Pursuant to Rule 13d-3 under the Securities Exchange Act of 1934, Mr. B. Francis Saul II may be deemed to possess beneficial ownership of some or all of the Common Stock of the Company owned by Chevy Chase Bank because he has, or may be deemed to have, sole or shared voting and/or investment power of those shares of Common Stock.

 
 
**ITEM 13.**

**CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

Because of the nature of the Company’s relationship with the Bank and its affiliates, most of the Company’s transactions, including the acquisition of Mortgage Assets, constitute transactions with related persons.  It is the Company’s policy that the terms of any financial dealings with the Bank and its affiliates will be no less favorable to the Company than those available from third parties in the mortgage lending industry.  In addition, the Company’s Articles of Incorporation, as amended, require that, as long as any Series A Preferred Shares are outstanding, the Independent Directors must approve, in advance, (a) any redemption of any shares of Common Stock and (b) any amendment, modification, termination or election not to renew any of the Advisory Agreement, the Servicing Agreement or the Mortgage Loan Purchase Agreement (collectively, the “Agreements”).  

 

-29-

Transactions between the Company and the Bank occurring in the normal course of business pursuant to any of the Agreements are not individually reviewed, approved or ratified.  The Company has not adopted procedures for review of, or standards for approval of, transactions with other related parties that would be required to be reported under the rules of the Securities and Exchange Commission, but instead will review such transactions on a case-by-case basis.  In addition, as a subsidiary of the Bank, certain loans and other transactions between the Company and those other related parties would be subject to regulatory limitations, including a requirement that they be on market terms.

 

Set forth below are certain transactions between the Company and its directors and affiliates.  Management believes that the transactions with related parties described herein have been conducted on substantially the same terms as similar transactions with unrelated parties.

The Bank administers the day-to-day operations of the Company and is entitled to receive fees in connection with the Advisory Agreement.  Advisory fees paid to the Bank for the year ended December 31, 2007 totaled $200,000.  See “Business - The Advisor.”

 

The Company purchased Residential Mortgage Loans from the Bank totaling $21,200,366 and $63,675,650 for the years ended December 31, 2007 and 2006, respectively.

 

The Bank services the Residential Mortgage Loans included in the Company’s portfolio and is entitled to receive fees in connection with the Servicing Agreement.  Loan servicing fees paid to the Bank for the year ended December 31, 2007 totaled $763,928.  See “Business - Servicing.”

 

The Company borrowed $75,000,000 from the Bank on December 20, 2004, and used the proceeds to purchase Residential Mortgage Loans from the Bank.  During the year ended December 31, 2007, the Company repaid the remaining balance of $47,700,000 on the loan.  During the years ended December 31, 2007, 2006 and 2005, the Company incurred $936,692, $4,124,514 and $3,153,396, respectively, of interest expense on these borrowings.

 

**ITEM 14**.

**PRINCIPAL ACCOUNTING FEES AND SERVICES**

 

The firm of Ernst & Young LLP has examined the financial statements of the Company for the period from January 1, 2002 to December 31, 2007.  Ernst & Young LLP reports to, and is engaged at the direction of, the Audit Committee.  The aggregate fees billed by Ernst & Young LLP totaled $62,751 and $54,123 during the years ended December 31, 2007 and 2006, respectively, and consisted solely of audit fees. 

 

The Audit Committee approves, in advance, the engagement of the independent accountants to provide services to the Company.

 

-30-

**PART IV**

 

 

 

**ITEM 15.**

**EXHIBITS, FINANCIAL STATEMENT SCHEDULES**

 

 

 

 

(a)1

The following financial statements of the Company are included in Item 8 of this report:

 

Report of Independent Auditors

Statements of Financial Condition at December 31, 2007 and 2006

Statements of Operations for the Years Ended December 31, 2007, 2006 and 2005

Statements of Stockholders’ Equity for the Years Ended December 31, 2007, 2006 and 2005

Statements of Cash Flows for the Years Ended December 31, 2007, 2006 and 2005

 

Notes to Financial Statements

 

 

 

 

(a)2

All other schedules for which provision is made in the applicable accounting of the Securities and Exchange Commission are not required under the related instruction or are inapplicable and therefore have been omitted.

 

 

 

 

(a)3

Exhibits:

 

 

 

 

3.1

Articles of Incorporation of the Company, as amended (incorporated herein by reference to Exhibit 3.1 of the Company’s 1996 Annual Report on Form 10-K).

 

 

 

 

3.2

Bylaws of the Company (incorporated herein by reference to Exhibit 3(b) of Form S-11 (file number 333-10495) filed by the Company).

 

 

 

 

4.1

Articles Supplementary of 10 3/8% Noncumulative Exchangeable Preferred Stock, Series A (incorporated herein by reference to Exhibit 4.1 of the Company’s 1996 Annual Report on Form 10-K).

 

 

 

 

10.1

Residential Mortgage Loan Purchase Agreement between the Company and the Bank (incorporated herein by reference to Exhibit 10.1 of the Company’s 1996 Annual Report on Form 10-K).

 

 

 

 

10.2

Mortgage Loan Servicing Agreement between the Company and the Bank (incorporated herein by reference to Exhibit 10.2 of the Company’s 1996 Annual Report on Form 10-K).

 

 

 

 

10.3

Advisory Agreement between the Company and the Bank (incorporated herein by reference to Exhibit 10.3 of the Company’s 1996 Annual Report on Form 10-K).

 

 

 

 

10.4

Amendment to Servicing Agreement as modified on June 17, 2003 effective July 1, 2003 (incorporated herein by reference to Exhibit 10.4 of the Company’s report on Form 10-Q for the quarterly period ended June 30, 2003).

 

 

 

 

10.5

Loan Agreement by and between Chevy Chase Preferred Capital Corporation and Chevy Chase Bank, F.S.B. dated December 20, 2004 (incorporated herein by reference to Exhibit 10.5 of the Company’s 2004 Annual Report on Form 10-K).

 

 

 

*

12.1

Computation of ratio of earnings to fixed charges and Preferred Stock dividend requirements.

 

 

 

*

31.1

Rule 13a-14(a) / 15d – 14(a) Certifications of Chief Executive Officer.

 

 

 

*

31.2

Rule 13a-14(a) / 15d – 14(a) Certifications of Chief Financial Officer.

 

 

 

*

32.1

Section 1350 Certifications of Chief Executive Officer.

 

 

 

*

32.2

Section 1350 Certifications of Chief Financial Officer.

 

 

 

*****Filed herewith.

-31-

Exhibit 12.1

 

 

**CHEVY CHASE PREFERRED CAPITAL CORPORATION**

**COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES**

**AND PREFERRED STOCK DIVIDEND REQUIREMENTS**

(in thousands, except ratio data)

 

 

As of or for the year ended December 31,

 

 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$         17,832

 

$         18,231

 

$         18,071

 

$         16,292

 

$         15,932

Fixed charges

 

-

 

-

 

-

 

-

 

-

Earnings before fixed charges

 

$         17,832

 

$         18,231

 

$         18,071

 

$         16,292

 

$         15,932

 

 

 

 

 

 

 

 

 

 

 

Fixed charges, as above

 

$          -

 

$          -

 

$          -

 

$          -

 

$          -

Preferred stock dividend requirements

 

15,563

 

15,563

 

15,563

 

15,563

 

15,563

Fixed charges including preferred stock 

dividends

 

$         15,563

 

$         15,563

 

$         15,563

 

$         15,563

 

$         15,563

 

 

 

 

 

 

 

 

 

 

 

Ratio of earnings to fixed charges and

 

 

 

 

 

 

 

 

 

 

Preferred stock dividend requirements

 

1.15x

 

1.17x

 

1.16x

 

1.05x

 

1.02x

 

 

 

 

 

 

 

 

 

 

 

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in Bethesda, Maryland on March 21, 2007.

 

CHEVY CHASE PREFERRED CAPITAL CORPORATION

 

 
 
March 24, 2008

By:

/s/ B. Francis Saul II  

 

   B. Francis Saul II

Chairman of the Board of Directors, 

President and Chief Executive Officer

 

         (Principal Executive Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following officers and directors of the Registrant and in the capacities and on the dates indicated.

 

NAME

TITLE

DATE

 

 

/s/ Alexander R.M. Boyle  

Director

March 24, 2008

Alexander R.M. Boyle

 

/s/ Joel A. Friedman  

Senior Vice President

March 24, 2008

Joel A. Friedman

and Controller

 

(Principal Accounting Officer)

 

/s/ Stephen R. Halpin, Jr.  

Director, Executive Vice President

March 24, 2008

Stephen R. Halpin, Jr.  

and Chief Financial Officer

 

(Principal Financial Officer)

 

/s/ Thomas H. McCormick  

Director, Executive Vice President

March 24, 2008

Thomas H. McCormick

and General Counsel

 

 

/s/ N. Alexander MacColl, Jr.  

Director

March 24, 2008

N. Alexander MacColl, Jr.

 

/s/ H. Gregory Platts  

Director

March 24, 2008

H. Gregory Platts

 

 

/s/ B. Francis Saul II  

Chairman of the Board of Directors,

March 24, 2008

B. Francis Saul II

President and Chief Executive Officer

 

(Principal Executive Officer)

 Exhibit 31.1

 

**CERTIFICATION**

I, B. Francis Saul II, certify that:

 

 

1.

I have reviewed this annual report on Form 10-K for the year ending December 31, 2007 of Chevy Chase Preferred Capital Corporation;

 

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 

 

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

 

a)

designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; 

 

 

b)

designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

 

c)

evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

 

d)

disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonable likely to materially affect, the registrant’s internal control over financial reporting; and

 

 

5.

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

 

a)

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

 

 

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

 
 
March 24, 2008

/s/ B. FRANCIS SAUL II

B. Francis Saul II

Chairman and Chief Executive Officer 

Exhibit 31.2

**CERTIFICATION**

I, Stephen R. Halpin, Jr., certify that:

 

 

1.

I have reviewed this annual report on Form 10-K for the year ending December 31, 2007 of Chevy Chase Preferred Capital Corporation;

 

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 

 

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

 

a)

designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

 

b)

designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

 

c)

evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

 

d)

disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonable likely to materially affect, the registrant’s internal control over financial reporting; and

 

 

5.

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

 

a)

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

 

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
March 24, 2008

/s/ STEPHEN R. HALPIN, JR.

Stephen R. Halpin, Jr.

 

Director, Executive Vice President and

 

Chief Financial Officer

Exhibit 32.1

 

**CERTIFICATION OF CHIEF EXECUTIVE OFFICER**

 

**PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO**

**SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002**

 

The undersigned, B. Francis Saul II, the Chairman and Chief Executive Officer of Chevy Chase Preferred Capital Corporation (the "Company"), has executed this certification in connection with the filing with the Securities and Exchange Commission of the Company's Annual Report on Form 10-K for the year ending December 31, 2007 (the “Report”). The undersigned hereby certifies that:

 

(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 
 
March 24, 2008

/s/  B. FRANCIS SAUL II

B. Francis Saul II 

Chairman and Chief Executive Officer

Exhibit 32.2

 

**CERTIFICATION OF CHIEF FINANCIAL OFFICER**

 

**PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO**

**SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002**

 

The undersigned, Stephen R. Halpin, Jr., the Executive Vice President and Chief Financial Officer of Chevy Chase Preferred Capital Corporation (the "Company"), has executed this certification in connection with the filing with the Securities and Exchange Commission of the Company's Annual Report on Form 10-K for the year ending December 31, 2007 (the “Report”). The undersigned hereby certifies that:

 

(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 
 
March 24, 2008

/s/ STEPHEN R. HALPIN, JR.

Stephen R. Halpin, Jr. 

Director, Executive Vice President and 

Chief Financial Officer

 

 

 

 

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