Saul B F Real Estate Investment Trust 424B3 Prospectus supplement

Registration No. 333-104068

Rule 424(b)(3)

Supplement Dated August 16, 2004

to Prospectus Dated January 22, 2004

B. F. SAUL

REAL ESTATE INVESTMENT TRUST

QUARTERLY REPORT

FOR QUARTER ENDED

JUNE 30, 2004

TABLE OF CONTENTS

Financial Statements (Unaudited):
(a)	Consolidated Balance Sheets at June 30, 2004 and September 30, 2003	3
(b)	Consolidated Statements of Operations for the three-month and nine-month periods ended June 30, 2004 and 2003	4
(c)	Consolidated Statements of Comprehensive Income and Changes in Shareholders’ Equity for the three-month and nine-month periods ended June 30, 2004 and 2003	6
(d)	Consolidated Statements of Cash Flows for the nine-month periods ended June 30, 2004 and 2003	7
(e)	Notes to Consolidated Financial Statements	9
Management’s Discussion and Analysis of Financial Condition and Results of Operations:
(a)	Financial Condition	17
	Real Estate	17
	Banking	17
(b)	Liquidity and Capital Resources	24
	Real Estate	24
	Banking	25
(c)	Results of Operations
	Three months ended June 30, 2004 compared to three months ended June 30, 2003	27
	Nine months ended June 30, 2004 compared to nine months ended June 30, 2003	32

2

Financial Statements

Consolidated Balance Sheets

B. F. SAUL REAL ESTATE INVESTMENT TRUST

(In thousands)	June 30, 2004			September 30, 2003
	(Unaudited)
ASSETS
Real Estate
Income-producing properties
Hotels	$	261,948		$	251,710
Office and industrial		182,935			180,385
Other		2,803			2,803
		447,686			434,898
Accumulated depreciation		(175,765	)		(162,453	)
		271,921			272,445
Land parcels		41,708			42,425
Real estate held for sale		2,185			2,560
Investment in Saul Holdings and Saul Centers		58,502			53,383
Cash and cash equivalents		35,456			18,979
Note receivable and accrued interest - related party		6,077			2,987
Other assets		44,564			36,506
Total real estate assets		460,413			429,285
Banking
Cash and other deposits		392,231			414,627
Securities purchased under agreements to resell		50,000			—
Loans held for securitization and/or sale		1,883,115			1,378,831
Investment securities (market value $70,671 and $46,531, respectively)		71,153			46,345
Mortgage-backed securities (market value $440,432 and $490,764, respectively)		436,512			478,392
Loans receivable (net of allowance for losses of $48,362 and $58,397, respectively)		8,307,162	��		7,559,557
Federal Home Loan Bank stock		138,861			107,374
Real estate held for investment or sale (net of allowance for losses of $202 for both periods)		21,592			22,745
Property and equipment, net		480,842			490,731
Automobiles subject to lease, net		531,062			855,410
Goodwill and other intangible assets, net		24,103			24,329
Interest-only strips receivable		236,705			139,781
Other assets		315,099			261,318
Total banking assets		12,888,437			11,779,440
TOTAL ASSETS	$	13,348,850		$	12,208,725
LIABILITIES
Real Estate
Mortgage notes payable	$	309,463		$	318,265
Mortgage note payable - real estate held for sale		4,096			4,172
Notes payable - secured		250,000			203,800
Notes payable - unsecured		56,052			55,349
Accrued dividends payable - preferred shares of beneficial interest		1,202			6,139
Other liabilities and accrued expenses		62,110			65,131
Total real estate liabilities		682,923			652,856
Banking
Deposit accounts		8,639,662			8,100,505
Borrowings		203,664			168,314
Federal Home Loan Bank advances		2,552,214			1,987,469
Other liabilities		478,529			533,137
Capital notes - subordinated		175,000			250,000
Total banking liabilities		12,049,069			11,039,425
Commitments and contingencies
Minority interest held by affiliates		108,671			98,062
Minority interest - other		296,013			249,698
TOTAL LIABILITIES		13,136,676			12,040,041
SHAREHOLDERS’ EQUITY
Preferred shares of beneficial interest, $10.50 cumulative, $1 par value, 90 million shares authorized, 516,000 shares issued and outstanding, liquidation value $51.6 million		516			516
Common shares of beneficial interest, $1 par value, 10 million shares authorized, 6,641,598 shares issued		6,642			6,642
Paid-in surplus		92,943			92,943
Retained earnings		155,914			112,424
		256,015			212,525
Less cost of 1,834,088 common shares of beneficial interest in treasury		(43,841	)		(43,841	)
TOTAL SHAREHOLDERS’ EQUITY		212,174			168,684
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	13,348,850		$	12,208,725

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

3

Consolidated Statements of Operations

B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)

	For the Three Months Ended June 30,						For the Nine Months Ended June 30,
(In thousands, except per share amounts)	2004			2003			2004			2003
REAL ESTATE
Income
Hotels	$	27,490		$	23,685		$	71,097		$	63,212
Office and industrial (including $1,261, $1,266, $3,749 and $3,848 of rental income from banking segment, respectively)		9,657			9,661			28,570			29,607
Other		431			301			1,214			905
Total income		37,578			33,647			100,881			93,724
Expenses
Direct operating expenses:
Hotels		16,385			15,143			45,698			42,537
Office and industrial properties		2,921			2,840			8,680			8,567
Land parcels and other		367			317			989			871
Interest expense		12,001			12,265			38,297			36,942
Amortization of debt expense		2,619			306			3,076			856
Depreciation		4,662			4,633			13,792			14,554
Advisory, management and leasing fees - related parties		3,439			3,202			9,724			9,172
General and administrative		6,926			670			8,174			1,681
Total expenses		49,320			39,376			128,430			115,180
Equity in earnings (losses) of unconsolidated entities:
Saul Holdings and Saul Centers		1,971			1,806			6,012			6,366
Other		(80	)		—			(460	)		(376	)
Impairment loss on investments		—			—			—			(625	)
Gain on sale of property		117			—			2,768			—
REAL ESTATE OPERATING LOSS	$	(9,734	)	$	(3,923	)	$	(19,229	)	$	(16,091	)
BANKING
Interest income
Loans	$	102,103		$	99,102		$	299,534		$	304,235
Mortgage-backed securities		5,133			7,730			15,626			30,573
Trading securities		363			1,202			1,150			3,541
Investment securities		333			295			840			894
Other		1,607			1,548			4,651			5,092
Total interest income		109,539			109,877			321,801			344,335
Interest expense
Deposit accounts		14,145			19,748			41,984			65,131
Borrowings		21,069			30,835			80,407			93,650
Total interest expense		35,214			50,583			122,391			158,781
Net interest income		74,325			59,294			199,410			185,554
Provision for loan losses		(5,644	)		5,920			(5,150	)		20,379
Net interest income after provision for loan losses		79,969			53,374			204,560			165,175
Other income
Deposit servicing fees		33,240			31,611			95,546			91,216
Servicing and securitization income		47,900			33,035			135,360			77,182
Automobile rental income, net		37,748			58,574			125,514			182,671
Gain on mortgage banking activities		1,471			6,403			7,820			14,635
Other		11,600			9,882			33,668			32,387
Total other income		131,959			139,505			397,908			398,091

Continued on following page.

4

Consolidated Statements of Operations (Continued)

B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)

	For the Three Months Ended June 30,						For the Nine Months Ended June 30,
(In thousands, except per share amounts)	2004			2003			2004			2003
BANKING (Continued)
Operating expenses
Salaries and employee benefits	$	59,353		$	53,158		$	169,981		$	158,042
Servicing assets amortization and other loan expenses		2,316			13,242			30,071			37,060
Property and equipment (including $1,261, $1,266, $3,749 and $3,848 of rental expense paid to real estate segment, respectively)		9,296			9,588			28,914			29,169
Marketing		3,332			3,950			7,881			6,996
Data processing		8,812			8,645			26,722			26,127
Depreciation and amortization		38,546			52,896			126,617			167,047
Other		14,126			14,128			52,435			42,829
Total operating expenses		135,781			155,607			442,621			467,270
BANKING OPERATING INCOME	$	76,147		$	37,272		$	159,847		$	95,996
TOTAL COMPANY
Income before taxes, minority interest and discontinued operations	$	66,413		$	33,349		$	140,618		$	79,905
Income tax provision		22,951			11,913			49,220			27,752
Income before minority interest and discontinued operations		43,462			21,436			91,398			52,153
Minority interest held by affiliates		(8,513	)		(3,537	)		(14,808	)		(8,741	)
Minority interest — other		(7,254	)		(6,329	)		(29,940	)		(18,985	)
TOTAL COMPANY INCOME FROM CONTINUING OPERATIONS	$	27,695		$	11,570		$	46,650		$	24,427
DISCONTINUED REAL ESTATE OPERATIONS
Loss from operations of discontinued real estate asset (including loss on disposal of $215, $—, $215, $—, respectively)		(326	)		(133	)		(995	)		(757	)
Income tax benefit		(114	)		(47	)		(348	)		(265	)
LOSS ON DISCONTINUED REAL ESTATE OPERATIONS		(212	)		(86	)		(647	)		(492	)
TOTAL COMPANY NET INCOME	$	27,483		$	11,484		$	46,003		$	23,935
Dividends: Real Estate Trust’s preferred shares of beneficial interest		(1,355	)		(1,355	)		(4,064	)		(4,064	)
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS	$	26,128		$	10,129		$	41,939		$	19,871
NET INCOME PER COMMON SHARE
Income before minority interest and discontinued operations	$	8.75		$	4.16		$	18.16		$	9.97
Minority interest held by affiliates		(1.77	)		(0.73	)		(3.08	)		(1.81	)
Minority interest — other		(1.51	)		(1.31	)		(6.23	)		(3.94	)
Discontinued operations		(0.04	)		(0.02	)		(0.13	)		(0.10	)
NET INCOME PER COMMON SHARE (BASIC AND DILUTED)	$	5.43		$	2.10		$	8.72		$	4.12

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

5

Consolidated Statements of Comprehensive Income and Changes in Shareholders’ Equity

B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)

	For the Three Months Ended June 30,						For the Nine Months Ended June 30,
(Dollars in thousands)	2004			2003			2004			2003
COMPREHENSIVE INCOME
Net income	$	27,483		$	11,484		$	46,003		$	23,935
Other comprehensive income		—			—			—			—
TOTAL COMPREHENSIVE INCOME	$	27,483		$	11,484		$	46,003		$	23,935
CHANGES IN SHAREHOLDERS’ EQUITY
PREFERRED SHARES OF BENEFICIAL INTEREST
Beginning and end of period (516,000 shares)	$	516		$	516		$	516		$	516
COMMON SHARES OF BENEFICIAL INTEREST
Beginning and end of period (6,641,598 shares)		6,642			6,642			6,642			6,642
PAID-IN SURPLUS
Beginning and end of period		92,943			92,943			92,943			92,943
RETAINED EARNINGS
Beginning of period		129,226			80,598			112,424			68,438
Net income		27,483			11,484			46,003			23,935
Adjustments - Saul Holdings Investments		560			587			1,551			3,005
Dividends:
Real Estate Trust preferred shares of beneficial interest:
Distributions payable		(1,355	)		(1,355	)		(4,064	)		(4,064	)
End of period		155,914			91,314			155,914			91,314
ACCUMULATED OTHER COMPREHENSIVE INCOME
Beginning of period		—			—			—			—
Net unrealized holding gains (losses)		—			—			—			—
End of period		—			—			—			—
TREASURY SHARES
Beginning of period (1,834,088, 1,814,688, 1,834,088 and 1,814,688 shares)		(43,841	)		(41,848	)		(43,841	)		(41,848	)
Purchases (19,400 shares)		—			(1,993	)		—			(1,993	)
End of period (1,834,088 shares)		(43,841	)		(43,841	)		(43,841	)		(43,841	)
TOTAL SHAREHOLDERS’ EQUITY	$	212,174		$	147,574		$	212,174		$	147,574

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

6

Consolidated Statements of Cash Flows

B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)

	For the Nine Months Ended June 30,
(In thousands)	2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES
Real Estate
Net loss	$	(13,227	)	$	(11,027	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Gain on sale of property		(2,768	)		—
Loss on disposal of discontinued real estate asset		215			—
Depreciation		14,047			14,884
Increase in accounts receivable and accrued income		(8,736	)		(5,988	)
Deferred tax benefit		(661	)		(683	)
Decrease in accounts payable and accrued expenses		(4,520	)		(8,579	)
Amortization of debt expense		3,978			1,560
Equity in earnings of unconsolidated entities, net		(5,552	)		(5,990	)
Impairment loss on investments		—			625
Dividends and tax sharing payments		22,355			20,498
Other		(675	)		(4,594	)
		4,456			706
Banking
Net income		59,230			34,962
Adjustments to reconcile net income to net cash used in operating activities:
Amortization of premiums, discounts and net deferred loan fees		20,639			16,552
Depreciation and amortization		126,617			167,047
Deferred tax provision (benefit)		(34,397	)		25,646
(Gain) loss on on sales of property and equipment		(818	)		364
Provision for loan losses		(5,150	)		20,379
Proceeds from sales of trading securities		570,288			1,625,746
Net fundings of loans held for securitization and/or sale		(4,740,413	)		(4,310,629	)
Proceeds from sales of loans held for sale and/or securitization		4,027,872			2,428,736
Gain on mortgage banking activities		(7,820	)		(14,635	)
Gain on sales of real estate held for sale		(1,301	)		(5,757	)
Increase in interest-only strips receivable		(96,924	)		(38,004	)
Increase in other assets		(53,616	)		(18,793	)
Increase (decrease) in other liabilities		(14,999	)		40,029
Minority interest held by affiliates		14,808			8,741
Minority interest - other		15,693			7,313
		(120,291	)		(12,303	)
Net cash used in operating activities		(115,835	)		(11,597	)
CASH FLOWS FROM INVESTING ACTIVITIES
Real Estate
Capital expenditures - properties		(13,597	)		(4,749	)
Property sales		3,719			—
Note receivable and accrued interest — related party
Repayments		750			2,250
Advances		(3,840	)		—
Investment in Saul Holdings and Saul Centers		3,279			3,141
Other investments		(689	)		(1,467	)
		(10,378	)		(825	)
Banking
Net proceeds from redemption of Federal Home Loan Bank stock		192,559			105,096
Purchases of Federal Home Loan Bank stock		(224,047	)		(106,414	)
Proceeds from maturities of investment securities		10,000			—
Purchases of investment securities		(35,000	)		—
Net proceeds from sales of real estate		7,882			11,677
Disbursements for real estate held for investment or sale		(2,413	)		(2,740	)
Net proceeds from sales of property and equipment		23,320			—
Net purchases of property and equipment		(42,065	)		(32,434	)
Net principal collected of loans receivable		4,221,739			3,328,544
Net (purchases) repayments of automobiles subject to lease		227,319			(4,217	)
Principal collected on mortgage-backed securities		150,539			496,074
Purchases of loans receivable		(5,449,975	)		(4,062,146	)
		(920,142	)		(266,560	)
Net cash used in investing activities		(930,520	)		(267,385	)

Continued on following page.

7

Consolidated Statements of Cash Flows (Continued)

B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited)

	For the Nine Months Ended June 30,
(In thousands)	2004			2003
CASH FLOWS FROM FINANCING ACTIVITIES
Real Estate
Proceeds from mortgage financing	$	—		$	46,000
Principal curtailments and repayments of mortgages		(7,980	)		(46,079	)
Net secured note financings (repayments)		46,200			6,150
Proceeds from sales of unsecured notes		9,942			3,799
Repayments of unsecured notes		(9,239	)		(3,905	)
Costs of obtaining financings		(7,524	)		(1,344	)
Purchase of treasury stock		—			(1,993	)
Dividends paid - preferred shares of beneficial interest		(9,000	)		(9,000	)
		22,399			(6,372	)
Banking
Proceeds from customer deposits and sales of certificates of deposit		38,486,221			33,588,985
Customer withdrawals of deposits and payments for maturing certificates of deposit		(37,947,064	)		(33,048,116	)
Net increase (decrease) in securities sold under repurchase agreements		5,036			(374,647	)
Advances from the Federal Home Loan Bank		12,582,819			7,161,330
Repayments of advances from the Federal Home Loan Bank		(12,018,074	)		(7,064,980	)
Net increase in other borrowings		30,314			14,543
Issuance of 6-7/8% subordinated debentures		171,938			—
Issuance of 8% Noncumulative Perpetual Preferred Stock, Series C		120,622			—
Redemption of 13% Noncumulative Perpetual Preferred Stock, Series A		(81,750	)		—
Redemption of 9-1/4% Subordinated Debentures		(252,775	)		—
Cash dividends paid on preferred stock		(8,250	)		(7,313	)
Cash dividends paid on common stock		(21,000	)		(15,000	)
		1,068,037			254,802
Net cash provided by financing activities		1,090,436			248,430
Net increase (decrease) in cash and cash equivalents		44,081			(30,552	)
Cash and cash equivalents at beginning of period		433,606			465,686
Cash and cash equivalents at end of period	$	477,687		$	435,134
Components of cash and cash equivalents at end of period as presented in the consolidated balance sheets:
Real Estate
Cash and cash equivalents	$	35,456		$	7,472
Banking
Cash and other deposits		392,231			427,662
Securities purchased under agreements to resell		50,000			—
Cash and cash equivalents at end of period	$	477,687		$	435,134
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (net of amount capitalized)	$	166,530		$	206,134
Income taxes		74,622			16,921
Shares of Saul Centers, Inc. common stock		6,087			5,844
Cash received during the year from:
Dividends on shares of Saul Centers, Inc. common stock		4,470			4,090
Distributions from Saul Holdings Limited Partnership		4,895			4,895
Supplemental disclosures of noncash activities:
Rollovers of notes payable - unsecured		4,474			5,532
Loans receivable exchanged for mortgage-backed securities held to maturity		108,640			—
Loans receivable transferred to real estate acquired in settlement of loans		3,082			3,019

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

8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. General- The Trust has prepared its financial statements and other disclosures on a fully consolidated basis. The term “Trust” used in the text and the financial statements included herein refers to the combined entity, which includes B.F. Saul Real Estate Investment Trust and its subsidiaries, including Chevy Chase Bank, F.S.B. and its subsidiaries (“Chevy Chase” or the “Bank”). “Real Estate Trust” refers to B.F. Saul Real Estate Investment Trust and its subsidiaries, excluding Chevy Chase and Chevy Chase’s subsidiaries. The operations conducted by the Real Estate Trust are designated as “Real Estate,” while the business conducted by the Bank and its subsidiaries is identified by the term “Banking.” In the opinion of management, the consolidated financial statements reflect all adjustments necessary for a fair presentation of the Trust’s financial position and results of operations. All such adjustments are of a normal recurring nature. These financial statements and the accompanying notes should be read in conjunction with the Trust’s audited consolidated financial statements included in its Form 10-K for the fiscal year ended September 30, 2003. The results of operations for interim periods are not necessarily indicative of results to be expected for the year.

Certain reclassifications of prior periods’ information have been made to conform with the presentation for the three and nine months ended June 30, 2004, including the reclassification of certain income and expense amounts to loss from operations of discontinued real estate asset to assure comparability of all periods presented.

2. Consolidated financial statements- The accompanying financial statements include the accounts of the Real Estate Trust, which is involved in the ownership and development of income-producing properties. The accounts of the Bank have also been consolidated. Accordingly, the accompanying financial statements reflect the assets, liabilities, operating results and cash flows for two business operations: Real Estate and Banking. All significant inter-company transactions, except as disclosed elsewhere in the financial statements, have been eliminated in consolidation. Tax sharing and dividend payments between the Real Estate Trust and the Bank are presented gross in the Consolidated Statements of Cash Flows. For purposes of calculating primary and diluted earnings per share, weighted average common shares outstanding totaled 4,807,510 for both the three and the nine-month periods ended June 30, 2004, 4,817,210 for the three-month period ended June 30, 2003 and 4,823,653 for the nine-month period ended June 30, 2003. No dividends have been declared on the common shares in any of the periods presented.

3. Taxes- The Real Estate Trust voluntarily terminated its qualification as a real estate investment trust under the Internal Revenue Code during fiscal 1978. As a result of the Real Estate Trust’s acquisition of an additional 20% equity interest in the Bank in June 1990, the Bank became a member of the Real Estate Trust’s affiliated group filing consolidated federal income tax returns. The current effect of the Real Estate Trust’s consolidation of the Bank’s operations into its federal income tax return results in the use of the Real Estate Trust’s net operating losses to reduce the federal income taxes the Bank would otherwise owe.

4. Investment in Saul Centers, Inc. and Saul Holdings Limited Partnership - During the nine-month period ended June 30, 2004, the Real Estate Trust purchased, either through dividend reinvestment or direct purchase, approximately 237,000 shares of common stock of Saul Centers, Inc. (“Saul Centers”), and as of June 30, 2004 owned approximately 3,981,000 shares representing 24.7% of such company’s outstanding common stock. As of June 30, 2004, the market value of these shares was approximately $127.8 million. Substantially all these shares have been pledged as collateral with the Real Estate Trust’s credit line banks.

In fiscal 1993, the Real Estate Trust entered into a series of transactions in connection with the initial public offering of Saul Centers. The Real Estate Trust transferred its 22 shopping centers and one of its office properties, together with the debt associated with such properties, to a newly formed partnership, Saul Holdings Limited Partnership (“Saul Holdings Partnership”), in which as of June 30, 2004 the Real Estate Trust owns (directly or through one of its wholly owned subsidiaries) a 19.6% interest, other entities affiliated with the Real Estate Trust own a 4.7% interest and Saul Centers owns a 75.7% interest. Under the Saul Holdings Partnership agreement, the units are generally convertible on a one-for-one basis into common stock of Saul Centers. However, at the current time, the units held by the Real Estate Trust are not convertible into Saul Centers common stock because of restrictions contained in the Saul Holdings Partnership agreement on the number of shares of common stock of Saul Centers that the Real Estate Trust and its affiliates can beneficially own at any point in time. The Real Estate Trust shares in cash distributions from operations and from capital transactions involving the sale of properties. The partnership agreement of Saul Holdings Partnership provides for quarterly distributions to the partners out of net cash flow. The quarterly distributions since inception have been 39 cents per unit. During the nine-month period ended June 30, 2004, the Real Estate Trust received total cash distributions of $4.9 million from Saul Holdings Partnership. Substantially all of the Real Estate Trust’s ownership interest in Saul Holdings Partnership has been pledged as collateral with the Real Estate Trust’s credit line banks.

In connection with the transfer of its properties to Saul Holdings Partnership, the Real Estate Trust was relieved of approximately $196 million in mortgage debt and deferred interest. Pursuant to a reimbursement agreement among the partners of Saul Holdings Partnership and its subsidiary limited partnerships (collectively, the “Partnerships”), the Real Estate Trust and its subsidiaries that are partners in the Partnerships agreed to reimburse Saul Centers and the other partners in the event the Partnerships fail to make payments with respect to certain portions of the Partnerships’ debt obligations and Saul Centers or any such other partners personally make payments with respect to such debt obligations. At June 30, 2004, the maximum potential obligations of the Real Estate Trust and its subsidiaries under this agreement totaled approximately $100.0 million.

9

4. Investment in Saul Centers Inc. and Saul Holdings Limited Partnership (Continued)

As of June 30, 2004, the Real Estate Trust, through its partnership interest in Saul Holdings Partnership of 19.6% and its ownership of common shares of Saul Centers of 24.7%, effectively owns 38.3% of the consolidated entities of Saul Centers. Following are the Saul Centers unaudited condensed Consolidated Balance Sheets as of June 30, 2004 and September 30, 2003 and unaudited Consolidated Statements of Operations for the nine month periods ended June 30, 2004 and 2003. The consolidated statements include the accounts of Saul Centers, its subsidiaries, Saul Holdings Partnership and other subsidiary partnerships which are majority owned by Saul Centers.

SAUL CENTERS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)	June 30, 2004			September 30, 2003
Assets
Real estate investments	$	651,177		$	537,172
Accumulated depreciation		(172,851	)		(161,153	)
Other assets		56,456			41,515
Total assets	$	534,782		$	417,534
Liabilities and stockholders’ equity (deficit)
Notes payable	$	411,544		$	400,668
Other liabilities		27,024			22,470
Total liabilities		438,568			423,138
Total stockholders’ equity (deficit)		96,214			(5,604	)
Total liabilities and stockholders’ equity	$	534,782		$	417,534

10

4. Investment in Saul Centers Inc. and Saul Holdings Limited Partnership (Continued)

SAUL CENTERS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the Nine Months Ended June 30,
(In thousands)	2004			2003
Revenue
Base rent	$	64,461		$	57,149
Other revenue		15,897			14,455
Total revenue		80,358			71,604
Expenses
Operating expenses		16,153			15,034
Interest expense		18,702			19,316
Amortization of debt expense		647			618
Depreciation and amortization		14,947			12,266
General and administrative		5,695			4,533
Total expenses		56,144			51,767
Operating income		24,214			19,837
Gain on sale of property		182			—
Income before minority interest		24,396			19,837
Minority interest		(6,090	)		(6,059	)
Net income		18,306			13,778
Preferred dividends		(5,244	)		—
Net income available to common shareholders	$	13,062		$	13,778

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5. Notes payable – secured -On February 25, 2004, the Real Estate Trust issued, in a private offering, $250.0 million aggregate principal amount of 7.50% Senior Secured Notes due 2014 (the “2004 Notes”). A substantial portion of the net proceeds of the offering were used to redeem the $200 million 9.75% Senior Secured Notes issued in March 1998 (the “1998 Notes”), including accrued interest through March 31, 2004 and pay a redemption premium, for early redemption of the notes, of $6.5 million which is included in General and administrative expense for the quarter ended June 30, 2004. These funds, totaling $216.25 million, which were escrowed at closing, were paid out on April 1, 2004. The Trust received approximately $28.1 million in proceeds from this offering after the redemption of the 1998 Notes, including accrued interest, the early redemption premium and after deducting costs associated with the offering. In addition, the Real Estate Trust wrote-off unamortized debt costs of $2.4 million, included in Amortization of debt expense for the quarter ended June 30, 2004, relating to the unamortized debt costs of the 1998 Notes. The 2004 Notes are nonrecourse obligations of the Real Estate Trust and are secured by a first priority perfected security interest in all of the common stock of the Bank held by the Real Estate Trust. The Real Estate Trust plans to use the net proceeds to fund renovation and construction activities as well as for general corporate purposes.

6. Discontinued operations –On June 22, 2004 the Real Estate Trust determined it would sell one of its hotel properties because the property no longer meets the Real Estate Trust’s investment criteria and is located outside of the Real Estate Trust’s core markets. Therefore, on June 22, 2004, the Real Estate Trust determined that the held for sale criteria in accordance with FASB No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” has been met. Accordingly, the Real Estate Trust has written down its investment in the property to its fair value, less cost to sell. The asset, classified as Real estate held for sale on the Consolidated Balance Sheets, is subject to a mortgage note of $4.1 million, included in Mortgage note payable – real estate held for sale on the Consolidated Balance Sheets. The Real Estate Trust has recognized a loss of $215,000 as a result of this write-down, which is included in Loss from operations of discontinued real estate asset on the Consolidated Statements of Operations. The Real Estate Trust expects the sale of this asset to occur in the next twelve months.

7. Adoption of recently issued accounting pronouncements - In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities.” FIN 46 is an Interpretation of Accounting Research Bulletin No. 51 and addresses consolidation by business enterprises of variable interest entities (“VIEs”). FIN 46 is based on the theory that an enterprise controlling another entity through interests other than voting interests should consolidate the controlled entity. Business enterprises are required under the provisions of FIN 46 to identify VIEs, based on specified characteristics, and then determine whether they should be consolidated. An enterprise that holds a majority of the variable interests in another enterprise is considered the primary beneficiary of that enterprise and, therefore, should consolidate the VIE. The primary beneficiary of a VIE is also required to include various disclosures in interim and annual financial statements. Additionally, an enterprise that holds a significant variable interest in a VIE, but that is not the primary beneficiary, is also required to make certain disclosures. The adoption of FIN 46 did not have an impact on the Real Estate Trust’s financial condition or results of operations.

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8. Industry segment information - Real Estate Trust

Industry segment information with regard to the Real Estate Trust is presented below. For information regarding the Bank, please refer to the “Banking” sections of the accompanying financial statements.

	Nine Months Ended June 30,
(In thousands)	2004			2003
INCOME (from continuing operations)
Hotels	$	71,097		$	63,212
Office and industrial properties		28,570			29,607
Other		1,214			905
	$	100,881		$	93,724
OPERATING PROFIT (LOSS) (from continuing operations)(1)
Hotels	$	16,675		$	11,355
Office and industrial properties		14,839			15,823
Other		208			17
		31,722			27,195
Equity earnings of unconsolidated entities, net		5,552			5,990
Impairment loss on investments		—			(625	)
Gain on sale of property		2,768			—
Interest and debt expense		(41,373	)		(37,798	)
Advisory, management and leasing fees - related parties		(9,724	)		(9,172	)
General and administrative		(8,174	)		(1,681	)
Operating loss from continuing operations	$	(19,229	)	$	(16,091	)
IDENTIFIABLE ASSETS (AT PERIOD END)
Hotels	$	177,553		$	176,213
Office and industrial properties		124,700			125,784
Other		158,160			124,687
	$	460,413		$	426,684
DEPRECIATION (from continuing operations)
Hotels	$	8,724		$	9,320
Office and industrial properties		5,051			5,217
Other		17			17
	$	13,792		$	14,554
CAPITAL EXPENDITURES AND PROPERTY ACQUISITIONS
Hotels	$	10,813		$	2,589
Office and industrial properties		2,551			1,967
Other		233			193
	$	13,597		$	4,749

⁽¹⁾ Operating profit (loss) includes income less direct operating expenses and depreciation

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9. Loans receivable:

Loans receivable is composed of the following:

(In thousands)	June 30, 2004			September 30, 2003
Single-family residential	$	5,067,215		$	4,397,394
Home equity		1,617,282			1,336,776
Real estate construction and ground		228,152			234,356
Commercial real estate and multifamily		38,632			19,435
Commercial		898,813			888,847
Prime automobile		313,587			492,896
Other consumer		111,007			180,734
		8,274,688			7,550,438
Deferred loan origination costs, net of unearned discounts		80,836			67,516
Allowance for losses on loans		(48,362	)		(58,397	)
		32,474			9,119
Total	$	8,307,162		$	7,559,557

10. Real estate held for investment or sale:

The Bank’s real estate held for investment is carried at the lower of aggregate cost or net realizable value. The Bank’s real estate acquired in settlement of loans or real estate owned (“REO”) is considered to be held for sale and is carried at the lower of cost or fair value (less estimated selling costs).

Real estate held for investment or sale is composed of the following:

(In thousands)	June 30, 2004		September 30, 2003
Real estate held for investment (net of allowance for losses of $202 for both periods)	$	925	$	925
Real estate held for sale		20,667		21,820
Total real estate held for investment or sale	$	21,592	$	22,745

14

11. Business segments:

The Bank has three operating segments: retail banking, commercial banking, and nonbanking services. Retail banking consists of traditional banking services, which include lending, leasing and deposit products offered to retail and small business customers. Commercial banking also consists of traditional banking services, as well as products and services tailored for larger corporate customers. Nonbanking services include asset management and similar services offered by subsidiaries of the Bank. In the following table, commercial banking and nonbanking services have been combined and reported as other.

	Retail Banking			Other			Total
Three Months Ended June 30, 2004
Operating income	$	195,159		$	12,468		$	207,627
Operating expense		126,637			11,422			138,059
Core earnings		68,522			1,046			69,568
Non-core items		2,087			4,492			6,579
Operating income	$	70,609		$	5,538		$	76,147
Average assets	$	11,774,066		$	1,209,854		$	12,983,920
Three Months Ended June 30, 2003
Operating income	$	185,398		$	12,186		$	197,584
Operating expense		146,971			10,467			157,438
Core earnings		38,427			1,719			40,146
Non-core items		(2,874	)		—			(2,874	)
Operating income	$	35,553		$	1,719		$	37,272
Average assets	$	10,696,921		$	1,169,258		$	11,866,179
	Retail Banking			Other			Total
Nine Months Ended June 30, 2004
Operating income	$	556,001		$	38,113		$	594,114
Operating expense		409,127			32,362			441,489
Core earnings		146,874			5,751			152,625
Non-core items		2,549			4,673			7,222
Operating income	$	149,423		$	10,424		$	159,847
Average assets	$	11,352,113		$	1,186,071		$	12,538,184
Nine Months Ended June 30, 2003
Operating income	$	530,548		$	35,200		$	565,748
Operating expense		436,524			31,044			467,568
Core earnings		94,024			4,156			98,180
Non-core items		(1,503	)		(681	)		(2,184	)
Operating income	$	92,521		$	3,475		$	95,996
Average assets	$	10,516,413		$	1,141,350		$	11,657,763

The financial information for each segment is reported on the basis used internally by the Bank’s management to evaluate performance. Core earnings excludes certain items such as income and expenses related to certain securitization transactions, adjustments to loan loss reserves in excess of net chargeoffs and certain other nonrecurring items. Items excluded from core earnings are shown as non-core items. Measurement of the performance of these segments is based on the management structure of the Bank and is not necessarily comparable with financial information from other entities. The information presented is not necessarily indicative of the segment’s results of operations if each of the segments were independent entities.

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12. Capital notes - subordinated:

On December 2, 2003, the Bank issued $175.0 million aggregate principal amount of 6 ⁷/8% subordinated debentures due 2013 (the “2003 Debentures”). On January 2, 2004, the net proceeds of the offering, along with short-term borrowings, were used to redeem all $150.0 million of the 9¼% subordinated debentures due 2005 (the “1993 Debentures”) and all $100.0 million of the 9¼% subordinated debentures due 2008 (the “1996 Debentures”).

13. Issuance and redemption of preferred stock:

In October 2003, the Bank sold $125.0 million of its 8% Noncumulative Perpetual Preferred Stock, Series C (the “Series C Preferred Stock”). The net proceeds from the issuance of the Series C Preferred Stock were used to redeem all of the 13% Noncumulative Perpetual Preferred Stock, Series A, on October 31, 2003, at a price of $27.25 per share. The Series C Preferred Stock trades on the New York Stock Exchange under the symbol “CCX PrC.” The Bank will pay quarterly dividends in arrears at an annual rate of 8% on the Series C Preferred Stock only if the Board of Directors declares them and the OTS does not object. Dividends, once declared, are payable on or before the fifteenth day of February, May, August and November of each year. The dividend payment date for the initial dividend period, however, was January 15, 2004. Dividends not declared in a quarter will not be paid at any future time, except that upon a liquidation or redemption, accrued dividends for the current period will be paid.

The Series C Preferred Stock is includable in the Bank’s core capital. The holders of the Series C Preferred Stock have no voting rights, except in certain limited circumstances.

The Series C Preferred Stock may not be redeemed before October 1, 2008 except under certain circumstances. On and after October 1, 2008, the Series C Preferred Stock may be redeemed at the option of the Bank, in whole or in part, from time to time, at a redemption price of $25.00 per share, plus all distributions accrued and unpaid on the Series C Preferred Stock that have been declared, and accrued and unpaid dividends for the then-current dividend period, whether or not declared, up to the date of such redemption.

16

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

The Trust has prepared its financial statements and other disclosures on a fully consolidated basis. The term “Trust” used in the text and the financial statements included herein refers to the combined entity, which includes B.F. Saul Real Estate Investment and its subsidiaries, including Chevy Chase and Chevy Chase’s subsidiaries. “Real Estate Trust” refers to B.F. Saul Real Estate Investment Trust and its subsidiaries, excluding Chevy Chase and Chevy Chase’s subsidiaries. The operations conducted by the Real Estate Trust are designated as “Real Estate,” while the business conducted by the Bank and its subsidiaries is identified by the term “Banking.”

The principal business activities of the Real Estate Trust are the ownership of 80% of the outstanding common stock of the Bank, whose assets accounted for 97% of the Trust’s consolidated assets at June 30, 2004, and the ownership and development of income-producing properties. By virtue of its ownership of a majority interest in the Bank, the Trust is a savings and loan holding company and subject to regulation, examination and supervision by the OTS.

The following discussion and analysis provides information that management believes to be necessary for an understanding of the Trust’s financial condition and results of operations, and should be read in conjunction with the accompanying financial statements, notes thereto and other information contained in this document.

FINANCIAL CONDITION

REAL ESTATE

The Real Estate Trust’s investment portfolio at June 30, 2004, consisted primarily of hotels, office projects, and land parcels. During the quarter ended June 30, 2004, the Real Estate Trust’s hotel portfolio included 18 properties containing 3,573 available rooms. The office property portfolio consisted of 13 properties with a total gross leasable area of 1,978,000 square feet.

The hotel portfolio experienced an average occupancy of 65.1% and an average room rate of $90.73 during the nine-month period ended June 30, 2004, compared to an average occupancy of 59.8% and an average room rate of $86.54 during the same period in the prior year. REVPAR (revenue per available room) for the hotels was $59.03 for the nine-month period ended June 30, 2004, a 14.0% increase over REVPAR for the nine-month period ended June 30, 2003 of $51.78.

Office space in the Real Estate Trust’s office property portfolio was 88.9% leased at June 30, 2004, compared to a leasing rate of 86.2% at both June 30, 2003 and March 31, 2004. At June 30, 2004, of the total gross leasable area of 1,978,000 square feet, 44,993 square feet (2.3%) and 258,907 square feet (13.1%) are subject to leases expiring in the remainder of fiscal 2004 and fiscal 2005.

BANKING

General. The Bank’s assets increased by $485.4 million during the current quarter to $12.9 billion at June 30, 2004. Total loans increased $508.5 million to $10.2 billion at June 30, 2004. The Bank recorded operating income of $76.1 million during the quarter ended June 30, 2004, compared to operating income of $37.3 million during the quarter ended June 30, 2003. The increase in operating income is attributable to decreases in interest expense, the provision for loan losses and operating expenses, and was partially offset by a decrease in other (non-interest) income.

On December 2, 2003, the Bank issued $175.0 million of its 2003 Debentures. On January 2, 2004, the net proceeds of that offering, along with short-term borrowings, were used to redeem all $250.0 million of the 1993 Debentures and the 1996 Debentures.

At June 30, 2004, the Bank’s tangible, core, tier 1 risk-based and total risk-based regulatory capital ratios were 6.04%, 6.04%, 8.41% and 10.87%, respectively. The Bank’s regulatory capital ratios exceeded the requirements under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) as well as the standards established for “well-capitalized” institutions under the prompt corrective action regulations issued pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”). See “Capital.”

During the quarter ended June 30, 2004, the Bank declared and paid out of retained earnings a cash dividend on its Common Stock in the amount of $800 per share. The Bank also declared a cash dividend on its Preferred Stock in the amount of $0.50 per share, which was paid May 17, 2004.

17

Asset Quality. The following table sets forth information concerning the Bank’s non-performing assets. The figures shown are after charge-offs and, in the case of REO, after all valuation allowances.

Non-Performing Assets

(Dollars in thousands)

	June 30, 2004			March 31, 2004			September 30, 2003
Non-performing assets:
Non-accrual loans:
Residential mortgage	$	7,667		$	11,017		$	6,567
Home equity		1,444			1,461			1,480
Real estate and construction and ground		—			—			1,004
Total non-accrual real estate loans		9,111			12,478			9,051
Commercial		347			349			249
Subprime automobile		1,618			2,187			4,372
Other consumer		1,312			1,319			1,928
Total non-accrual loans (1)		12,388			16,333			15,600
Real estate acquired in settlement of loans		20,667			18,791			21,820
Total non-performing assets	$	33,055		$	35,124		$	37,420
Allowance for losses on loans	$	48,362		$	54,000		$	58,397
Allowance for losses on real estate held for investment		202			202			202
Total allowances for losses	$	48,564		$	54,202		$	58,599
Ratios:
Non-performing assets to total assets		0.26	%		0.28	%		0.32	%
Allowance for losses on real estate loans to non-accrual real estate loans(1)		100.80	%		71.23	%		75.65	%
Allowance for losses on loans to non-accrual loans (1)		390.39	%		330.62	%		374.34	%
Allowance for losses on loans to total loans receivable(2)		0.47	%		0.55	%		0.65	%

⁽¹⁾ Before deduction of allowances for losses.

⁽²⁾ Includes loans receivable and loans held for securitization and/or sale, before deduction of allowance for losses.

Non-performing assets totaled $33.1 million at June 30, 2004, compared to $35.1 million at March 31, 2004. The $2.0 million decrease in non-performing assets for the current quarter resulted from a decrease in non-accrual loans which was partially offset by an increase in REO. During the quarter ended June 30, 2004, the Bank’s REO increased $1.9 million to $20.7 million as a result of the foreclosure of three residential properties. The Bank maintained $48.4 million and $54.0 million of valuation allowances on its loan portfolio at June 30, 2004 and March 31, 2004, respectively.

Delinquent Loans. At June 30, 2004, delinquent loans totaled $34.1 million, or 0.3% of loans, a decrease of $16.0 million from the level at March 31, 2004. The following table sets forth information regarding the Bank’s delinquent loans at June 30, 2004.

	Principal Balance (Dollars in thousands) Loans Delinquent for
	30-59 days			60-89 days			Total
Residential Mortgage	$	4,470		$	2,262		$	6,732
Home Equity		4,229			595			4,824
Other Real Estate		—			—			—
Commercial		2,073			950			3,023
Subprime Automobile		9,456			2,809			12,265
Other Consumer		5,236			2,020			7,256
Total	$	25,464		$	8,636		$	34,100
Total as a Percentage of Loans(1)		0.2	%		0.1	%		0.3	%

⁽¹⁾ Includes loans held for sale and/or securitization, before valuation allowances, unearned premiums and discounts and deferred loan origination fees (costs).

During the current quarter, the process of renewing two residential construction loans totaling $7.6 million (which had been classified delinquent 30-59 days in the March 31, 2004 quarter) was completed so that at June 30, 2004, there were no delinquent other real estate loans.

Delinquent subprime automobile loans decreased from $13.2 million at March 31, 2004 to $12.3 million at June 30, 2004.

18

Commercial loans classified as delinquent 30-89 days consisted of 14 loans totaling $3.0 million at June 30, 2004, compared to 13 loans totaling $10.6 million at March 31, 2004. The total at March 31, 2004 included 8 loans with an aggregate balance of $8.4 million which were renewed during the current quarter.

Potential Problem Assets. Although not considered non-performing assets, primarily because the loans are not 90 or more days past due and the borrowers have not abandoned control of the properties, potential problem assets are experiencing problems sufficient to cause management to have serious doubts as to the ability of the borrowers to comply with present repayment terms. At June 30, 2004 and March 31, 2004, potential problem assets totaled $5.3 million and $15.4 million, respectively. The decrease resulted from the repayment in full during the current quarter of the Bank’s aggregate balances of $9.9 million in two syndicated loans.

Troubled Debt Restructurings. At June 30, 2004 and March 31, 2004, the Bank had no troubled debt restructurings.

Real Estate Held for Investment. At June 30, 2004 and March 31, 2004, real estate held for investment consisted of one property with a book value of $0.9 million, net of valuation allowances of $0.2 million.

19

Allowances for Losses. The following tables show loss experience by asset type and the components of the allowance for losses on loans.

Analysis of Allowance for and Charge-offs of Loans

(Dollars in thousands)

	Nine Months Ended June 30,						Three Months Ended June 30,
	2004			2003			2004			2003
Balance at beginning of period	$	58,397		$	66,079		$	54,000		$	63,487
Provision for loan losses		(5,150	)		20,379			(5,644	)		5,920
Charge-offs:
Single family residential		(232	)		(259	)		(32	)		(51	)
Home equity		(556	)		(646	)		(184	)		(230	)
Commercial real estate and multifamily		—			(382	)		—			(2	)
Subprime automobile		(13,001	)		(23,347	)		(3,074	)		(6,489	)
Other consumer		(7,517	)		(8,187	)		(1,971	)		(2,553	)
Total charge-offs		(21,306	)		(32,821	)		(5,261	)		(9,325	)
Recoveries:
Home equity		208			151			68			35
Commercial real estate and multifamily		—			6			—			—
Subprime automobile		11,925			8,852			4,028			3,899
Other consumer		4,288			2,091			1,171			721
Total recoveries		16,421			11,100			5,267			4,655
Charge-offs, net of recoveries		(4,885	)		(21,721	)		6			(4,670	)
Balance at end of period	$	48,362		$	64,737		$	48,362		$	64,737
Provision for loan losses to average loans(1) (2)		(0.07	%)		0.33	%		(0.22	%)		0.27	%
Net loan charge-offs to average loans(1) (2)		0.07	%		0.35	%		0.00	%		0.21	%
Ending allowance for losses on loans to total loans(2) (3)		0.47	%		0.74	%		0.47	%		0.74	%

⁽¹⁾ Annualized

⁽²⁾ Includes loans held for securitization and/or sale.

⁽³⁾ Before deduction of allowance for losses.

Components of Allowance for Losses on Loans by Type

(Dollars in thousands)

	June 30, 2004				September 30, 2003
	Amount		Percent of Loans to Total Loans		Amount		Percent of Loans to Total Loans
Balance at end of period allocated to:
Single family residential	$	4,275	68.2	%	$	2,161	64.7	%
Home equity		2,740	16.0			2,426	15.0
Commercial real estate and multifamily		144	0.4			162	0.2
Real estate construction and ground		2,025	2.3			2,098	2.6
Commercial		9,821	8.9			14,400	10.0
Subprime automobile		12,000	0.4			16,000	1.1
Other consumer		8,450	3.8			10,082	6.4
Unallocated		8,907	—			11,068	—
Total	$	48,362			$	58,397

20

At June 30, 2004, the Bank’s total valuation allowances for losses on loans and real estate held for investment or sale was $48.6 million, a decrease of $5.6 million from $54.2 million at March 31, 2004. The allowance for losses on loans represents management’s estimate of credit losses inherent in the Bank’s loan portfolio as of the balance sheet date. The Bank’s allowance consists of several key elements, which include the allocated allowance, specific allowances for identified loans and the unallocated allowance. Management reviews the adequacy of the valuation allowances on loans using a variety of measures and tools including historical loss performance, delinquency status, current economic conditions, internal risk ratings and current underwriting policies and procedures.

The allowance for losses on loans secured by real estate totaled $9.2 million at June 30, 2004, which constituted 100.8% of total non-accrual real estate loans. During the three months ended June 30, 2004, the Bank recorded net charge-offs of $0.1 million on these assets. The allowance for losses on single-family residential loans was $4.3 million at June 30, 2004, an increase of $0.7 million from the level at March 31, 2004.

The allowance for losses on other consumer loans, including automobile, home improvement and related loans, overdraft lines of credit and other consumer loans decreased to $20.5 million at June 30, 2004, from $21.1 million at March 31, 2004.

The allowance for losses on commercial loans was reduced to $9.8 million at June 30, 2004, from $14.3 million at March 31, 2004. The decrease resulted from the repayment in full of two loans during the current quarter of the Bank’s interests in two syndicated loans for which the bank had established a combined allowance for losses totaling $4.8 million.

The unallocated allowance for losses decreased to $8.9 million at June 30, 2004, from $9.8 million at March 31, 2004. The unallocated allowance is based upon management’s evaluation and judgement of various conditions that are not directly measured in the determination of the allocated allowance. The conditions evaluated in connection with the unallocated allowance include existing general economic and business conditions affecting key lending areas of the Bank, credit quality trends, collateral volumes, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience, regulatory examination results and findings of the Bank’s internal credit evaluations.

The Bank’s valuation allowance for losses on real estate held for investment or sale was $0.2 million at June 30, 2004 and March 31, 2004.

Asset and Liability Management. The following table presents the interest rate sensitivity of the Bank’s interest-earning assets and interest-bearing liabilities at June 30, 2004, which reflects loan amortization and management’s estimate of loan prepayments. Variable rate loans are assumed to mature in the period in which their interest rates are next scheduled to adjust. Prepayment rates for the Bank’s loans are based on recent actual and market experience. Statement savings accounts with balances under $20,000 are classified based upon management’s assumed annual attrition rate of 17.5%, and those with balances of $20,000 or more, as well as all NOW accounts, are assumed to be subject to repricing within six months or less. The table contains information of the Bank only and does not include consolidation or elimination entries required for the Trust’s financial presentation.

21

Interest Rate Sensitivity Table (Gap)

(Dollars in thousands)

	Six Months or Less			More than Six Months through One Year			More than One Year through Three Years			More than Three Years through Five Years			More than Five Years			Total
As of June 30, 2004
Real estate loans:
Adjustable-rate	$	3,127,902		$	401,333		$	782,902		$	859,679		$	548		$	5,172,364
Fixed-rate		38,707			31,572			72,902			30,184			8,765			182,130
Home equity credit lines and second mortgages		1,399,425			34,329			100,813			59,958			82,518			1,677,043
Commercial		717,947			14,014			46,216			33,677			85,283			897,137
Consumer and other		140,615			97,281			160,512			23,327			5,115			426,850
Loans held for securitization and/or sale		1,883,115			—			—			—			—			1,883,115
Mortgage-backed securities		78,411			61,671			83,430			126,403			86,597			436,512
Other investments		246,566			—			71,153			—			—			317,719
Total interest-earning assets		7,632,688			640,200			1,317,928			1,133,228			268,826			10,992,870
Total non-interest earning assets		—			—			—			—			1,895,567			1,895,567
Total assets	$	7,632,688		$	640,200		$	1,317,928		$	1,133,228		$	2,164,393		$	12,888,437
Deposits:
Fixed maturity deposits	$	936,824		$	388,327		$	319,446		$	103,124		$	—		$	1,747,721
NOW, statement and passbook accounts		2,879,893			51,432			171,299			116,590			248,468			3,467,682
Money market deposit accounts		2,339,452			—			—			—			—			2,339,452
Borrowings:
Capital notes - subordinated		—			—			—			—			175,000			175,000
Other		1,929,055			123,185			427,540			236,628			39,470			2,755,878
Total interest-bearing liabilities		8,085,224			562,944			918,285			456,342			462,938			10,485,733
Minority interest		—			—			—			—			175,391			175,391
Total non-interest bearing liabilities		—			—			—			—			1,546,813			1,546,813
Stockholders’ equity		—			—			—			—			680,500			680,500
Total liabilities & stockholders’ equity	$	8,085,224		$	562,944		$	918,285		$	456,342		$	2,865,642		$	12,888,437
Gap	$	(452,536	)	$	77,256		$	399,643		$	676,886		$	(194,112	)
Cumulative gap	$	(452,536	)	$	(375,280	)	$	24,363		$	701,249		$	507,137
Cumulative gap as a percentage of total assets		(3.5	)%		(2.9	)%		0.2	%		5.4	%		3.9	%

The interest sensitivity “gap” shown in the table represents the sum of all interest-earning assets minus all interest-bearing liabilities subject to repricing within the same period. The one-year gap, as a percentage of total assets, was a negative 2.9% at June 30, 2004, compared to a negative 5.4% at March 31, 2004. The change in the Bank’s one-year gap during this period results from various initiatives undertaken by management in light of the current low interest rate environment, including increased origination of short-term adjustable rate loans which were mostly funded through the use of short-term deposits and borrowings. The Bank continues to consider a variety of strategies to manage its interest rate risk position.

Capital. At June 30, 2004, the Bank complied with all of its regulatory capital requirements under FIRREA, and its capital ratios exceeded the ratios established for “well-capitalized” institutions under OTS prompt corrective action regulations.

22

The following table shows the Bank’s regulatory capital levels at June 30, 2004, compared to the regulatory requirements in effect at that date. The information below is based upon the Bank’s understanding of the regulations and interpretations currently in effect and may be subject to change. The table contains information of the Bank only and does not include consolidation or elimination entries required for the Trust’s financial presentation.

Regulatory Capital

(Dollars in thousands)

	Actual					Minimum Capital Requirement				Excess Capital
	Amount			As a % of Assets		Amount		As a % of Assets		Amount		As a % of Assets
Stockholders’ equity per financial statements	$	680,500
Minority interest in REIT Subsidiary(1)		144,000
		824,500
Adjustments for tangible and core capital:
Intangible assets		(42,440	)
Non-includable subsidiaries(2)		(933	)
Non-qualifying purchased/originated loan servicing rights		(3,961	)
Total tangible capital		777,166		6.04	%	$	192,864	1.50	%	$	584,302	4.54	%
Total core capital(3)		777,166		6.04	%	$	514,304	4.00	%	$	262,862	2.04	%
Tier 1 risk-based capital(3)		777,166		8.41	%	$	370,401	4.00	%	$	406,765	4.41	%
Adjustments for total risk-based capital:
Subordinated capital debentures		175,000
Allowance for general loan losses		48,362
Total supplementary capital		223,362
Total available capital		1,000,528
Equity investments(2)		(2,231	)
Total risk-based capital(3)	$	998,297		10.87	%	$	740,802	8.00	%	$	257,495	2.87	%

⁽¹⁾ Eligible for inclusion in core capital in an amount up to 25% of the Bank’s core capital pursuant to authorization from the OTS.

⁽²⁾ Reflects an aggregate offset of $0.2 million representing the general allowance for losses maintained against the Bank’s equity capital investments and non-includable subsidiaries which, pursuant to OTS guidelines, is available as a “credit” against the deductions otherwise required for such investments.

⁽³⁾ Under the OTS “prompt corrective action” regulations, the standards for classification as “well capitalized” are a leverage (or “core capital”) ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital ratio of at least 10.0%.

OTS capital regulations provide a five-year holding period (or such longer period as may be approved by the OTS) for REO to qualify for an exception from treatment as an equity investment. If an REO property is considered an equity investment, its then-current book value is deducted from total risk-based capital. The following table sets forth the Bank’s REO at June 30, 2004, by the fiscal year in which the property was acquired through foreclosure.

Fiscal Year	(In thousands)
1990	$	2,231	(1)
1991		11,369	(2)
1995		4,665	(2)
2003		56
2004		2,346
Total REO	$	20,667

⁽¹⁾ The Bank treats this amount as an equity investment for regulatory capital purposes.

⁽²⁾ The Bank received an extension of the holding periods of these properties through April 7, 2005.

23

LIQUIDITY AND CAPITAL RESOURCES

REAL ESTATE

The Real Estate Trust’s cash flows from operating activities have been historically insufficient to meet all of its cash flow requirements. The Real Estate Trust’s internal sources of funds, primarily cash flow generated by its income-producing properties, generally have been sufficient to meet its cash needs other than the repayment of principal on outstanding debt, including outstanding unsecured notes sold to the public, the payment of interest on its indebtedness, and the payment of capital improvement costs. In the past, the Real Estate Trust funded such shortfalls through a combination of external funding sources, primarily new financings, the sale of unsecured notes, refinancing of maturing mortgage debt, proceeds from asset sales, and dividends and tax sharing payments from the Bank. For the foreseeable future, the Real Estate Trust’s ability to generate positive cash flow from operating activities and to meet its liquidity needs, including debt service payments, repayment of debt principal and capital expenditures, will continue to depend on these available external sources. Dividends received from the Bank are a component of funding sources available to the Real Estate Trust. The availability and amount of dividends in future periods is dependent upon, among other things, the Bank’s operating performance and income, and regulatory restrictions on such payments.

The Real Estate Trust believes that the financial condition and operating results of the Bank in recent periods should enhance prospects for the Real Estate Trust to receive tax sharing payments and dividends from the Bank. During the nine-month period ended June 30, 2004, the Bank made tax sharing payments totaling $5.6 million and dividend payments totaling $16.8 million to the Real Estate Trust. Tax sharing and dividend payments received by the Real Estate Trust are presented as cash flows from operating activities in the Consolidated Statements of Cash Flows.

In recent years, the operations of the Real Estate Trust have generated net operating losses while the Bank has reported net income. It is anticipated that the Trust’s consolidation of the Bank’s operations into the Trust’s federal income tax return will result in the use of the Real Estate Trust’s net operating losses to reduce the federal income taxes the Bank would otherwise owe. If in any future year, the Bank has taxable losses or unused credits, the Real Estate Trust would be obligated to reimburse the Bank the greater of (i) the tax benefit to the group using such tax losses or unused tax credits in the group’s consolidated federal income tax returns or (ii) the amount of the refund which the Bank would otherwise have been able to claim if it were not being included in the consolidated federal income tax return of the group.

During the nine-month period ended June 30, 2004, the Trust purchased through dividend reinvestment or direct purchase, 237,000 shares of common stock of Saul Centers and as of June 30, 2004 owned approximately 3,981,000 shares representing 24.7% of such company’s outstanding common stock. As of June 30, 2004, the market value of these shares was approximately $127.8 million. Substantially all these shares have been pledged as collateral with the Real Estate Trust’s credit line banks.

As the owner, directly and through two wholly-owned subsidiaries, of a limited partnership interest in Saul Holdings Limited Partnership (“Saul Holdings Partnership”) the Real Estate Trust shares in cash distributions from operations and from capital transactions involving the sale of properties. The partnership agreement of Saul Holdings Partnership provides for quarterly cash distributions to the partners out of net cash flow. During the nine-month period ended June 30, 2004, the Real Estate Trust received total cash distributions of $4.9 million from Saul Holdings Partnership. Substantially all of the Real Estate Trust’s ownership interest in Saul Holdings Partnership has been pledged as collateral with the Real Estate Trust’s lines of credit banks.

In March 1998, the Real Estate Trust issued $200.0 million aggregate principal amount of 9.75% Senior Secured Notes due 2008, (the “1998 Notes”).

On February 25, 2004, the Real Estate Trust issued, in a private offering, $250.0 million aggregate principal amount of 7.50% Senior Secured Notes due 2014 (the “2004 Notes”). A substantial portion of the net proceeds of the offering were used to redeem the 1998 Notes, including accrued interest through March 31, 2004 and pay a redemption premium, for early redemption of the notes, of $6.5 million. These funds, totaling $216.25 million, which were escrowed at closing, were paid out on April 1, 2004. The Trust received approximately $28.1 million in proceeds from this offering after the redemption of the 1998 Notes, including accrued interest, the early redemption premium and after deducting costs associated with the offering. The 2004 Notes are nonrecourse obligations of the Real Estate Trust and are secured by a first priority perfected security interest in all of the common stock of the Bank held by the Real Estate Trust. The Real Estate Trust plans to use the net proceeds to fund renovation and construction activities as well as for general corporate purposes.

The Real Estate Trust is currently selling unsecured notes, with maturities ranging from one to ten years, primarily to provide funds to repay maturing unsecured notes. To the degree that the Real Estate Trust does not sell new unsecured notes in amounts sufficient to finance completely the scheduled repayments of outstanding unsecured notes as they mature, it will finance such repayments from other sources of funds.

24

The Real Estate Trust has a $55.0 million secured revolving credit line with an unrelated bank that matures on December 12, 2006, with provisions for extending the term annually. This facility is secured by a portion of the Real Estate Trust’s ownership in Saul Holdings Partnership and Saul Centers. Interest is computed by reference to a floating rate index. At June 30, 2004, the Real Estate Trust had no outstanding borrowings and unrestricted availability of $55.0 million.

The Real Estate Trust also has an additional $45.0 million revolving credit line with an unrelated bank that matures on September 26, 2006. This facility is secured by a portion of the Real Estate Trust’s ownership in Saul Holdings Partnership and Saul Centers. Interest is computed by reference to a floating rate index. At June 30, 2004, the Real Estate Trust had no outstanding borrowings and unrestricted availability of $45.0 million.

The maturity schedule for the Real Estate Trust’s outstanding debt at June 30, 2004 for the balance of fiscal 2004 and subsequent years is set forth in the following table:

Debt Maturity Schedule

(In thousands)

Fiscal Year	Mortgage Notes Payable		Mortgage Note Payable - Real Estate Held For Sale		Notes Payable Secured		Notes Payable Unsecured		Total
2004 (1)	$	2,960	$	25	$	—	$	2,991	$	5,976
2005		16,207		110		—		11,354		27,671
2006		94,554		118		—		7,799		102,471
2007		5,415		128		—		5,992		11,535
2008		5,814		137		—		3,941		9,892
Thereafter		184,513		3,578		250,000		23,975		462,066
Total	$	309,463	$	4,096	$	250,000	$	56,052	$	619,611

⁽¹⁾ July 1, 2004 - September 30, 2004

Of the total mortgage debt outstanding at June 30, 2004, $305.8 million was non-recourse to the Real Estate Trust.

REAL ESTATE DEVELOPMENT AND CAPITAL EXPENDITURES

The Real Estate Trust owns various land parcels with approximately 380 acres of available land. These parcels offer potential development opportunities for the Trust.

The Real Estate Trust believes that the capital improvement costs for its income-producing properties will be in the range of $11.0 to $14.0 million per year for the next several years.

BANKING

Liquidity. The goal of liquidity management is to provide adequate funds to meet changes in loan demand or unexpected deposit withdrawals. The Bank accomplishes this goal by maintaining liquid assets in the form of cash and short-term investments, as well as sufficient unused borrowing capacity with securities dealers and other wholesale lenders. Growth in the Bank’s core deposits and principal and interest payments on loans and mortgage-backed securities also provide sources of liquidity. In addition, the Bank’s mortgage loan portfolio can be used as collateral for advances from the Federal Home Loan Bank (“FHLB”) of Atlanta.

At June 30, 2004, the estimated remaining collateral, after market value and other adjustments, of that portion of the Bank’s assets that may be pledged to the FHLB of Atlanta and various securities dealers totaled $3.3 billion, or 25.9% of total assets. The Bank’s maximum credit availability with the FHLB of Atlanta was recently increased to 50% of total assets, provided that the Bank has sufficient collateral to pledge against its advances and subject to certain limitations and conditions imposed by the FHLB of Atlanta.

Also at June 30, 2004, the Bank had cash and other short-term assets totaling $442.2 million, or 3.4% of total assets.

25

The Bank also accesses a variety of other short-term and long-term funding sources, including securitizations and sales of loan receivables. As part of its mortgage banking activities, the Bank sold or securitized and sold $1.6 billion of single-family residential mortgage loans during the June 2004 quarter. Generally, all long-term, fixed-rate residential mortgage loans originated during the current quarter have been or are in the process of being sold. Variable rate mortgage loans are either sold or placed into the Bank’s portfolio.

Management believes that the Bank’s primary sources of funds will be sufficient to meet the Bank’s foreseeable long-term liquidity needs. The mix of funding sources used from time to time will be determined by a number of factors, including capital planning objectives, lending and investment strategies and market conditions.

Commitments and Contingencies. In connection with its loan origination, securitization and sale activities, the Bank generally receives or retains various interests in the sold loans, which may include servicing assets, securities, or interest-only strips receivable. The Bank sometimes retains a limited amount of recourse with its securitization through one or more means, most often through the establishment of reserve accounts, overcollateralization of receivables or retention of subordinated asset-backed certificates. The Bank records these interests as assets on its financial statements. In some cases, the Bank determines the carrying value of the assets based on future cash flows expected to be received by the Bank from the underlying assets. Some of these cash flows are payable to the Bank before the claims of others, while other cash flows are subordinated to the claims of others. The following tables summarize the carrying value of these assets at June 30, 2004 and March 31, 2004.

	June 30, 2004
	Not Subordinated		Subordinated		Total
	(in thousands)
Servicing assets	$	138,172	$	—	$	138,172
Interest-only certificates		132,959		—		132,959
Interest-only strips receivable		101,804		1,942		103,746
Overcollateralization of loans		—		1,532		1,532
Reserve accounts		3,956		15,393		19,349
Total	$	376,891	$	18,867	$	395,758
	March 31, 2004
	Not Subordinated		Subordinated		Total
	(in thousands)
Servicing assets	$	111,765	$	—	$	111,765
Interest-only certificates		94,273		—		94,273
Interest-only strips receivable		103,180		2,578		105,758
Overcollateralization of loans		—		2,245		2,245
Reserve accounts		3,084		17,476		20,560
Total	$	312,302	$	22,299	$	334,601

The Bank also is obligated under various recourse provisions related to the swap of single-family residential loans for mortgage-backed securities issued by the Bank. At June 30, 2004, recourse to the Bank under these arrangements was $3.8 million, consisting of restricted cash accounts amounting to $2.0 million and overcollateralization of receivables amounting to $1.8 million. At March 31, 2004, recourse to the Bank under these arrangements was $4.5 million, consisting of restricted cash accounts amounting to $2.7 million and overcollateralization of receivables amounting to $1.8 million.

The Bank also is obligated under recourse provisions related to the servicing of certain residential mortgage loans. At June 30, 2004 and March 31, 2004, recourse to the Bank under these arrangements totaled $4.1 million and $3.9 million, respectively.

There were no material commitments for capital expenditures at June 30, 2004.

26

RESULTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE MONTHS ENDED JUNE 30, 2003

REAL ESTATE

The Real Estate Trust recorded a loss from operations before depreciation and amortization of debt service of $2.5 million and an operating loss of $9.7 million in the quarter ended June 30, 2004 (the “2004 quarter”) compared to income from operations before depreciation and amortization of debt service of $1.0 million and an operating loss of $3.9 million in the quarter ended June 30, 2003 (the “2003 quarter”). The changes reflect improved operating results in the hotel portfolio which were completely offset by the write-off of unamortized debt costs of $2.4 million and the early redemption premium of $6.5 million, included in general and administrative expense, associated with the payoff of the Real Estate Trust’s $200 million Senior Secured Notes.

Income after direct operating expenses from hotels increased $2.6 million, or 30.0%, in the 2004 quarter from the level achieved in the 2003 quarter. Total revenue increased $3.8 million, or 16.1%, as the overall occupancy percentage for the hotel properties increased from 67.5% for the 2003 quarter to 73.4% for the 2004 quarter, an 8.7% increase, while the average room rate increased $7.94, or 9.1%, from $86.86 in the 2003 quarter to $94.80 in the 2004 quarter, reflecting the strong demand at the Real Estate Trust’s hotel properties, particularly the Northern Virginia and Florida properties. Room sales for the 2004 quarter increased $3.5 million, or 19.0%, from the 2003 quarter, while food, beverage and other sales increased $282,000, or 5.5%. Direct operating expenses increased approximately $1.2 million, or 8.2% reflecting increased operating costs, such as payroll costs, advertising and other operating costs associated with the increased hotel occupancy.

Income after direct operating expenses from office and industrial properties decreased $85,000, or 1.2%, in the 2004 quarter compared to the 2003 quarter. Total revenue remained constant at $9.7 million in each period. Successful leasing efforts during the quarter have increased the office and industrial overall occupancy percentage from 86.2% at June 30, 2003 to 88.9% at June 30, 2004. The revenue generated from the increased occupancy is offset by lower rental rates as leases turn over. Direct operating expenses increased $81,000, or 2.9%, as higher bad debt, leasing, and utility costs offset lower property taxes.

Other income, which includes interest income, income from other real estate properties and other miscellaneous income, increased $130,000, or 43.2%, principally due to increased revenue from the Real Estate Trust’s other real estate investments and higher interest income in the quarter reflecting the increased invested cash balance resulting from the net proceeds received from the $250 million Senior Secured Debt offering.

Land parcels and other expense increased $50,000, or 15.8% in the 2004 quarter when compared to the 2003 quarter as a result of increased operating expenses at the Real Estate Trust’s other real estate properties.

Interest expense decreased $264,000 in the 2004 quarter. Interest expense in the 2004 quarter includes interest of approximately $4.7 million on the new $250 million, 7.50% Senior Secured Notes which were issued on February 25, 2004, interest expense in the 2003 quarter includes interest of approximately $4.9 million on the redeemed $200 million, 9.75% Senior Secured Notes. Other interest expense was lower due to lower mortgage and line of credit balances and lower interest rates on those borrowings. The average balance of outstanding borrowings increased to $654.5 million in the 2004 quarter from $588.7 million in the 2003 quarter, reflecting the increased principal of the Senior Secured Note Debt and the overlap period for that debt which offset lower mortgage and line of credit balances. The average cost of borrowings was 7.46% in the 2004 quarter and 8.59% in the 2003 quarter reflecting the 225 basis point reduction in the outstanding Senior Secured Note debt.

Amortization of debt expense increased $2.3 million, reflecting the write-off of unamortized debt costs of $2.4 million relating to the $200 million Senior Secured Notes. This increase was slightly offset by lower other debt cost amortization reflecting debt refinancing and extensions which settled during the prior fiscal year.

Depreciation expense remained relatively stable at approximately $4.6 million for each of the periods.

Advisory, management and leasing fees paid to related parties increased $237,000 or 7.4%, in the 2004 quarter when compared to the 2003 quarter. The advisory fee in the 2004 quarter was $472,000 per month compared to $458,000 per month for the 2003 quarter, an aggregate increase of $42,000. The remainder of the cost increase, totaling $195,000, was due mainly to higher hotel management fees reflecting the 16.1% increase in hotel revenue.

General and administrative expense increased approximately $6.3 million from $670,000 in the 2003 quarter to $6.9 million in the 2004 quarter due to the $6.5 million redemption premium paid as a result of the early redemption of the $200 million Senior Secured Notes. This increase was slightly offset by lower legal, accounting and licensing costs.

27

Equity in earnings of unconsolidated entities reflected net earnings of $1.9 million in the 2004 quarter as compared to $1.8 million in the 2003 quarter, an increase of $85,000, or 4.7%. Earnings from Saul Holdings Partnership and Saul Centers were higher by $165,000 in the 2004 quarter primarily due to the operating income generated as a result of the acquisition activity of those entities partially offset by dilution caused by a November 2003 Saul Centers preferred stock offering. Losses from other investments totaled $80,000 in the 2004 quarter. No losses were recorded in the 2003 quarter. These losses are a result of write-downs of a certain non-public investment accounted for under the equity method.

During the 2004 quarter the Real Estate Trust received a refund of approximately $117,000 for an expenditure relating to a September 2003 land sale. The original gain on the sale of this parcel was recorded in the fiscal year ended September 30, 2003. This refund has been recorded as an additional gain on sale of this land parcel in the 2004 quarter.

During the 2004 quarter the Real Estate Trust determined it would sell one of its hotel properties and has written down its investment in this asset by $215,000 to reflect its estimated fair value, less cost to sell, of $2.2 million. Included in the 2004 quarter Loss from Operations of Discontinued Real Estate Asset of $326,000 is the $215,000 write-down. The Real Estate Trust expects the sale of this asset to occur in the next twelve months.

BANKING

Overview. The Bank recorded operating income of $76.1 million for the three months ended June 30, 2004 (the “2004 quarter”), compared to operating income of $37.3 million for the three months ended June 30, 2003 (the “2003 quarter”). The increase in operating income was attributable to decreases in interest expense, the provision for loan losses and operating expenses, and was partially offset by a decrease in other (non-interest) income.

Net Interest Income. Net interest income, before the provision for loan losses, increased $15.0 million (or 25.3%) in the 2004 quarter. The Bank recorded interest income of $0.1 million on non-accrual and restructured loans during the 2004 quarter. The Bank would have recorded interest income of $0.3 million during the 2004 quarter if non-accrual assets and restructured loans had been current in accordance with their original terms. See “Financial Condition – Asset Quality – Non-Performing Assets.”

28

The following table sets forth, for the periods indicated, information regarding the total amount of income from interest-earning assets and the resulting yields, the interest expense associated with interest-bearing liabilities, expressed in dollars and rates, and the net interest spread and net yield on interest-earning assets. The table contains information of the Bank only and does not include consolidation or elimination entries required for the Trust’s financial presentation.

Net Interest Margin Analysis

(Dollars in thousands)

	Three Months Ended June 30,
	2004						2003
	Average Balances		Interest		Yield/ Rate		Average Balances		Interest		Yield/ Rate
Assets:
Interest-earning assets:
Loans receivable, net(1)	$	10,255,040	$	102,103	3.98	%	$	8,721,134	$	99,102	4.55	%
Mortgage-backed securities		457,437		5,133	4.49			584,719		7,730	5.29
Federal funds sold and securities purchased under agreements to resell		54,176		135	1.00			59,264		180	1.21
Trading securities		29,958		363	4.85			89,451		1,202	5.38
Investment securities		70,355		333	1.89			46,386		295	2.54
Other interest-earning assets		228,140		1,472	2.58			191,362		1,368	2.86
Total		11,095,106		109,539	3.95			9,692,316		109,877	4.53
Noninterest-earning assets:
Cash		284,551						285,242
Real estate held for investment or sale		20,110						25,389
Property and equipment, net		480,758						468,404
Automobiles subject to lease, net		577,980						1,017,678
Goodwill and other intangible assets, net		24,144						24,519
Other assets		501,271						352,631
Total assets	$	12,983,920					$	11,866,179
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits	$	2,168,508		1,128	0.21		$	1,856,236		1,211	0.26
Savings deposits		1,233,148		841	0.27			1,132,980		1,293	0.46
Time deposits		1,732,718		8,167	1.89			1,929,111		11,821	2.45
Money market deposits		2,329,320		4,009	0.69			2,141,681		5,423	1.01
Total deposits		7,463,694		14,145	0.76			7,060,008		19,748	1.12
Borrowings		3,182,342		21,069	2.65			2,710,964		30,835	4.55
Total liabilities		10,646,036		35,214	1.32			9,770,972		50,583	2.07
Noninterest-bearing items:
Noninterest-bearing deposits		1,209,721						1,112,177
Other liabilities		307,226						299,817
Minority interest		175,391						144,000
Stockholders’ equity		645,546						539,213
Total liabilities and stockholders’ equity	$	12,983,920					$	11,866,179
Net interest income			$	74,325					$	59,294
Net interest spread(2)					2.63	%					2.46	%
Net yield on interest-earning assets(3)					2.68	%					2.45	%
Interest-earning assets to interest-bearing liabilities					104.22	%					99.20	%

⁽¹⁾ Includes loans held for sale and/or securitization. Interest on non-accruing loans has been included only to the extent reflected in the Condensed Consolidated Statements of Operations; however, the loan balance is included in the average amount outstanding until transferred to real estate acquired in settlement of loans.

⁽²⁾ Equals weighted average yield on total interest-earning assets less weighted average rate on total interest-bearing liabilities.

⁽³⁾ Equals annualized net interest income divided by the average balances of total interest-earning assets.

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The following table presents certain information regarding changes in interest income and interest expense of the Bank during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate); changes in rate (change in rate multiplied by old volume); and changes in rate and volume.

Volume and Rate Changes in Net Interest Income

(Dollars in thousands)

	Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003 Increase (Decrease) Due to Change in(1)
	Volume			Rate			Total Change
Interest income:
Loans(2)	$	59,372		$	(56,371	)	$	3,001
Mortgage-backed securities		(1,533	)		(1,064	)		(2,597	)
Federal funds sold and securities purchased under agreements to resell		(15	)		(30	)		(45	)
Trading securities		(731	)		(108	)		(839	)
Investment securities		429			(391	)		38
Other interest-earning assets		777			(673	)		104
Total interest income		58,299			(58,637	)		(338	)
Interest expense:
Deposit accounts		6,829			(12,432	)		(5,603	)
Borrowings		27,421			(37,187	)		(9,766	)
Total interest expense		34,250			(49,619	)		(15,369	)
Increase (decrease) in net interest income	$	24,049		$	(9,018	)	$	15,031

⁽¹⁾ The net change attributable to the combined impact of volume and rate has been allocated in proportion to the absolute value of the change due to volume and the change due to rate.

⁽²⁾ Includes loans held for sale and/or securitization.

Interest income in the 2004 quarter decreased $0.3 million (or 0.3%) from the 2003 quarter primarily as a result of lower average yields and lower average balances of mortgage-backed securities. Partially offsetting the decreased income was an increase in loan interest income caused by a $1.5 billion increase in the average balances of loans receivable.

The Bank’s net interest spread increased to 2.63% in the 2004 quarter from 2.46% in the 2003 quarter. The 17 basis point increase reflected a smaller decrease in interest-earning asset average yields than interest-bearing liability average costs. Average interest-earning assets as a percentage of average interest-bearing liabilities increased to 104.2% for the 2004 quarter compared to 99.2% for the 2003 quarter.

Interest income on loans, the largest category of interest-earning assets, increased $3.0 million (or 3.0%) from the 2003 quarter primarily because of higher average balances of loans receivable offset by lower average yields caused by declines in the various indices on which interest rates on adjustable rate loans are based. The average yield on the loan portfolio decreased 57 basis points (from 4.55% to 3.98%) from the 2003 quarter. Interest income on single-family residential loans increased $9.5 million due to $1.6 billion of higher average balances, which was partially offset by lower average yields during the 2004 quarter. Lower average yields and lower average balances of automobile loans resulted in a $7.2 million (or 52.5%) decrease in interest income on those loans.

Interest income on mortgage-backed securities decreased $2.6 million (or 33.6%) due to a $127.3 million reduction in average balances as well as a decrease in the average interest rates on those securities from 5.29% to 4.49%.

Interest expense on deposits decreased $5.6 million (or 28.4%) during the 2004 quarter, due to decreased average rates. The 36 basis point decrease in the average rate on deposits (from 1.12% to 0.76%) resulted from a reduction in the rates paid by the Bank in response to declines in market interest rates. The decrease in the average rate on deposits was partially offset by higher average balances of $403.6 million compared to the 2003 quarter.

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Interest expense on borrowings decreased $9.8 million (or 31.7%) in the 2004 quarter compared to the 2003 quarter. Interest expense on advances from the FHLB of Atlanta decreased $6.3 million (or 26.2%) during the 2004 quarter due to lower average rates paid on the advances which was partially offset by higher average balances. The Bank replaced maturing higher cost advances with lower cost advances during the quarter. The average balances of subordinated debentures decreased by $75.0 million, and the average rate on those borrowings decreased by 245 basis points resulting in a decrease of $2.8 million in interest expense. On December 2, 2003, the Bank issued $175.0 million aggregate principal amount of 6 ⁷/8% subordinated debentures due 2013. On January 2, 2004, the net proceeds of the offering, along with short-term borrowings, were used to redeem all $250.0 million of the Bank’s 9¼% subordinated debentures due 2005 and 2008.

Provision for Loan Losses. During the 2004 quarter, the Bank recorded a negative provision for loan losses of $5.6 million, compared to a provision of $5.9 million in the 2003 quarter. Management’s prior decisions to discontinue subprime automobile lending and indirect consumer lending, and focus more on residential mortgages, have improved the overall credit quality of the Bank’s loan portfolio. As the balances of automobile loans continue to decline, charge-offs and delinquencies also have been declining. In addition, the Bank’s interest in two syndicated loans, for which the Bank had established a combined allowance for losses totaling $4.8 million, were repaid in full during the current quarter. The combination of these factors contributed to the Bank’s decision to reduce the provision for loan losses. See “Financial Condition – Asset Quality – Allowances for Losses.”

Other income. Other non-interest income decreased to $132.0 million in the 2004 quarter from $139.5 million in the 2003 quarter. The $7.5 million (or 5.4%) decrease was primarily attributable to decreases in automobile rental income and gain on mortgage banking activities, and was partially offset by an increase in servicing and securitization income and deposit servicing fees.

Automobile rental income decreased to $37.7 million in the 2004 quarter from $58.6 million in the prior corresponding quarter. The $20.9 million decrease resulted primarily from a $439.7 million (or 43.2%) decrease in average outstanding leases as a result of the Bank’s prior decision to discontinue origination of automobile leases.

Gain on mortgage banking activities decreased to $1.5 million in the 2004 quarter, from $6.4 million in the 2003 quarter, as a result of decreased sales volume in the 2004 quarter.

Servicing and securitization income increased to $47.9 million in the 2004 quarter, from $33.0 million in the 2003 quarter, primarily as a result of a gain of $47.5 million resulting from the securitization and sale of $1.3 billion of loans during the 2004 quarter compared to a gain of $28.6 million resulting from the securitization and sale of $760.4 million of loans in the 2003 quarter.

Operating Expenses. Operating expenses during the 2004 quarter decreased $19.8 million (or 12.7%) from the 2003 quarter. The decrease was largely due to reductions in depreciation and amortization and servicing assets amortization and other loan expenses, and was partially offset by an increase in salaries and employee benefits.

Depreciation and amortization expense decreased $14.4 million (or 27.2%), largely as a result of decreased depreciation expense of automobiles subject to lease. Depreciation expense related to automobiles subject to lease decreased $14.2 million, to $28.7 million for the 2004 quarter, due to lower levels of outstanding leases. The reduced levels reflect the Bank’s prior decision to discontinue origination of automobile leases.

Servicing assets amortization and other loan expenses decreased $10.9 million (or 82.5%) as a result of an increase in the value of the Bank’s mortgage servicing assets, which resulted in the reduction in the mortgage servicing rights valuation allowance.

Salaries and employee benefits increased $6.2 million (or 11.7%) in the 2004 quarter due primarily to increased expenses in the residential mortgage lending area and retail branch network.

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RESULTS OF OPERATIONS

NINE MONTHS ENDED JUNE 30, 2004 COMPARED TO NINE MONTHS ENDED JUNE 30, 2003

REAL ESTATE

The Real Estate Trust recorded a loss from operations before depreciation and amortization of debt service of $2.4 million and an operating loss of $19.2 million in the nine-month period ended June 30, 2004 (the “2004 period”) compared to a loss from operations before depreciation and amortization of debt service of $681,000 and an operating loss of $16.1 million in the nine-month period ended June 30, 2003 (the “2003 period”). The changes reflect improved operating results in the hotel portfolio and the gain associated with a land sale which were completely offset by declining results in the office and industrial portfolio, increased interest expense, the write-off of unamortized debt costs of $2.4 million and the early redemption premium of $6.5 million, included in general and administrative expense, associated with the payoff of the Real Estate Trust’s $200 million Senior Secured Notes.

Income after direct operating expenses from hotels increased $4.7 million, or 22.8%, in the 2004 period from the level achieved in the 2003 period. Total revenue increased $7.9 million, or 12.5%, as the overall occupancy percentage for the hotel properties increased from 59.8% for the 2003 period to 65.1% for the 2004 period while the average room rate increased $4.19, or 4.8%, from $86.54 in the 2003 period to $90.73 in the 2004 period, reflecting the strong demand at the Real Estate Trust’s hotel properties, particularly the Northern Virginia and Florida properties. Room sales for the 2004 period increased approximately $7.2 million, or 14.5%, from the 2003 period, while food, beverage and other sales increased approximately $700,000, or 5.4%. Direct operating expenses increased $3.2 million, or 7.4% reflecting increased operating costs, such as payroll costs, advertising and other operating costs associated with the increased hotel occupancy.

Income after direct operating expenses from office and industrial properties decreased $1.1 million, or 5.5%, in the 2004 period compared to the 2003 period. Total revenue decreased $1.0 million, or 3.5%, in the 2004 period as increased vacancy, specifically at two of the Trust’s office properties, offset contractual rent increases. In addition, leased space is turning over at lower rental rates in the current period. Direct operating expenses increased $113,000 between the periods as increased insurance, payroll and bad debt expenses were slightly offset by lower property taxes and repair and maintenance costs.

Other income, which includes interest income, income from other real estate properties and other miscellaneous income, increased $309,000, or 34.1%, in the 2004 period principally due to increased revenue from the Real Estate Trust’s other real estate investments and higher interest income in the period reflecting the increased invested cash balance resulting from the net proceeds received from the $250 million Senior Secured Debt offering.

Land parcels and other expense increased $118,000, or 13.5% in the 2004 period when compared to the 2003 period as a result of increased operating expenses at the Real Estate Trust’s other real estate properties.

Interest expense increased $1.4 million from $36.9 million in the 2003 period to $38.3 million in the 2004 period. Interest expense in the 2004 period includes interest on the new $250 million Senior Secured Notes which were issued on February 25, 2004 and interest is payable from that date, therefore interest expense includes interest on both the $200 million and the $250 million Senior Secured Debt from February 25, 2004 through March 31, 2004. This overlap in interest resulted in additional interest charges of approximately $1.9 million in the 2004 period. This increase in interest expense was slightly offset by lower interest expense on other debt due to lower mortgage and line of credit balances and lower interest rates on those borrowings. The average balance of outstanding borrowings increased to $644.8 million in the 2004 period from $585.2 million in the 2003 period, reflecting the overlap period of the Senior Secured Debt which offset lower mortgage and line of credit balances. The average cost of borrowings was 8.08% in the 2004 period and 8.65% in the 2003 period, reflecting the 225 basis point reduction in the outstanding Senior Secured Note debt.

Amortization of debt expense increased $2.2 million, reflecting the write-off of unamortized debt costs of $2.4 million relating to the $200 million Senior Secured Notes. This increase was slightly offset by lower other debt cost amortization reflecting debt refinancing and extensions which settled during the prior fiscal year.

Depreciation expense decreased $762,000, or 5.2%, as a result of the retirement of certain office tenant improvements and hotel improvements in the 2003 period.

Advisory, management and leasing fees paid to related parties increased $552,000, or 6.0%, in the 2004 period when compared to the 2003 period. The advisory fee in the 2004 period was $472,000 per month compared to $458,000 per month for the 2003 period, an aggregate increase of $126,000. The remainder of the cost increase, totaling $426,000, was due to higher hotel management fees reflecting the 12.5% increase in hotel revenue and increased office leasing costs paid.

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General and administrative expense increased $6.5 million from $1.7 million in the 2003 period to $8.2 million in the 2004 period due to the $6.5 million redemption premium paid as a result of the early redemption of the $200 million Senior Secured Notes. Other increases, such as the write-off of certain acquisition and development costs for projects that the Real Estate Trust has determined not to pursue were offset by lower legal and licensing costs.

Equity in earnings of unconsolidated entities reflected net earnings of $5.6 million in the 2004 period as compared to $6.0 million in the 2003 period, a decrease of approximately $400,000. Earnings from Saul Holdings Partnership and Saul Centers were lower by $354,000 in the 2004 period primarily due to the dilution caused by a November 2003 Saul Centers preferred stock offering. Losses from other investments totaled $460,000 in the 2004 period as compared to losses of $376,000 in the 2003 period. These losses are a result of write-downs of a certain non-public investment accounted for under the equity method.

The Real Estate Trust recorded an impairment charge of $625,000 in the 2003 period due to write-downs of certain non-public investments accounted for under the cost method. No impairment charges were recorded in the 2004 period.

In February 2004 the Commonwealth of Virginia acquired 7.93 acres of land owned by the Real Estate Trust for use in a highway project. The purchase price of the land was $3.6 million and resulted in a gain of approximately $2.7 million. In addition, during the quarter ended June 30, 2004 the Real Estate Trust received a refund of approximately $117,000 for an expenditure relating to a September 2003 land sale. The original gain on the sale of this parcel was recorded in the fiscal year ended September 30, 2003. This refund has been recorded as an additional gain on sale of this land parcel in the quarter ended June 30, 2004. There were no property sales in the 2003 period.

During the quarter ended June 30, 2004 the Real Estate Trust determined it would sell one of its hotel properties and has written down its investment in this asset by $215,000 to reflect its estimated fair value, less cost to sell, of $2.2 million. Included in the 2004 period Loss from Operations of Discontinued Real Estate Asset of $995,000 is the $215,000 write-down. The Real Estate Trust expects the sale of this asset to occur in the next twelve months.

BANKING

Overview. The Bank recorded operating income of $159.8 million and for the nine months ended June 30, 2004 (the “2004 period”), compared to operating income of $96.0 million for the nine months ended June 30, 2003 (the “2003 period”). The increase in operating income was attributable to decreases in interest expense, the provision for loan losses and operating expenses, and was partially offset by decreases in interest income and other (non-interest) income.

Net Interest Income. Net interest income, before the provision for loan losses, increased $13.9 million (or 7.5%) in the 2004 period. The Bank recorded interest income of $0.2 million on non-accrual and restructured loans during the 2004 period. The Bank would have recorded interest income of $1.0 million during the 2004 period if non-accrual assets and restructured loans had been current in accordance with their original terms. See “Financial Condition – Asset Quality – Non-Performing Assets.”

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The following table sets forth, for the periods indicated, information regarding the total amount of income from interest-earning assets and the resulting yields, the interest expense associated with interest-bearing liabilities, expressed in dollars and rates, and the net interest spread and net yield on interest-earning assets. The table contains information of the Bank only and does not include consolidation or elimination entries required for the Trust’s financial presentation.

Net Interest Margin Analysis

(Dollars in thousands)

	Nine Months Ended June 30,
	2004						2003
	Average Balances		Interest		Yield/ Rate		Average Balances		Interest		Yield/ Rate
Assets:
Interest-earning assets:
Loans receivable, net(1)	$	9,774,116	$	299,534	4.09	%	$	8,307,835	$	304,235	4.88	%
Mortgage-backed securities		441,309		15,626	4.72			742,873		30,573	5.49
Federal funds sold and securities purchased under agreements to resell		69,186		520	1.00			68,551		677	1.32
Trading securities		31,294		1,150	4.90			82,946		3,541	5.69
Investment securities		54,232		840	2.07			46,412		894	2.57
Other interest-earning assets		214,724		4,131	2.57			185,478		4,415	3.17
Total		10,584,861		321,801	4.05			9,434,095		344,335	4.87
Noninterest-earning assets:
Cash		286,749						300,072
Real estate held for investment or sale		20,648						24,915
Property and equipment, net		481,739						469,717
Automobiles subject to lease, net		687,223						1,069,893
Goodwill and other intangible assets, net		24,216						24,664
Other assets		452,748						334,407
Total assets	$	12,538,184					$	11,657,763
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits	$	2,058,719		3,182	0.21		$	1,753,540		3,628	0.28
Savings deposits		1,190,082		2,444	0.27			1,081,867		4,110	0.51
Time deposits		1,727,358		24,333	1.88			1,977,616		40,078	2.70
Money market deposits		2,315,382		12,025	0.69			2,072,053		17,315	1.11
Total deposits		7,291,541		41,984	0.77			6,885,076		65,131	1.26
Borrowings		3,008,893		80,407	3.56			2,747,162		93,650	4.55
Total liabilities		10,300,434		122,391	1.58			9,632,238		158,781	2.20
Noninterest-bearing items:
Noninterest-bearing deposits		1,115,212						1,057,630
Other liabilities		305,526						294,259
Minority interest		175,391						144,000
Stockholders’ equity		641,621						529,636
Total liabilities and stockholders’ equity	$	12,538,184					$	11,657,763
Net interest income			$	199,410					$	185,554
Net interest spread(2)					2.47	%					2.67	%
Net yield on interest-earning assets(3)					2.51	%					2.62	%
Interest-earning assets to interest-bearing liabilities					102.76	%					97.94	%

⁽¹⁾ Includes loans held for sale and/or securitization. Interest on non-accruing loans has been included only to the extent reflected in the Condensed Consolidated Statements of Operations; however, the loan balance is included in the average amount outstanding until transferred to real estate acquired in settlement of loans.

⁽²⁾ Equals weighted average yield on total interest-earning assets less weighted average rate on total interest-bearing liabilities.

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The following table presents certain information regarding changes in interest income and interest expense of the Bank during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate); changes in rate (change in rate multiplied by old volume); and changes in rate and volume.

Volume and Rate Changes in Net Interest Income

(Dollars in thousands)

	Nine Months Ended June 30, 2004 Compared to Nine Months Ended June 30, 2003 Increase (Decrease) Due to Change in(1)
	Volume			Rate			Total Change
Interest income:
Loans(2)	$	66,339		$	(71,040	)	$	(4,701	)
Mortgage-backed securities		(11,121	)		(3,826	)		(14,947	)
Federal funds sold and securities purchased under agreements to resell		10			(167	)		(157	)
Trading securities		(1,954	)		(437	)		(2,391	)
Investment securities		191			(245	)		(54	)
Other interest-earning assets		891			(1,175	)		(284	)
Total interest income		54,356			(76,890	)		(22,534	)
Interest expense:
Deposit accounts		5,875			(29,022	)		(23,147	)
Borrowings		12,461			(25,704	)		(13,243	)
Total interest expense		18,336			(54,726	)		(36,390	)
Increase (decrease) in net interest income	$	36,020		$	(22,164	)	$	13,856

⁽¹⁾ The net change attributable to the combined impact of volume and rate has been allocated in proportion to the absolute value of the change due to volume and the change due to rate.

⁽²⁾ Includes loans held for sale and/or securitization.

Interest income in the 2004 period decreased $22.5 million (or 6.5%) from the 2003 period primarily as a result of lower interest income on mortgage-backed securities, which resulted from lower average yields on and lower average balances of those securities. Also contributing to the decreased income were lower average yields on loans receivable, which was partially offset by a $1.5 billion increase in the average balances of loans receivable.

The Bank’s net interest spread decreased to 2.47% in the 2004 period from 2.67% in the 2003 period. The 20 basis point decrease primarily reflected a greater decrease in interest-earning asset average yields than interest-bearing liability average costs. Average interest-earning assets as a percentage of average interest-bearing liabilities increased to 102.8% for the 2004 period compared to 97.9% for the 2003 period.

Interest income on loans, the largest category of interest-earning assets, decreased $4.7 million from the 2003 period primarily because of lower average yields caused by declines in the various indices on which interest rates on adjustable rate loans are based. Higher average balances of loans receivable partially offset the decline in interest income. The average yield on the loan portfolio decreased 79 basis points (from 4.88% to 4.09%) from the 2003 period. Lower average yields and lower average balances of automobile loans resulted in a $22.4 million (or 48.2%) decrease in interest income on those loans. Interest income on single-family residential loans increased $17.7 million due to $1.5 billion of higher average balances, which was partially offset by lower average yields during the 2004 period.

Interest income on mortgage-backed securities decreased $14.9 million (or 48.9%) due to a $301.6 million reduction in average balances and, to a lesser extent, a decrease in the average interest rates on those securities from 5.49% to 4.72%.

Interest expense on deposits decreased $23.1 million (or 35.5%) during the 2004 period, due to decreased average rates. The 49 basis point decrease in the average rate on deposits (from 1.26% to 0.77%) resulted from a reduction in the rates paid by the Bank in response to declines in market interest rates. The decrease in the average rate on deposits was partially offset by higher average balances of $406.5 million compared to the 2003 period.

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Interest expense on borrowings decreased $13.2 million (or 14.1%) in the 2004 period compared to the 2003 period. The average balance of securities sold under repurchase agreements decreased by $314.8 million, and the average rate on those borrowings decreased 52 basis points resulting in a decrease of $3.5 million in interest expense. Interest expense on advances from the FHLB of Atlanta decreased $4.8 million (or 6.7%) during the 2004 period due to lower average rates paid on the advances, which were partially offset by higher average balances. The Bank replaced maturing higher cost advances with lower cost advances during the period. In addition, the average rate on subordinated debentures decreased to 7.74% from 9.25% resulting in a decrease of $4.5 million in interest expense. On December 2, 2003, the Bank issued $175.0 million aggregate principal amount of 6 ⁷/8% subordinated debentures due 2013. On January 2, 2004, the net proceeds of the offering, along with short-term borrowings, were used to redeem all $250.0 million of the Bank’s 9¼% subordinated debentures due 2005 and 2008.

Provision for Loan Losses. During the 2004 period, the Bank recorded a negative provision for loan losses of $5.2 million, compared to a provision of $20.4 million in the 2003 period. Management’s prior decisions to discontinue subprime automobile lending and indirect consumer lending, and focus more on residential mortgages, have improved the overall credit quality of the Bank’s loan portfolio. As balances of automobile loans continue to decline, charge-offs and delinquencies also have been declining. In addition, the Bank’s interest in two syndicated loans, for which the Bank had established a combined allowance for losses totaling $4.8 million, were repaid in full during the current quarter. The combination of these factors contributed to the Bank’s decision to reduce the provision for loan losses. See “Financial Condition – Asset Quality – Allowances for Losses.”

Other income. Other non-interest income decreased slightly to $397.9 million in the 2004 period from $398.1 million in the 2003 period. The $0.2 million decrease was primarily attributable to decreases in automobile rental income and gain on mortgage banking activities, and was offset by an increase in servicing and securitization income.

Automobile rental income decreased to $125.5 million in the 2004 period from $182.7 million in the prior corresponding period. The $57.2 million decrease resulted primarily from a $382.7 million (or 35.8%) decrease in average outstanding leases as a result of the Bank’s prior decision to discontinue origination of automobile leases.

Gain on mortgage banking activities decreased to $7.8 million in the 2004 period, from $14.6 million in the 2003 period, as a result of decreased sales volume in the 2004 period.

Servicing and securitization income increased to $135.4 million in the 2004 period, from $77.2 million in the 2003 period, primarily as a result of gains of $125.1 million resulting from the securitization and sale of $3.4 billion of loans during the 2004 period compared to gains of $60.6 million resulting from the securitization and sale of $1.7 billion of loans in the 2003 period.

Operating Expenses. Operating expenses during the 2004 period decreased $24.6 million (or 5.3%) from the 2003 period. The decrease in operating expenses is largely due to a decline in depreciation and amortization and servicing assets amortization and other loan expenses, and was partially offset by increases in salaries and employee benefits and other expenses.

Depreciation and amortization expense decreased $40.4 million (or 24.2%), largely as a result of decreased depreciation expense of automobiles subject to lease. Depreciation expense related to automobiles subject to lease decreased $35.0 million, to $97.0 million for the 2004 period, due to lower levels of outstanding leases. The reduced levels reflect the Bank’s prior decision to discontinue origination of automobile leases.

Servicing assets amortization and other loan expenses decreased $7.0 million (or 18.9%) as a result of an increase in the value of the Bank’s mortgage servicing assets, which resulted in the reduction in the mortgage servicing rights valuation allowance.

Salaries and employee benefits increased $11.9 million (or 7.6%) in the 2004 period due primarily to increased expenses in the residential mortgage lending area and retail branch network.

Other operating expenses increased $9.6 million (or 22.4%) primarily as a result of costs related to the January 2, 2004 redemption of the Bank’s $250.0 million of subordinated debentures due 2005 and 2008.

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