Saul B F Real Estate Investment Trust 10-K 2007 FY Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2007

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            

Commission File number 1-7184

B. F. SAUL REAL ESTATE INVESTMENT TRUST

(Exact name of registrant as specified in its charter)

Maryland	52-6053341
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

7501 Wisconsin Avenue, Bethesda, Maryland	20814
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (301) 986-6000

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

Title of each class	Name of each exchange on which registered
N/A	N/A

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

N/A

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act    Yes  ¨    No  x

Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was requires to file such reports), and (2) has been subject to such filing requirement for the past 90 days.    Yes  x    No  ¨

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

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

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).    Yes  ¨    No  x

There were no Common Shares of Beneficial Interest held by non-affiliates of the registrant as of March 31, 2007.

The number of Common Shares of Beneficial Interest, $1 Par Value, outstanding as of December 20, 2007 was 4,807,510.

TABLE OF CONTENTS

ITEM 1. BUSINESS
Overview	4
Real Estate	4
Banking	4
Federal Taxation	35
ITEM 1A. RISK FACTORS	36
ITEM 1B. UNRESOLVED STAFF COMMENTS	44
ITEM 2. PROPERTIES	43
Real Estate	44
Banking	44
ITEM 3. LEGAL PROCEEDINGS	45
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	45
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES	46
ITEM 6. SELECTED FINANCIAL DATA	46
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	49
Financial Condition	50
Real Estate	50
Banking	51
Liquidity and Capital Resources	61
Real Estate	61
Banking	65
Results of Operations	68
Fiscal 2007 Compared to Fiscal 2006	68
Real Estate	68
Banking	70
Fiscal 2006 Compared to Fiscal 2005	74
Real Estate	74
Banking	75
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	77
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	78
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	135
ITEM 9A. CONTROLS AND PROCEDURES	135
ITEM 9B. OTHER INFORMATION	135

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PART III
ITEM 10. TRUSTEES, EXECUTIVES OFFICERS AND CORPORATE GOVERNANCE	136
Executive Officers of the Trust Who Are Not Directors	136
Committees of the Board of Trustees	137
ITEM 11. EXECUTIVE COMPENSATION	137
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS	145
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND TRUSTEE INDEPENDENCE	145
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES	148
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES	149

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Disclosure Regarding Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”) relating to our operations, results of operations and other matters that are based on our current expectations, estimates, assumptions and projections. Words such as “may,” “will,” “should,” “likely,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “believes,” “estimates” and similar expressions are used to identify these forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Forward-looking statements are based upon assumptions as to future events that might not prove to be accurate. Actual outcomes and results could differ materially from what is expressed or forecast in these forward-looking statements. Risks, uncertainties and other factors that might cause such differences, some of which could be material, include, but are not limited to the factors discussed below under the section entitled “Risk Factors.”

PART I

ITEM 1. BUSINESS

OVERVIEW

B.F. Saul Real Estate Investment Trust operates as a Maryland real estate investment trust. The Real Estate Trust began its operations in 1964 as an unincorporated business trust organized under a Declaration of Trust governed by District of Columbia law. The Real Estate Trust terminated its status as a qualified real estate investment trust for federal income tax purposes in 1978 and is now taxable as a corporation. On October 24, 1988, the Real Estate Trust amended its Declaration of Trust to qualify as a statutory real estate investment trust under Maryland law.

The principal business activities of the Trust are the ownership of 80% of the outstanding common stock of Chevy Chase Bank, F.S.B. (“Chevy Chase” or the “Bank”), whose assets accounted for 95% of the Trust’s consolidated assets at September 30, 2007, and the ownership and development of income-producing properties. By virtue of its ownership of a majority interest in Chevy Chase, the Trust is a savings and loan holding company and subject to regulation, examination and supervision by the Office of Thrift Supervision, also know as “OTS.” See “Banking—Holding Company Regulation.”

The Trust recorded net income of $34.6 million in the fiscal year ended September 30, 2007, compared to a net income of $57.0 million in the fiscal year ended September 30, 2006.

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

REAL ESTATE

The Real Estate Trust’s long-term objectives are to increase cash flow from operations and to maximize capital appreciation of its real estate. The properties owned by the Real Estate Trust are located predominantly in the Mid-Atlantic and Southeastern regions of the United States and consist principally of hotels, office projects, undeveloped land parcels and the development of for-sale townhomes.

The Real Estate Trust has significant relationships with B.F. Saul Company (“Saul Company”) and its wholly owned subsidiary, B.F. Saul Property Company, (“Saul Property Co.”). Saul Company, founded in 1892, specializes in commercial property management and leasing, hotel management, development and construction management, acquisitions, sales and financing of real estate property and insurance. Certain officers and trustees of the Real Estate Trust are also officers and/or directors of Saul Company and Saul Property Co. Other than uncompensated officers, the Real Estate Trust has no employees. See “Item 13. Certain Relationships and Related Transactions — Management Personnel.”

Saul Company acts as the Real Estate Trust’s investment advisor and manages the financial, accounting, information technology, insurance, legal, tax and other administrative affairs of the Real Estate Trust. Saul Property Co. acts as leasing and management agent for the income-producing properties owned by the Real Estate Trust, and plans and oversees the development of new properties and the expansion and renovation of existing properties. Prior to October 1, 2005, the duties performed by Saul Company in its capacity as the Real Estate Trust’s investment advisor were performed by a wholly-owned subsidiary of Saul Company, Saul Advisory Company, L.L.C. (the “Former Advisor”).

BANKING

Chevy Chase Bank, F.S.B., referred to in this Annual Report on Form 10-K as “Chevy Chase” or the “Bank,” is a federally chartered and federally insured stock savings bank which at September 30, 2007 was conducting business from 284 full-service branch offices, including 54 grocery store banking centers, and more than 1,000 automated teller machines in Maryland, Delaware, Virginia and the

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District of Columbia. The Bank’s home office is in McLean, Virginia and its executive offices are in Bethesda, Maryland, both suburban communities of Washington, DC. The Bank either directly or through a wholly owned subsidiary, also maintains two commercial loan production offices located in Baltimore, Maryland and Northern Virginia and nine mortgage loan production offices in the mid-Atlantic region. In addition, the Bank uses third party originators to supplement its direct origination of loans. At September 30, 2007, the Bank had total assets of $15.1 billion, total deposits of $10.9 billion and total stockholders’ equity of $812.1 million. Based on total assets at September 30, 2007, Chevy Chase is the largest full-service bank headquartered in the Washington, DC metropolitan area.

Chevy Chase is a consumer oriented, full-service banking institution principally engaged in the business of attracting deposits from the public and using those deposits, together with borrowings and other funds, to make loans secured by real estate, primarily residential mortgage loans, and other consumer loans. The Bank also has an active commercial lending program which includes offering small business loans through its deposit branches. The Bank’s principal deposit and lending markets are located in the Washington, DC and Baltimore, Maryland metropolitan areas. The Bank’s wholesale activities include the acquisition of loans through third party originators. As a complement to its basic deposit and lending activities, the Bank provides related financial services to its customers, including securities brokerage and insurance products offered through its subsidiaries. In addition, the Bank offers a variety of investment products and provides fiduciary services to a primarily institutional customer base through its subsidiary, ASB Capital Management LLC, and to a primarily high net worth customer base through another subsidiary, Chevy Chase Trust Company.

The Bank seeks to capitalize on its status as the largest full-service bank headquartered in the Washington, DC metropolitan area by expanding its community banking operations. Accordingly, the Bank continues to build its branch and alternative delivery systems, to maintain and expand its mortgage banking operations, and to offer a broad range of consumer products, including home equity loans and lines of credit and other consumer loans. In addition, the Bank continues to emphasize its commercial banking program, with a focus on businesses operating in the Washington, DC and Baltimore, Maryland metropolitan areas. The Bank also continues to further develop the fee-based services it provides to customers, including securities brokerage, trust, asset management and insurance products offered through its subsidiaries.

Chevy Chase recorded operating income of $110.8 million for the year ended September 30, 2007, compared to operating income of $138.8 million for the year ended September 30, 2006. At September 30, 2007, the Bank’s tangible, core, tier 1 risk-based and total risk-based regulatory capital ratios were 5.97%, 5.97%, 8.85% and 10.85%, respectively. Those ratios exceeded the standards established for “well-capitalized” institutions under the prompt corrective action regulations established pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991, also known as “FDICIA.”

Chevy Chase is subject to comprehensive regulation, examination and supervision by the Office of Thrift Supervision (the “OTS”) and, to a lesser extent, by the Federal Deposit Insurance Corporation (the “FDIC”). The Bank’s deposit accounts are insured by the FDIC up to $100,000 per insured depositor and up to $250,000 for certain retirement accounts.

Recent Developments

The ongoing turmoil in the credit markets and deteriorating conditions in the U.S. housing markets worsened during the quarter ended September 30, 2007, and continue to negatively affect the Bank and its operations. See, “Risk Factors—The current turmoil in the mortgage markets could continue to adversely affect our business and operations” and “Risk Factors—Continued deteriorating conditions in the U.S. housing markets may lead to increased losses on loans.” Due to reduced investor demand and less favorable terms and pricing in the capital markets for securitizations and sales of residential mortgage loans, the Bank did not securitize assets during the last quarter of fiscal 2007 and is unable to predict if or when it will do so in the future. As a result, the Bank has been retaining in its own portfolio, adjustable rate loans that it previously securitized, while continuing to originate and sell in the secondary market fixed and hybrid fixed/adjustable loans. The Bank’s ability to retain an increasing number of loans in its portfolio eventually will be constrained by its regulatory capital requirements. Although loan production levels have fallen, due in part to the deteriorating housing market, the Bank also has taken affirmative steps to reduce its volume of loan originations, particularly residential mortgage loans originated through third-party or correspondent distribution channels, by, for example, tightening its loan underwriting guidelines. The Bank also has made staff reductions to reflect the reduced loan volumes.

Deteriorating conditions in the housing market also have contributed to increases in the Bank’s levels of delinquent and non-performing assets and the allowance for possible credit losses. To the extent current housing market conditions continue or worsen, the Bank’s level of problem assets and credit losses may increase.

Management believes it has taken steps that will help position the Bank to operate successfully in the current environment, but there can be no assurances that if market conditions continue to deteriorate, the Bank’s financial condition and/or results of operations will not continue to be adversely affected.

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REAL ESTATE

Real Estate Investments

The Real Estate Trust’s investment portfolio consists principally of seasoned operating properties. The Real Estate Trust expects to hold its properties as long-term investments and has no maximum period for retention of any investment. It may acquire additional income-producing properties, expand and improve its properties, or sell such properties, as and when circumstances warrant. The Real Estate Trust also may participate with other entities in property ownership, through joint ventures or other types of co-ownership.

The following tables set forth, at and for the periods indicated, certain information regarding the properties in the Real Estate Trust’s investment portfolio at September 30, 2007. The Real Estate Trust substantially completed construction of the Dulles Hampton Inn on October 18, 2007.

Hotels

			Average Occupancy (2)						Average Room Rate
			Year Ended September 30,						Year Ended September 30,
Location	Name	Rooms (1)	2007		2006		2005		2007		2006		2005
FLORIDA
Boca Raton	Boca Raton SpringHill Suites	146	68	%	72	%	75	%	$	95.50	$	102.43	$	88.46
Boca Raton	Boca Raton TownePlace Suites	91	69	%	71	%	79	%	$	96.80	$	106.32	$	83.04
Ft. Lauderdale	Ft. Lauderdale TownePlace Suites	95	63	%	72	%	80	%	$	109.99	$	99.99	$	81.41
MARYLAND
Gaithersburg	Gaithersburg Holiday Inn	300	63	%	68	%	68	%	$	92.73	$	91.71	$	87.03
Gaithersburg	Gaithersburg TownePlace Suites	91	79	%	68	%	70	%	$	94.51	$	101.36	$	92.08
MICHIGAN
Auburn Hills	Crowne Plaza Auburn Hills (3)	190	67	%	67	%	62	%	$	99.43	$	98.92	$	97.92
VIRGINIA
Arlington	National Airport Crowne Plaza	308	68	%	67	%	65	%	$	159.76	$	156.17	$	137.10
Arlington	National Airport Holiday Inn	280	73	%	70	%	68	%	$	131.03	$	130.51	$	120.03
Herndon	Herndon Holiday Inn Express	115	80	%	79	%	74	%	$	120.31	$	113.91	$	104.27
McLean	Tysons Corner Courtyard	229	77	%	77	%	74	%	$	163.09	$	162.32	$	151.02
McLean	Crowne Plaza Tysons Corner (4)	316	65	%	68	%	65	%	$	145.76	$	140.33	$	124.22
Sterling	Best Western Dulles (3)	122	78	%	78	%	74	%	$	117.63	$	117.55	$	114.97
Sterling	Dulles Airport Holiday Inn	297	77	%	73	%	70	%	$	108.34	$	122.94	$	113.90
Sterling	Dulles Airport TownePlace Suites	95	68	%	67	%	72	%	$	107.09	$	119.97	$	111.16
Sterling	Cascades Marketplace Hampton Inn	152	80	%	73	%	72	%	$	111.21	$	114.74	$	113.3
Sterling	Dulles South Hampton Inn (5)	137	77	%	68	%	—		$	114.80	$	109.87		—
Sterling	SpringHill Suites Dulles (6)	158	57	%	—		—		$	128.50		—		—
WASHINGTON, D.C.	The Hay Adams (7)	145	76	%	79	%	—		$	422.98	$	401.64		—
PROPERTIES SOLD
Cincinnati	Cincinnati Holiday Inn (8)	—	—		—		49	%		—		—	$	70.12
Rochester	Rochester Airport Holiday Inn (8)	—	—		—		65	%		—		—	$	73.32
		3,267	71	%	70	%	68	%	$	136.54	$	128.88	$	106.81

(1) Available rooms as of September 30, 2007.

(2) Average occupancy is calculated by dividing the rooms occupied by the rooms available.

(3) Hotel re-flagged in October 2007.

(4) Hotel re-flagged in September 2007.

(5) Asset acquired November 1, 2005

(6) Construction substantially completed and asset placed in service on January 8, 2007.

(7) Asset acquired March 24, 2006.

(8) Asset sold in fiscal 2006.

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Office and Industrial

		Gross Leasable Area (1)	Leasing Percentages						Expiring Leases (1)
Location	Name		September 30,						Year Ending September 30,
			2007		2006		2005		2008		2009
FLORIDA
Fort Lauderdale	Commerce Center	61,149	97	%	100	%	92	%	1,814		35,217
GEORGIA
Atlanta	900 Circle 75 Parkway	345,502	86	%	87	%	84	%	88,744		63,249
Atlanta	1000 Circle 75 Parkway	89,412	85	%	88	%	87	%	5,661		30,911
Atlanta	1100 Circle 75 Parkway	269,049	66	%	83	%	90	%	41,223		22,756
MARYLAND
Bethesda	8001 Wisconsin Avenue (3)	12,131	82	%	100	%	100	%	4,060		1,300
Laurel	Sweitzer Lane	150,020	100	%	100	%	100	%	NONE		NONE
Bethesda	Garden Plaza (4)	177,633	100	%	—		—		2,949		7,154
VIRGINIA
McLean	8201 Greensboro Drive	360,854	95	%	98	%	99	%	73,786		28,751
McLean	Tysons Park Place	247,581	95	%	91	%	96	%	27,928		10,820
Sterling	Dulles North	59,886	100	%	100	%	100	%	12,802		47,084
Sterling	Dulles North Two	79,210	90	%	90	%	100	%	1,800		69,219
Sterling	Dulles North Four	100,207	0	%	100	%	100	%	NONE		NONE
Sterling	Dulles North Five	80,391	100	%	100	%	100	%	NONE		NONE
Sterling	Dulles North Six	53,517	100	%	100	%	100	%	NONE		NONE
Sterling	Loudoun Tech I	81,514	100	%	75	%	24	%	NONE		NONE
	Totals	2,168,056	86	%	92	%	91	%	260,767	(2)	316,461	(2)

(1) Square feet

(2) Represents 12.0% and 14.6%, respectively, of the Real Estate Trust’s office and industrial portfolio in terms of square footage as of September 30, 2007.

(3) Acquired May 25, 2005.

(4) Acquired March 29, 2007.

Land Parcels

Location	Name	Acres	Zoning
FLORIDA
Boca Raton	Arvida Park of Commerce	6.5	Mixed Use
Fort Lauderdale	Commerce Center	1.6	Office, Warehouse
GEORGIA
Atlanta	Circle 75 (1)	76.7	Residential, Office, Industrial
KANSAS
Overland Park	Overland Park	136.6	Residential, Office, Retail
MICHIGAN
Auburn Hills	Auburn Hills Holiday Inn	0.5	Commercial
VIRGINIA
Ashburn	Ashburn Village	88.4	Mixed use
Sterling	Cedar Green	10.2	Commercial
Sterling	Church Road	32.0	Office, Industrial
Sterling	Sterling Boulevard (1)	9.7	Hotel, Industrial
Sterling	Loudoun Tech II	7.4	Commercial
	Total	369.6

(1) Development commenced on a portion of the property in fiscal 2006 or 2007 and the applicable value of the land was transferred to Construction in Progress.

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Other Real Estate Investments

PURCHASE-LEASEBACK PROPERTIES (1)

APARTMENTS

Location	Name	Number of Units
TENNESSEE
Knoxville	Country Club	232
SHOPPING CENTERS
Location	Name	Gross Leasable Area (2)
GEORGIA
Warner Robbins	Houston Mall	264,000

(1) The Real Estate Trust owns the land under certain income-producing properties and receives fixed ground rent, which is subject to periodic escalation, from the owners of the improvements. In certain instances, the Real Estate Trust also receives percentage rent based upon the income generated by the properties.

(2) Square feet.

Investment in Saul Holdings Limited Partnership and Saul Centers, Inc.

On August 26, 1993, the Real Estate Trust consummated a series of transactions in connection with the initial public offering of Saul Centers, Inc. (“Saul Centers”) in which it transferred 22 shopping center properties and one of its office properties together with the $196 million of mortgage debt and deferred interest associated with such properties, to a newly organized limited partnership, Saul Holdings Limited Partnership (“Saul Holdings”), and one of two newly organized subsidiary limited partnerships of Saul Holdings. In exchange for the transferred properties, the Real Estate Trust received securities representing a 21.5% limited partnership interest in Saul Holdings. Entities under common control with the Trust received limited partnership interests collectively representing a 5.5% partnership interest in Saul Holdings in exchange for the transfer of property management functions and certain other properties to Saul Holdings and its subsidiaries. Saul Centers received a 73.0% general partnership interest in Saul Holdings in exchange for the contribution of approximately $220.7 million to Saul Holdings. Affiliates of the Trust received certain cash distributions from Saul Holdings and purchased 4.0% of the common stock of Saul Centers in a private offering consummated concurrently with the initial public offering of such common stock. Certain officers and trustees of the Trust are also officers and/or directors of Saul Centers. See “Item 13. Certain Relationships and Related Transactions — Management Personnel.”

As of September 30, 2007, the Real Estate Trust owned, directly or through one of its wholly owned subsidiaries, 5,348,000 shares of Saul Centers representing 30.2% of the company’s outstanding common stock.

As of September 30, 2007 the Real Estate Trust owned, directly or through one of its wholly owned subsidiaries, 4,378,000 units of limited partnership interests in Saul Holdings, representing an 18.9% limited partnership interest. The Real Estate Trust owns rights enabling it to convert its limited partnership interests in Saul Holdings into shares of Saul Centers’ common stock on the basis of one share of Saul Centers’ common stock for each partnership unit. However, under the terms of the limited partnership agreement of Saul Holdings Limited Partnership, at the current time, most of the units may not be converted into shares of Saul Centers’ common stock because the conversion would cause the Real Estate Trust and certain affiliates of the Trust to exceed the ownership limitation under our articles of incorporation, which restricts the amount of our equity they may constructively or beneficially own, denoted by reference to provisions of the Internal Revenue Code of 1986, as amended, which we refer to as the Code.

The shares of Saul Centers’ common stock are listed on the New York Stock Exchange under trading symbol “BFS.”

Saul Centers operates as a real estate investment trust for federal income tax purposes under Sections 856 through 860 of the Code. Under the Code, REITs are subject to numerous organizational and operational requirements. If Saul Centers continues to qualify as a REIT, it generally will not be subject to federal income tax, provided it makes certain distributions to its stockholders and meets certain organizational and other requirements. Saul Centers has made and has announced that it intends to continue to make regular quarterly dividend distributions to its stockholders.

Allocations and Distributions of Saul Holdings: The net income or net loss of Saul Holdings for tax purposes generally will be allocated to Saul Centers and the limited partners in accordance with their percentage interests, subject to compliance with the applicable provisions of the Code and the regulations promulgated thereunder. Net cash flow after reserves of Saul Holdings and after reimbursement of specified expenses will be distributed quarterly to the partners in proportion to their respective partnership interests.

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Competition

As an owner of, or investor in, commercial real estate properties, the Real Estate Trust is subject to competition from a variety of other owners of similar properties in connection with their sale, lease or other disposition and use. Management believes that success in such competition is dependent upon the geographic location of the property, the performance of property managers, the amount of new construction in the area and the maintenance and appearance of the property. Additional competitive factors with respect to commercial and industrial properties are the ease of access to the property, the adequacy of related facilities such as parking, and the ability to provide rent concessions and additional tenant improvements while keeping rents competitive. Management believes that general economic circumstances and trends and new properties in the vicinity of each of the Real Estate Trust’s properties also will be competitive factors.

Environmental Matters

The Real Estate Trust’s properties are subject to various laws and regulations relating to environmental and pollution controls. The Real Estate Trust requires an environmental study to be performed with respect to a property that may be subject to possible environmental hazards prior to its acquisition to ascertain that there are no material environmental hazards associated with such property. Although the effect upon the Real Estate Trust of the application of environmental and pollution laws and regulations cannot be predicted with certainty, management believes that their application either prospectively or retrospectively will not have a material adverse effect on the Real Estate Trust’s property operations.

Holding Company Regulation

The Trust, the Saul Company, B. F. Saul Company, a Maryland Corporation (formerly Chevy Chase Property Company) referred to in this report as “CCPC,” and CCPC’s wholly-owned subsidiary, Westminster Investing Corporation, collectively referred to in this report as the “Holding Companies,” are registered as “savings and loan holding companies” because of their direct or indirect ownership interests in the Bank, and are subject to regulation, examination and supervision by the OTS. The Bank is prohibited from making or guaranteeing loans or advances to or for the benefit of the Holding Companies or other affiliates engaged in activities beyond those permissible for bank holding companies and from investing in the securities of the Holding Companies or other affiliates. Transactions between the Bank and the Holding Companies must be on terms substantially the same, or at least as favorable to the Bank, as those that would be available to non-affiliates.

OTS supervision of the Holding Companies includes a review of the adequacy of the Holding Companies’ capital, their level of debt, and their ability to fund outstanding debt obligations, and OTS guidance suggests that particular scrutiny will be given to holding companies that, like the Holding Companies, are engaged in real estate activities.

The Holding Companies must obtain OTS approval before acquiring any federally insured savings institution or any savings and loan holding company. The status of the Holding Companies as “unitary thrift holding companies” and the activities in which the Holding Companies may engage have been grandfathered under the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”). As grandfathered unitary thrift holding companies, the Holding Companies are virtually unrestricted in the types of business activities in which they may engage provided the Bank continues to meet the QTL test. See “Banking—Qualified Thrift Lender (“QTL”) Test.” The GLB Act prohibits the sale of grandfathered unitary thrift holding companies such as the Holding Companies (together with their thrift subsidiaries) or their thrift subsidiaries alone to commercial companies. Corporate reorganizations are expressly permitted.

If the Holding Companies were to acquire one or more federally insured institutions and operate them as separate subsidiaries rather than merging them into the Bank, the Holding Companies would become “multiple” savings and loan holding companies. As multiple savings and loan holding companies, the Holding Companies would be subject to limitations on the types of business activities in which they would be permitted to engage, unless the additional thrifts were troubled institutions acquired pursuant to certain emergency acquisition provisions and all subsidiary thrifts met the QTL test. The Holding Companies may acquire and operate additional savings institution subsidiaries outside of Maryland and Virginia only if the laws of the target institution’s state specifically permit such acquisitions or if the acquisitions are made pursuant to emergency acquisition provisions.

The Trust and the Saul Company entered into an agreement with OTS’s predecessor, the Federal Savings and Loan Insurance Corporation, to maintain the Bank’s regulatory capital at the required levels, and, if necessary, to infuse additional capital to enable the Bank to meet those requirements. Since the execution of this agreement, the OTS has changed its policy and no longer requires such agreements from companies acquiring thrift institutions. In addition, the regulatory capital requirements applicable to the Bank have changed significantly as a result of FIRREA. The OTS has stated that capital maintenance agreements entered into prior to the modification of OTS policy and the enactment of FIRREA were not affected by those changes. The Trust and the Saul Company have not sought to modify the existing agreement. To the extent the Bank is unable to meet regulatory capital requirements in the future, the OTS could seek to enforce the obligations of the Trust and the Saul Company under the agreement.

If the Bank were to become “undercapitalized” under the prompt corrective action regulations, it would be required to file a capital restoration plan with the OTS setting forth, among other things, the steps the Bank would take to become “adequately capitalized.” The OTS could not accept the plan unless the Holding Companies guaranteed in writing the Bank’s compliance with that plan. The aggregate liability of the Holding Companies under such a commitment would be limited to the lesser of:

• an amount equal to 5.0% of the Bank’s total assets at the time the Bank became “undercapitalized,” and

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• the amount necessary to bring the Bank into compliance with all applicable capital standards as of the time the Bank fails to comply with its capital plan.

If the Holding Companies refused to provide the guarantee, the Bank would be subject to the more restrictive supervisory actions applicable to “significantly undercapitalized” institutions. See “Banking—Prompt Corrective Action.”

BANKING

Regulation

Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank (the “FHLB”) of Atlanta, which is one of 12 FHLBs administered by the Federal Housing Finance Board, an independent agency within the executive branch of the federal government. The FHLBs serve as central credit facilities for their members. Their primary credit mission is to facilitate residential mortgage lending and support community and economic development activity in rural and urban communities. The Bank regularly obtains advances from the FHLB of Atlanta. At September 30, 2007, the Bank had outstanding advances of $2.0 billion. See Note 23 to the Consolidated Financial Statements in this report and “Deposits and Other Sources of Funds – Borrowings.”

As a member of the FHLB of Atlanta, the Bank is required to acquire and hold shares of capital stock in that bank in an amount equal to the greater of:

• 1.0% of mortgage-related assets;

• $500; or

• 5.0% of outstanding advances.

The Bank had an investment of $115.3 million in the capital stock of the FHLB of Atlanta at September 30, 2007. The Bank earned dividends on that stock of $6.5 million and $7.0 million during the years ended September 30, 2007 and 2006, respectively. On December 28, 2006, the Federal Housing Finance Board issued a final rule that prohibits FHLBs that have existing excess stock exceeding 1% of the FHLB’s total assets from paying dividends to members in the form of stock or otherwise issue additional shares of excess stock. Excess stock is stock that is held by members and that exceeds the minimum amount of FHLB stock they are required to hold.

Membership in the FHLB is voluntary for federal thrifts like the Bank. Because membership is required to obtain advances from the FHLB and the Bank continues to rely on FHLB advances as an important source of funds, the Bank currently intends to retain its voluntary membership in the FHLB of Atlanta.

Liquidity Requirements.The Bank is required to maintain sufficient liquidity to ensure its safe and sound operation. Failure to do so could subject the Bank to monetary penalties imposed by the OTS. Management believes that the Bank’s ratio of cash and cash equivalents and other liquid assets to deposits and short-term borrowings of 6.5% at September 30, 2007 was sufficient to ensure the Bank’s safe and sound operation.

Deposit Insurance Premiums.Under FDIC insurance regulations, the Bank is required to pay premiums for insurance of its deposit accounts into the Deposit Insurance Fund (“DIF”). The FDIC annually sets the reserve level of the DIF within a statutory range of between 1.15% to 1.50% of insured deposits. The FDIC set the reserve level at 1.25% for 2007 and it will remain at that level for 2008. If the reserve level of the insurance fund falls below 1.15%, or is expected to do so within six months, the FDIC must adopt a restoration plan that will restore the DIF to a 1.15% ratio generally within five years. If the reserve level exceeds 1.35%, the FDIC may return some of the excess in the form of dividends to insured institutions.

Under the FDIC’s risk-based premium system, which was significantly revised effective January 1, 2007, the amount of an institution’s deposit insurance premiums is based upon its classification in one of four risk categories based on overall supervisory ratings and prompt corrective action categories.

Highly rated, well-capitalized institutions generally remain in the lowest risk category. However, unlike the system in place prior to January 1, 2007 under which those institutions paid no deposit insurance premiums, premiums for those institutions now range between five and seven basis points depending on a variety of factors. For institutions like the Bank, those factors are supervisory ratings in various categories and long-term debt ratings. The Bank’s specific premium is determined by a mathematical formula incorporating those factors, subject to supervisory adjustments of up to 0.5 basis points. Institutions in the three higher risk categories currently pay premiums of 10, 28 or 43 basis points. For 2007, a one-time initial assessment credit against future premiums was granted to institutions that, like the Bank, have made past contributions to the deposit insurance fund. The Bank’s available credit was sufficient to offset premiums otherwise payable for the nine months ended September 30, 2007. However, beginning October 1, 2007, most of the Bank’s credit has been used and, based upon its classification as September 30, 2007, the Bank anticipates paying deposit insurance premiums of approximately $ 9.0 million in fiscal 2008, assuming current premium levels remain unchanged. On November 5, 2007, the FDIC announced that it would decide whether to adjust the existing premium levels in March 2008.

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Commercial banks and thrifts continue to be required to share in the payment of interest due on Financing Corporation (“FICO”) bonds used to provide liquidity to the savings and loan industry in the 1980s. Annual FICO assessments added to deposit insurance premiums ranged from 1.14 to 1.24 basis points during the Bank’s 2007 fiscal year.

Deposit insurance may be terminated by the FDIC, after notice and a 30-day corrective period, if the FDIC finds that the Bank has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or condition imposed by the FDIC. The 30-day period may be eliminated by the FDIC with the approval of the OTS.

Regulatory Capital

The Bank is subject to:

• a minimum tangible capital requirement;

• a minimum core (or leverage) capital requirement; and

• a minimum risk-based capital requirement.

Each of these requirements generally must be no less stringent than the capital standards for national banks. At September 30, 2007, the Bank’s tangible capital ratio was 5.97%, its core (or leverage) capital ratio was 5.97%, and its total risk-based capital ratio was 10.85%, compared to the minimum requirements of 1.50%, 4.00% and 8.00%, respectively.

The tangible capital requirement adopted by the OTS requires the Bank to maintain “tangible capital” in an amount not less than 1.5% of tangible assets. “Tangible capital” is defined as core capital less investments in certain subsidiaries and any intangible assets (including supervisory goodwill), plus qualifying servicing assets valued at the amount that can be included in core capital.

Under the minimum leverage capital requirement, Chevy Chase must maintain a ratio of “core capital” to tangible assets of not less than 4.0%. “Core capital” generally includes common shareholders’ equity, noncumulative perpetual preferred stock and minority interests in consolidated subsidiaries, less investments, in certain subsidiaries and certain intangible assets.

Under OTS regulations, servicing assets can be included in core capital in an amount up to 100% of core capital. Non-mortgage servicing assets are subject to a sublimit of 25% of core capital. For these purposes, servicing assets are valued at the lesser of 90% of fair market value or 100% of the current unamortized book value. At September 30, 2007, the Bank had qualifying servicing assets with a carrying value of $146.3 million, which constituted 16.3% of core capital at that date.

The OTS’s risk-based capital requirements require the Bank to maintain varying amounts of capital for an asset based on the degree of credit risk associated with that asset and to convert off-balance sheet items to on-balance sheet equivalent amounts in computing the Bank’s risk-based capital ratio.

There are currently four categories of risk-weightings:

• 0% for cash and similar assets;

• 20% for qualifying mortgage-backed securities;

• 50% for qualifying residential permanent real estate loans; and

• 100% for other assets, including consumer loans, commercial real estate loans, loans more than 90 days past due, and real estate acquired in settlement of loans.

The Bank generally must maintain risk-based capital equal to 8.0% of risk-weighted assets, with at least half of that amount in the form of core capital.

Under OTS regulations, residential mortgage loans with negative amortization features that are initially assigned to the 50% risk-weighting may have to be reassigned to the 100% risk-weighting if, as a result of negative amortization, the loan-to-value ratios are no longer “commensurate” with the risk associated with the loans.

Capital also must be maintained against assets sold with recourse despite the fact that the assets are accounted for as having been sold. The current rules:

• require that risk-based capital be held in an amount equal to the amount of residual interests (which include interest-only certificates and/or interest-only strips receivable (referred to collectively as “interest-only strips receivable”), spread accounts, cash collateral accounts, over-collateralization of receivables, retained subordinated interests and other similar forms of on-balance sheet assets that function as credit enhancements) that are retained on balance sheet following a securitization, net of any deferred tax liability (sometimes referred to as “dollar-for-dollar capital”), even if that amount exceeds the otherwise applicable capital requirement on the underlying loans;

• require a deduction from Tier 1 capital equal to the amount of credit enhancing interest-only strips receivable that exceeds 25% of Tier 1 capital; and

• apply a “ratings-based approach” that sets capital requirements for positions in securitizations according to their relative risk exposure.

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At September 30, 2007, the Bank did not have any credit enhancing interest-only strips receivable.

The Bank may use supplementary capital to satisfy the risk-based capital requirement up to an amount equal to its core capital. Supplementary capital includes cumulative perpetual preferred stock, qualifying non-perpetual preferred stock, qualifying subordinated debt, and allowances for loan losses up to a maximum of 1.25% of risk-weighted assets. At September 30, 2007, the Bank had $29.0 million in its allowance for loan losses, all of which was includable as supplementary capital.

Subordinated debt may be included in supplementary capital with OTS approval subject to a phase-out based on its remaining term to maturity. The phase-out permits these instruments to be included in supplementary capital under one of two options:

• at the beginning of each of the last five years prior to the maturity date of the instrument, the Bank must reduce the amount eligible to be included by 20% of the original amount, or

• during the seven years immediately prior to an instrument’s maturity, the Bank may include only the aggregate amount of maturing capital instruments that mature in any one year that does not exceed 20% of its capital.

The Bank uses the second option for its 6-7/8% subordinated debentures due 2013 (the “2003 Debentures”) and must continue to use that option for any future issuances as long as the prior issuance remains outstanding. At September 30, 2007, the Bank had $175.0 million in maturing subordinated capital instruments, all of which was includable as supplementary capital.

All or a portion of the assets of each of the Bank’s subsidiaries are generally consolidated with the assets of the Bank for regulatory capital purposes unless all of the Bank’s investments in, and extensions of credit to, those subsidiaries are deducted from capital. The Bank’s investments in, and loans to, subsidiaries engaged in activities not permissible for a national bank are, with certain exceptions, deducted from capital under each of the three regulatory capital requirements. The Bank’s real estate development subsidiaries are its only subsidiaries engaged in activities not permissible for a national bank. At September 30, 2007, the Bank’s investments in, and loans to, these “non-includable subsidiaries” totaled approximately $3.0 million, all of which was deducted from tangible capital.

OTS capital regulations also require a 100% deduction from total capital of all equity investments that are not permissible for national banks. At September 30, 2007, the Bank had one property with a book value of $2.5 million which was treated as an equity investment for regulatory capital purposes.

OTS capital regulations provide a five-year holding period for real estate acquired in settlement of loans (“REO” or “real estate held for sale”) to qualify for an exception from treatment as an equity investment. The five year period may be extended by the OTS. If an REO property is considered an equity investment, its then-current book value is deducted from total capital. Accordingly, if the Bank is unable to dispose of any REO property prior to the end of its applicable five-year holding period and is unable to obtain an extension of that five-year holding period from the OTS, the Bank could be required to deduct the then-current book value of such REO property from risk-based capital. In August 2007, the Bank received from the OTS additional extensions through August 13, 2008, of the holding periods for certain of its REO properties acquired through foreclosure in fiscal years 1990 and 1995. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Capital.”

On November 1, 2007, the OTS and the other U.S. federal financial institution regulators issued final regulations implementing the most “advanced approach” version of the Basel Committee on Banking Supervision’s revised risk-based capital framework for the largest U.S. banks. The new framework, referred to as Basel II, replaces the Basel Committee’s 1988 risk-based capital accord, which forms the basis for the current risk-based capital requirements of the OTS and the other U.S. federal financial institution regulators. The Basel II regulations are designed to improve the risk sensitivity of the existing risk-based capital requirements and to enhance the risk measurement and management practices of large internationally active U.S. banking organizations. Key components of the final U.S. version of Basel II include the following:

• requiring banks to maintain additional capital for operational risk based on their individual operational risk profile, as determined using their internal models;

• establishing a new mathematical models-based methodology for calculating minimum capital that relies on a bank’s internal risk measurement system to estimate various risk factors, including probability of default, loss-given-default, exposure-at-default and maturity, for its general credit (including wholesale and retail exposures), securitization and equity exposures;

• improving the sensitivity of capital adequacy standards to market risks that are not adequately captured under the current rules;

• requiring banks to develop a rigorous internal process for assessing their overall capital adequacy in relation to their total risk profile through various economic cycles, with these internal models subject to detailed supervisory review; and

• requiring banks to make enhanced public and supervisory disclosures of their capital structure, risk exposures and risk assessment processes.

Implementation of the Basel II “advanced approach” in the United States is not scheduled to begin until January 2008. The Bank will not be subject to these Basel II “advanced approach” requirements.

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In December 2006, the OTS and the other federal banking agencies proposed changes to the existing Basel I risk-based capital requirements, generally referred to as Basel IA, that would have applied to the majority of U.S. banks not subject to the Basel II advanced approach. Key elements of the Basel IA proposal would have added three new risk-weights and relied on loan-to-value ratios to assign risk-weights to residential mortgages. On July 20, 2007, the OTS and the other federal banking agencies announced that they would no longer proceed with the Basel IA proposal, and instead announced plans to issue a proposed rule that would provide smaller banks with the option to adopt the less sophisticated “standardized approach” under Basel II or remain under the current Basel I approach. The proposed “standardized approach” is expected to be released during the first quarter of 2008.

The Bank is unable to predict at this time whether or in what form any final changes to the capital requirements will be adopted by the OTS or their potential impact on the Bank.

The Bank’s ability to maintain capital compliance depends on a number of factors, including, for example, changes in regulatory requirements, general economic conditions and the condition of local markets. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Capital.” The OTS has the authority to require the Bank to maintain capital at levels above the minimum levels generally required, based on a variety of factors, including excessive exposure to interest rate risk, concentrations of credit risk, risks arising from non-traditional activities, and the Bank’s ability to manage those risks. The OTS has not imposed a higher requirement on the Bank.

Prompt Corrective Action. The OTS and the other federal banking agencies have adopted regulations which apply to every FDIC-insured commercial bank and thrift institution a system of mandatory and discretionary supervisory actions, which generally become more severe as the capital levels of an individual institution decline. The regulations establish five capital categories for purposes of determining an institution’s treatment under these prompt corrective action provisions.

An institution is categorized as “well capitalized” under the regulations if (i) it has a leverage ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital ratio of at least 10.0%, and (ii) is not subject to any written agreement, order, capital directive or prompt corrective action directive issued by the OTS to meet and maintain a specific capital level.

An institution is considered “adequately capitalized” if its leverage ratio is at least 4.0% (3.0% if rated in the highest supervisory category), its tier 1 risk-based capital ratio is at least 4.0% and its total risk-based capital ratio is at least 8.0%.

An institution with a leverage ratio below 4.0% (3.0% if rated in the highest supervisory category), a tier 1 risk-based capital ratio below 4.0% or a total risk-based capital ratio below 8.0% is considered “undercapitalized.” An institution with a leverage ratio or tier 1 risk-based ratio under 3.0% or a total risk-based ratio under 6.0% is considered “significantly undercapitalized.” Finally, an institution is considered “critically undercapitalized,” and subject to provisions mandating appointment of a conservator or receiver, if its ratio of “tangible equity” to total assets is 2.0% or less. “Tangible equity” generally includes core capital plus cumulative perpetual preferred stock.

An institution’s classification category can be downgraded if, after notice and an opportunity for a hearing, the OTS determines that the institution is in an unsafe or unsound condition or has received and has not corrected a less than satisfactory examination rating for asset quality, management, earnings or liquidity. The Bank has not received notice from the OTS of any potential downgrade.

At September 30, 2007, the Bank’s leverage ratio of 5.97%, its tier 1 risk-based ratio of 8.85%, and its total risk-based capital ratio of 10.85% exceeded the minimum ratios established for “well-capitalized” institutions.

Qualified Thrift Lender Test. The Bank must meet a Qualified Thrift Lender (“QTL”) test to avoid imposition of certain restrictions. The QTL test requires the Bank to maintain a “thrift investment percentage” equal to a minimum of 65%. The numerator of the percentage is the Bank’s “qualified thrift investments” and the denominator is the Bank’s “portfolio assets.” “Portfolio assets” is defined as total assets minus

• the Bank’s premises and equipment used to conduct the Bank’s business;

• liquid assets up to 20% of total assets; and

• intangible assets, including goodwill.

The QTL test must be met on a monthly average basis in nine out of every 12 months.

“Qualified thrift investments” consist of residential housing loans (including home equity loans and manufactured housing loans), mortgage-backed securities, FHLB and Fannie Mae stock, small business loans, credit card loans and educational loans. Portions of other assets can also be included, provided that the total does not exceed 20% of portfolio assets. Assets in this category include consumer loans (other than credit card and educational loans); 50% of residential housing loans originated and sold within 90 days; investments in real estate-oriented service corporations and 200% of mortgage loans for residences, churches, schools, nursing homes and small businesses in low- or moderate-income areas where credit demand exceeds supply. Intangible assets, including goodwill, are specifically excluded from qualified thrift investments.

The Bank had 90.7% of its assets invested in qualified thrift investments at September 30, 2007, and met the QTL test in each of the previous 12 months.

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An institution that fails to meet the QTL test is subject to significant penalties. Immediately after failing the QTL test, the institution may not:

• make any new investment or engage directly or indirectly in any other new activity unless the investment or activity would be permissible for a national bank;

• establish any new branch office at any location at which a national bank could not establish a branch office;

• obtain new advances from the FHLB; or

• pay dividends beyond the amounts permissible if it were a national bank.

One year following an institution’s failure to meet the QTL test, the institution’s holding company parent must register and be subject to supervision as a bank holding company. Three years after failure to meet the QTL test, an institution may not retain any investments or engage in any activities that would be impermissible for a national bank. Failure to meet the QTL test also could limit the Bank’s ability to establish and maintain branches outside of its home state of Virginia.

Because the Bank is engaged in activities that are not currently permissible for national banks, such as investing in subsidiaries that engage in real estate development activities, failure to satisfy the QTL test would require the Bank to terminate these activities and divest itself of any prohibited assets held at such time. Based on a review of the Bank’s current activities, management of the Bank believes that compliance with these restrictions would not have a significant adverse effect on the Bank. However, the B.F. Saul Real Estate Investment Trust (the “Trust”), which owns 80% of the common stock of the Bank, is engaged in real estate ownership and development activities currently prohibited for bank and financial holding companies. As a result, failure by the Bank to meet the QTL test, in the absence of a significant restructuring of the Trust’s operations, would, in effect, require the Trust to reduce its ownership of the Bank to a level at which it no longer would be deemed to control the Bank. See “Holding Company Regulation.”

The Bank has taken, and will continue to take, steps to meet the QTL test by structuring its balance sheet to include the required percentage of qualified thrift investments.

Dividends and Other Capital Distributions. OTS regulations limit the ability of the Bank to make “capital distributions.” “Capital distributions” include payment of dividends, stock repurchases, cash-out mergers, repurchases of subordinated debt and other distributions charged against the capital accounts of an institution. The regulations do not apply to interest or principal payments on debt, including interest or principal payments on the Bank’s outstanding subordinated debentures.

The Bank must notify the OTS before making any capital distribution. In addition, the Bank must apply to the OTS to make any capital distribution if the Bank does not qualify for expedited treatment under OTS regulations. If the Bank qualifies for expedited treatment, an application is required only if the total amount of all of the Bank’s capital distributions for the year exceeds the sum of the Bank’s net income for the year and its retained net income for the previous two years.

In considering a notice or application, the OTS will not permit a capital distribution if:

• the Bank would be undercapitalized following the distribution;

• the capital distribution raises safety and soundness concerns; or

• the capital distribution violates any statute, regulation, agreement with the OTS, or condition imposed by the OTS.

The OTS has conditioned the Bank’s recent payments of common stock dividends on the Bank’s maintaining its well-capitalized status and there can be no assurance that the OTS will not impose a similar condition on payment of dividends on the 8% Preferred Stock.

Dividends paid on the 10 3/8% Noncumulative Exchangeable Preferred Stock, Series A, (the “REIT Preferred Stock”) issued by the Bank’s subsidiary, Chevy Chase Preferred Capital Corporation (the “REIT Subsidiary”), are not considered “capital distributions” provided the Bank is classified as “well capitalized.” However, if the Bank were not classified as “well capitalized,” the entire amount of the REIT Subsidiary preferred dividends would be treated as a capital distribution. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Capital.”

Failure of the Bank to remain well capitalized, therefore, could have a material adverse effect on the Bank’s ability to pay dividends on its common stock, preferred stock and REIT Preferred Stock.

In May 1988, in connection with the merger of a Virginia thrift into the Bank, the B.F. Saul Company (the “Saul Company”) and the Trust entered into a capital maintenance agreement in which they agreed not to cause the Bank, without prior written approval of the OTS, to pay dividends in any fiscal year in excess of 50% of the Bank’s net income for that fiscal year, provided that any dividends permitted under such limitation could be deferred and paid in a subsequent year.

The Bank is subject to other limitations on its ability to pay dividends. Under the indenture pursuant to which the Bank’s 2003 Debentures were issued, the Bank may not pay dividends on its stock unless, after giving effect to the dividend, no default or event of default has occurred and is continuing under the indenture and the Bank is in compliance with its regulatory capital requirements. In addition, the amount of the dividend (together with any other “restricted payments” under the indenture) may not exceed the sum of:

• $50.0 million;

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• 66 2/3% of the Bank’s consolidated net income (as defined) accrued on a cumulative basis commencing October 1, 2002; and

• the aggregate cash proceeds received by the Bank after October 1, 2002 from the sale of qualified capital stock or certain debt securities, minus the aggregate amount of any restricted payments (and certain amounts used to redeem securities) made by the Bank.

Dividends on the 8% Preferred Stock and the REIT Preferred Stock are excluded from this limit on restricted payments.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Capital” and “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

The payment of any dividends on the Bank’s common stock and preferred stock will be determined by the Board of Directors based on the Bank’s liquidity, asset quality profile, capital adequacy and recent earnings history, as well as economic conditions and other factors that the Board of Directors determines are relevant, including applicable government regulations and policies. See “Deposits and Other Sources of Funds – Borrowings.”

Lending Limits. The Bank generally is prohibited from lending to one borrower and its related entities amounts in excess of 15% of unimpaired capital and unimpaired surplus. The Bank may lend an additional 10% for loans fully secured by readily marketable collateral. The Bank’s regulatory lending limit was approximately $165.7 million at September 30, 2007, and no group relationships exceeded this limit at that date.

Safety and Soundness Standards. The federal financial institution regulators have developed standards to evaluate the operations of depository institutions, as well as standards relating to asset quality, earnings and compensation. The operational standards cover internal controls and audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and employee compensation. An institution that fails to meet a standard that is imposed through regulation may be required to submit a plan for corrective action within 30 days. If a savings association fails to submit or implement an acceptable plan, the OTS must order it to correct the deficiency, and may:

• restrict its rate of asset growth;

• prohibit asset growth entirely;

• require the institution to increase its ratio of tangible equity to assets;

• restrict the interest rate paid on deposits to the prevailing rates of interest on deposits of comparable amounts and maturities; or

• require the institution to take any other action the OTS determines will better carry out the purpose of prompt corrective action.

Imposition of these sanctions is within the discretion of the OTS in most cases, but is mandatory if the savings institution commenced operations or experienced a change in control during the 24 months preceding the institution’s failure to meet these standards, or underwent extraordinary growth during the preceding 18 months.

The asset quality standards require that the Bank establish and maintain a system to identify problem assets and prevent deterioration of those assets. The earnings standards require that the Bank establish and maintain a system to evaluate and monitor earnings and ensure that earnings are sufficient to maintain adequate capital and reserves.

The OTS and the other federal banking regulators have published guidance on the risks relating to “nontraditional mortgage products,” which include the Bank’s payment option and interest-only loan products. The guidance addresses:

• loan terms and underwriting standards including the need to qualify borrowers at the fully-indexed rate assuming a fully-amortizing payment and taking into account potential negative amortization, to avoid inappropriate use of “reduced documentation” or “stated income” loans, and to set introductory rates that minimize the likelihood of significantly increased borrower payments;

• portfolio and risk management practices, including appropriate monitoring and reporting systems, oversight of third-party originators, and adequate capital and allowances for loan losses; and

• consumer protection issues, including recommendations for the timing and content of appropriate disclosures about the costs, terms, features and risks of these types of loans.

Management believes that the Bank’s lending policies and practices currently comply with this guidance.

The OTS also has issued final guidance requiring thrifts actively engaged in commercial real estate (“CRE”) lending to identify and monitor their CRE loan concentrations, establish internal concentration limits, and implement appropriate risk management procedures based on the size and risks of their CRE portfolios. The guidance also identifies criteria that will be used by the OTS to identify those institutions with “CRE concentration risk” that may be subject to enhanced supervisory review. Based on those criteria, the Bank does not expect its existing CRE lending activities to be subject to enhanced review and does not expect the new guidelines to have a material effect on its operations.

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Regulatory Assessments. The OTS imposes five separate fees to fund its operations:

• semi-annual assessments for all savings institutions;

• examination fees for certain affiliates of savings institutions;

• application fees;

• securities filing fees; and

• publication fees.

Of these fees, the semi-annual assessments are the most significant, totaling $2.4 million for the Bank for the 12 month period ending December 31, 2007.

The OTS formula for charging examination and supervisory assessments imposes a surcharge on institutions with a supervisory rating of 3, 4 or 5. Surcharges are also imposed on “complex institutions,” which the OTS defines as any institution with over $1 billion of off-balance sheet assets consisting of loans serviced for others, trust assets and recourse obligations or direct credit substitutes. The Bank is treated as a “complex institution” for these purposes.

Environmental Regulation. The Bank’s business and properties are subject to federal and state laws and regulations governing environmental matters, including the regulation of hazardous substances and wastes. Under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (“CERCLA”), and under some state laws, owners of properties and secured lenders who take a deed-in-lieu of foreclosure, purchase a mortgaged property at a foreclosure sale, or operate a mortgaged property may become liable in some circumstances for the costs of cleaning up hazardous substances regardless of whether they have contaminated the property. These costs could exceed the original or unamortized principal balance of a loan or the value of the property securing a loan. The Bank is eligible in many instances for an exemption from CERCLA liability as a secured creditor, provided the Bank does not participate in the management of a property and only acts to protect its security interest in the property. Under this exemption, the Bank may foreclose on a mortgaged property, purchase it at a foreclosure sale or accept a deed-in-lieu of foreclosure, provided it seeks to sell the mortgaged property at the earliest practicable commercially reasonable time on commercially reasonable terms. Other federal and state environmental laws may impose additional liabilities in certain circumstances, including certain state laws that impose environmental liens that could be senior to the Bank’s prior recorded liens. These laws may influence the Bank’s decision whether to foreclose on property that is found to be contaminated. The Bank’s general policy is to obtain an environmental assessment prior to foreclosing on commercial property.

Other Regulations and Legislation. The Bank must obtain prior approval of the OTS before merging with another institution or before acquiring insured deposits through certain transactions.

The federal agencies regulating financial institutions possess broad enforcement authority over the institutions they regulate, including the authority to impose civil money penalties of up to $1 million per day for violation of laws and regulations.

Federally chartered thrifts like Chevy Chase generally are permitted to operate branches anywhere in the United States, provided that they meet the QTL test and their regulatory capital requirements and have at least a satisfactory rating under the Community Reinvestment Act (“CRA”).

Amounts realized by the FDIC from the liquidation or other resolution of any insured depository institution must be distributed to pay claims (other than secured claims to the extent of any such security) in the following order of priority:

• administrative expenses of the receiver;

• any deposit liability of the institution;

• any other general or senior liability of the institution (which is not an obligation described below);

• any obligation subordinated to depositors or general creditors which is not a stockholder obligation; and

• any obligation to stockholders arising as a result of their status as stockholders.

In response to the September 11, 2001 terrorist attacks, on October 26, 2001, President Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (the “USA Patriot Act”). Title III of the USA Patriot Act amends the Bank Secrecy Act and contains provisions designed to detect and prevent the use of the U.S. financial system for money laundering and terrorist financing activities by, among other things, imposing new compliance obligations on savings associations, trust companies and securities broker-dealers. Several of these compliance obligations focus on transactions between U.S. financial institutions and non-U.S. banks, entities and individuals, and therefore do not have a significant impact on the Bank’s operations. However, other anti-money laundering and related compliance obligations impact the Bank more directly, and regulatory scrutiny and enforcement of these obligations has increased significantly. The Bank has taken steps to enhance its anti-money laundering policies and procedures following enactment of the USA Patriot Act and continues to monitor developments regarding implementation of the Act and evolving regulatory policies and to make further adjustments to those policies and procedures as appropriate.

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On November 15, 2007, the House of Representatives passed a bill that would, among other things:

• create additional registration and licensing requirements for certain originators of residential mortgage loans;

• impose a new federal duty of care and anti-steering requirements on all originators of residential mortgage loans;

• create new minimum standards for all residential mortgage loans, including requirements that the lender determine that the consumer has a “reasonable ability to repay” the loan and, in the case of a refinancing, that the loan will provide a “net tangible benefit” to the consumer;

• expand the scope and enhance protections for certain “high-cost” loans; and

• place significant limitations on loans containing certain features, including negative amortization.

Banking industry groups have expressed significant concerns over the bill’s provisions, including its potential impact on the availability of mortgage credit. Several of the bill’s provisions, if enacted in their current form, could require further adjustments to the Bank’s loan policies and products and adversely affect its production volumes of loans containing certain features. While several Senators have announced plans to pursue legislation designed to prevent a recurrence of problems in certain segments of the mortgage market, prospects for Senate action remain unclear. Accordingly, the Bank is unable to predict whether and in what form any such legislation will eventually be enacted.

Federal Reserve System

The Federal Reserve Board requires the Bank to maintain reserves against its transaction accounts and certain non-personal deposit accounts. Because reserves generally must be maintained in cash or non-interest-bearing accounts, the effect of the reserve requirement is to decrease the Bank’s earnings.

Prior to December 21, 2006, the first $7.8 million of the Bank’s transaction account balances were subject to a 0% reserve requirement. A 3% reserve ratio applied to new transaction accounts over $7.8 million, up to and including $48.3 million. Any net transaction accounts over $48.3 million were subject to a 10% reserve requirement. Effective December 21, 2006, the FRB increased the amount of transaction accounts subject to a 0% reserve requirement from $7.8 million to $8.5 million and decreased the “low reserve tranche” from $48.3 million to $45.8 million. Effective November 20, 2007, the first $9.3 million of net transaction accounts will be exempt from reserve requirements. A 3% reserve ratio will be applied to net transaction accounts over $9.3 million up to and including $43.9 million. A reserve ratio of $1.0 million plus 10% will be applied to net transaction accounts in excess of $43.9 million. The Bank met its reserve requirements for each period during the year ended September 30, 2007.

Beginning October 1, 2011, the FRB will have the statutory authority to eliminate or reduce the reserve requirement on all deposits currently subject to a 3% reserve ratio, and to pay interest on reserves.

The Bank may borrow from the Federal Reserve’s “discount window.” Federal law imposes limitations on the ability of the Federal Reserve to lend to “undercapitalized” institutions through the discount window. Chevy Chase’s capital ratios exceeded the ratios established for “well-capitalized” institutions.

Community Reinvestment Act

Under the CRA and OTS regulations, the Bank has a continuing and affirmative obligation to help meet the credit needs of its local communities, including low- and moderate-income neighborhoods and low- and moderate-income individuals and families, consistent with the safe and sound operation of the institution. The OTS is required to assess the Bank’s CRA record in connection with its examination of the Bank. In addition, the OTS is required to take into account the Bank’s record of meeting the credit needs of its community in determining whether to grant approval for certain types of applications.

The Bank is committed to fulfilling its CRA obligation by providing access to a full range of credit-related products and services to all segments of its community. Based on the last OTS examination covering the period from January 2005 through March 2007, the Bank received an “Outstanding” CRA rating.

Other Aspects of Federal Law

The Bank is also subject to federal statutory provisions covering matters such as security procedures, currency transactions reporting, insider and affiliated party transactions, management interlocks, truth-in-lending, electronic funds transfers, funds availability, equal credit opportunity and privacy of consumer information.

Holding Company Regulation

The Trust, the Saul Company, CCPC, and Westminster Investing Corporation (collectively, the “Holding Companies”) are registered as “savings and loan holding companies” because of their direct or indirect ownership interests in the Bank, and are subject to regulation, examination and supervision by the OTS. The Bank is prohibited from making or guaranteeing loans or advances to or for the benefit of the Holding Companies or other affiliates engaged in activities beyond those permissible for bank holding companies and from investing in the securities of the Holding Companies or other affiliates. Transactions between the Bank and the Holding Companies must be on terms substantially the same, or at least as favorable to the Bank, as those that would be available to non-affiliates.

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OTS supervision of the Holding Companies includes a review of the adequacy of their capital, their level of debt, and their ability to fund outstanding debt obligations, and OTS guidance suggests that particular scrutiny will be given to holding companies that, like the Holding Companies, are engaged in real estate activities. On April 9, 2007, the OTS proposed revisions to its Savings and Loan Holding Company (“SLHC”) rating system that would place additional focus on risk exposure and risk management.

The Holding Companies must obtain OTS approval before acquiring any federally insured savings institution or any savings and loan holding company. The status of the Holding Companies as “unitary thrift holding companies” and the activities in which the Holding Companies may engage have been grandfathered under the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”). As grandfathered unitary thrift holding companies, the Holding Companies are virtually unrestricted in the types of business activities in which they may engage provided the Bank continues to meet the QTL test. See “Qualified Thrift Lender Test.” The GLB Act prohibits the sale of grandfathered unitary thrift holding companies such as the Holding Companies (together with their thrift subsidiaries) or their thrift subsidiaries alone to commercial companies. Corporate reorganizations are expressly permitted.

If the Holding Companies were to acquire one or more federally insured institutions and operate them as separate subsidiaries rather than merging them into the Bank, the Holding Companies would become “multiple” savings and loan holding companies. As multiple savings and loan holding companies, the Holding Companies would be subject to limitations on the types of business activities in which they would be permitted to engage, unless the additional thrifts were troubled institutions acquired pursuant to certain emergency acquisition provisions and all subsidiary thrifts met the QTL test. The Holding Companies may acquire and operate additional savings institution subsidiaries outside of Maryland and Virginia only if the laws of the target institution’s state specifically permit those acquisitions or if the acquisitions are made pursuant to emergency acquisition provisions.

The Trust and the Saul Company entered into an agreement with OTS’s predecessor, the Federal Savings and Loan Insurance Corporation, to maintain the Bank’s regulatory capital at the required levels, and, if necessary, to infuse additional capital to enable the Bank to meet those requirements. Since the execution of this agreement, the OTS has changed its policy and no longer requires such agreements from companies acquiring thrift institutions. In addition, the regulatory capital requirements applicable to the Bank have changed significantly as a result of FIRREA. The OTS had stated that capital maintenance agreements entered into prior to the modification of OTS policy and the enactment of FIRREA were not affected by those changes. The Trust and the Saul Company have not sought to modify the existing agreement. To the extent the Bank is unable to meet regulatory capital requirements in the future; the OTS could seek to enforce the obligations of the Trust and the Saul Company under the agreement.

The Trust has applied to the OTS for approval of a new thrift holding company. If approved by the OTS and if the Trust elected to proceed, the Trust’s ownership of 80% of the common stock of the Bank, subject to $250 million of senior secured notes, would be transferred to the new bank holding company, as permitted under the indenture governing the Trust’s senior secured notes. The decision of when and even whether to proceed with the formation of the new thrift holding company has not yet been made by the Trust.

If the Bank were to become “undercapitalized” under the prompt corrective action regulations, it would be required to file a capital restoration plan with the OTS setting forth, among other things, the steps the Bank would take to become “adequately capitalized.” The OTS could not accept the plan unless the Holding Companies guaranteed in writing the Bank’s compliance with that plan. The aggregate liability of the Holding Companies under such a commitment would be limited to the lesser of:

• an amount equal to 5.0% of the Bank’s total assets at the time the Bank became “undercapitalized,” or

• the amount necessary to bring the Bank into compliance with all applicable capital standards as of the time the Bank fails to comply with its capital plan.

If the Holding Companies refused to provide the guarantee, the Bank would be subject to the more restrictive supervisory actions applicable to “significantly undercapitalized” institutions. See “Regulation – Prompt Corrective Action.”

Recently Issued Accounting Standards

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

In September 2006, the Financial Accounting Standards Board (“FASB”) ratified Emerging Issues Task Force (“EITF”) consensus 06-5, “Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4” (“EITF 06-5”). EITF 06-5 eliminates the diversity in policyholder calculations of the amount that would be realized under a life insurance contract if that contract were terminated. Under EITF 06-5, policyholders will be required to recognize contract-based values at their net present value. EITF 06-5 is effective for the Bank’s fiscal year beginning October 1, 2007. The adoption of EITF 06-5 did not have a material impact on the Bank’s financial condition or results of operations.

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

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

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets” (“SFAS 156”). SFAS 156 amends SFAS 140 to require an entity (i) to initially measure all separately recognized servicing assets and servicing liabilities at fair value, if practicable; (ii) to separately present servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position; and (iii) to provide additional disclosures for all separately recognized servicing assets and servicing liabilities. In addition, SFAS 156 permitted an entity to irrevocably choose either the amortization method or the fair value measurement method for the subsequent measurement of each class of separately recognized servicing assets and servicing liabilities. SFAS 156 was effective for the Bank on October 1, 2006. As a result of the adoption of SFAS 156 the Bank identified its mortgage servicing rights (“MSRs”) relating primarily to residential mortgage loans as a class of servicing rights and elected to apply fair value accounting to this class of MSRs. Presently, this class, which also includes servicing rights related to home equity and home improvement loans, represents all of the Bank’s MSRs. The impact of the adoption, which represents the difference between the fair value and the carrying amount of the MSRs, net of any related valuation allowance, was $4,091, net of related income taxes, and was recorded as a cumulative-effect adjustment to retained earnings on October 1, 2006.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS 155”). SFAS 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”) by eliminating SFAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS 155 permits fair value measurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided that the whole instrument is accounted for on a fair value basis and eliminates a restriction on the passive derivative instruments that a qualifying special-purpose entity may hold. SFAS 155 applies to all financial instruments acquired or issued by the Bank on October 1, 2007 and upon adoption for existing bifurcated hybrid financial instruments not being used in hedging relationships. The adoption of this statement did not have a material effect on the Bank’s financial condition or results of operations.

Market Area

The Bank’s principal deposit and lending markets are located in the Washington, DC and Baltimore, Maryland metropolitan areas. Service industries and federal, state and local governments employ a significant portion of the Washington, DC area labor force. In addition a substantial number of the nation’s 500 largest corporations have some presence in these areas. The Washington, DC and Baltimore, Maryland area’s seasonally unadjusted unemployment rate are typically below the national rate and were 3.0% and 3.9% in September 2007, respectively, compared to the national rate of 4.7%.

Chevy Chase historically has relied on retail deposits originated in its branch network as its primary funding source. See “Deposits and Other Sources of Funds.” Chevy Chase’s principal market for deposits consists of Montgomery and Prince George’s Counties in Maryland and Fairfax County in Virginia. Approximately 5.7% of the Bank’s deposits at September 30, 2007 were obtained from depositors residing outside of Maryland, Virginia and the District of Columbia, as compared to 6.1% of the Bank’s deposits at September 30, 2006.

As of June 30, 2007, according to the most recently published industry statistics, Chevy Chase ranked fifth in market share in the Washington, DC metropolitan area with approximately 9.5% of deposits and fourteenth in the Baltimore, Maryland metropolitan area with 1.3% of deposits. At the same date, Chevy Chase had the largest market share of deposits in Montgomery County; ranked third in market share of deposits in Prince George’s County and ranked fifth in market share in Fairfax County. The per capita incomes of Montgomery and Fairfax Counties rank among the highest of counties and equivalent jurisdictions nationally. These two counties are also the Washington, DC area’s largest suburban employment centers, with a substantial portion of their labor force consisting of federal,

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state and local government employees. Private employment is concentrated in service and retail trade centers. The unemployment rate in each of Montgomery, Prince George’s and Fairfax Counties in August 2007 was 2.7%, 3.7% and 2.2%, respectively, each of which was below the national rate of 4.7%. The individual state rates were 3.7% for Maryland and 3.1% for Virginia for the same month.

The Bank historically has concentrated its lending activities in the Washington, DC metropolitan area. In recent years, the Bank has expanded its lending activities outside the Washington, DC metropolitan area, particularly California in the case of residential mortgage loans. See “Lending and Leasing Activities.”

Investment and Other Securities

The Bank is required by OTS regulations to maintain sufficient liquidity to ensure its safe and sound operations. See “Regulation – Liquidity Requirements.” To meet this requirement, the Bank maintains a portfolio of cash, federal funds, treasury securities and other readily marketable fixed-income securities. Management’s objective is to maintain liquidity at a level sufficient to assure adequate funds to meet expected and unexpected balance sheet fluctuations.

The Bank classifies its investment securities and mortgage-backed securities as either “held-to-maturity,” “available-for-sale” or “trading” at the time such securities are acquired. All its investment securities and mortgage-backed securities were classified as held-to-maturity at September 30, 2007 and 2006.

As part of its mortgage banking activities, the Bank exchanges loans held for sale for mortgage-backed securities and then sells the mortgage-backed securities, which are classified as trading securities, to third party investors in the month of issuance. Gains and losses on sales of trading securities are determined using the specific identification method. There were no mortgage-backed securities classified as trading securities at September 30, 2007 and 2006.

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Lending and Leasing Activities

Loan Portfolio Composition. At September 30, 2007, the Bank’s loan portfolio totaled $11.8 billion, which represented 78.4% of its total assets. All references in this report to the Bank’s loan portfolio refer to loans, whether they are held for sale and/or securitization or for investment, and exclude mortgage-backed securities. Loans collateralized by single-family residences constituted 83.6% of the loan portfolio and 65.1% of total assets at September 30, 2007. The following table sets forth information concerning the Bank’s loan portfolio, net of unfunded commitments, for the periods indicated.

Loan Portfolio

(Dollars in thousands)

	September 30,
	2007					2006					2005					2004					2003
	Balance			% of Total		Balance			% of Total		Balance			% of Total		Balance			% of Total		Balance			% of Total
Residential Mortgage (1)	$	8,245,176		70.1	%	$	7,107,302		67.7	%	$	7,530,315		68.9	%	$	7,166,935		68.6	%	$	5,761,993		64.7	%
Home equity (1)(2)		1,583,170		13.5			1,690,421		16.1			1,796,489		16.4			1,721,999		16.5			1,336,776		15.0
Other real estate		814,711		6.9			607,451		5.8			358,937		3.3			261,997		2.5			253,791		2.8
Commercial (2)		935,999		8.0			987,850		9.4			1,035,972		9.5			920,178		8.8			888,847		10.0
Automobile loans (1)		128,931		1.1			60,756		0.6			149,253		1.4			300,516		2.9			589,024		6.6
Other consumer		43,818		0.4			46,755		0.4			53,742		0.5			70,140		0.7			84,606		0.9
		11,751,805		100.0	%		10,500,535		100.0	%		10,924,708		100.0	%		10,441,765		100.0	%		8,915,037		100.0	%
Unearned premiums and discounts		354					441					654					894					1,428
Net deferred loan origination costs		116,898					112,419					125,210					116,124					80,320
Allowance for loan losses		(29,000	)				(25,000	)				(28,640	)				(37,750	)				(58,397	)
		88,252					87,860					97,224					79,268					23,351
Total loans receivable	$	11,840,057				$	10,588,395				$	11,021,932				$	10,521,033				$	8,938,388

(1) Includes loans held for securitization and/or sale, if any.

(2) Net of undisbursed portion of loans.

The Bank adjusts the composition of its loan portfolio in response to a variety of factors, including regulatory requirements and asset and liability management objectives. See “Regulation – Regulatory Capital,” “Regulation – Qualified Thrift Lender Test” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Asset and Liability Management.”

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Contractual Principal Repayments of Loans. The following table shows the scheduled contractual principal repayments of the Bank’s loans at September 30, 2007. The entire balance of loans held for securitization and/or sale is shown in the year ending September 30, 2007, because those loans are expected to be sold in less than one year.

Contractual Principal Repayments

(In thousands)

	Principal Balance Outstanding at September 30, 2007(1)		Approximate Principal Repayments Due in Years Ending September 30,
			2008		2009-2012		2013 and Thereafter
Single family residential	$	8,044,052	$	77,732	$	151,907	$	7,814,413
Home equity		1,583,170		17,843		161,884		1,403,443
Other real estate		814,711		779,395		35,316		—
Commercial		935,999		671,080		264,919		—
Automobile loans		128,823		30,292		88,579		9,952
Other consumer		43,818		6,085		25,823		11,910
Loans held for securitization and/or sale(2)		201,232		201,232		—		—
Total loans receivable(3)	$	11,751,805	$	1,783,659	$	728,428	$	9,239,718
Fixed-rate loans	$	2,160,826	$	1,111,763	$	568,156	$	480,907
Adjustable-rate loans		9,389,747		470,664		160,272		8,758,811
Loans held for securitization and/or sale(2)		201,232		201,232		—		—
Total loans receivable(3)	$	11,751,805	$	1,783,659	$	728,428	$	9,239,718

(1) Of the total amount of loans outstanding at September 30, 2007, which were due after one year, an aggregate principal balance of approximately $1.0 billion had fixed interest rates and an aggregate principal balance of approximately $8.9 billion had adjustable interest rates.

(2) Assumes loans held for securitization and/or sale are sold within one year.

(3) Before deduction of allowance for loan losses, unearned premiums and discounts and deferred loan origination fees (costs).

Actual payments may not reflect scheduled contractual principal repayments due to the effect of loan refinancings, prepayments and enforcement of due-on-sale clauses. Although the Bank’s single-family residential loans historically have had stated maturities of generally 30 to 40 years, those loans normally have remained outstanding for substantially shorter periods because of these factors. Due-on-sale clauses give the Bank the right to declare a “conventional loan” — one that is neither insured by the Federal Housing Administration nor partially guaranteed by the Veterans’ Administration — immediately due and payable in the event, among other things, that the borrower sells the property securing the loan without the consent of the Bank. At September 30, 2007, excluding loans held for securitization and/or sale, aggregate principal repayments of $1.6 billion from all loans are contractually due within the next year. Of this amount, $1.1 billion is due on fixed-rate loans and $470.7 million is due on adjustable-rate loans.

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Origination, Purchase and Sale of Real Estate Loans. The Bank has general authority to make loans secured by real estate located throughout the United States. The following table shows changes in the composition of the Bank’s real estate loan portfolio and the net change in mortgage-backed securities.

Origination, Purchase and Sale of Real Estate Loans

(In thousands)

	For the Year Ended September 30,
	2007			2006			2005
Real estate loan originations and purchases:
Single family residential	$	5,891,361		$	6,763,942		$	8,815,453
Home equity (1)		815,342			1,043,003			1,180,981
Other real estate(1)		721,588			597,801			393,470
Total originations and purchases		7,428,291			8,404,746			10,389,904
Principal repayments		(2,223,537	)		(2,836,637	)		(2,998,545	)
Sales		(3,380,365	)		(5,135,271	)		(6,296,737	)
Loans transferred to real estate acquired in settlement of loans		(18,603	)		(4,653	)		(4,657	)
		(5,622,505	)		(7,976,561	)		(9,299,939	)
Transfers to mortgage-backed securities(2)		(567,903	)		(708,752	)		(555,155	)
Increase (decrease) in real estate loans	$	1,237,883		$	(280,567	)	$	534,810

(1) Net of undisbursed portion of loans.

(2) Represents real estate loans which were pooled and exchanged for mortgage-backed securities.

Single-Family Residential Real Estate Lending (Excluding Home Equity Lending). The Bank originates a variety of loans secured by single-family residences. At September 30, 2007, $9.8 billion, or 83.6%, of the Bank’s loan portfolio consisted of loans secured by first or second mortgages on such properties, as compared to $8.8 billion, or 83.8%, at September 30, 2006. Of these amounts, $3.6 million and $2.7 million consisted of FHA-insured or VA-guaranteed loans at September 30, 2007 and 2006, respectively. At September 30, 2007 and 2006, the Bank had $202.2 million and $467.6 million, respectively, of single-family residential loans held for securitization and/or sale to investors. Approximately 36.8% of the principal balance of the Bank’s single-family residential real estate loans at September 30, 2007 were secured by properties located in California, as compared to 32.5% at September 30, 2006.

The Bank originates a wide variety of conventional residential mortgage loans, as well as FHA and VA loans, through its wholly owned mortgage banking subsidiary, B.F. Saul Mortgage Company, and through Chevy Chase Mortgage, a division of the Bank. The Bank currently offers fixed-rate loans with maturities of 15 to 40 years and adjustable-rate residential mortgage loans with maturities ranging from 30 to 40 years.

Most of the Bank’s single-family residential mortgage loans are originated by third parties. The Bank determines the specific loan products and rates under which the third party originates the loan, and subjects the loan to the Bank’s underwriting criteria and review. During the year ended September 30, 2007, approximately $4.0 billion of loans settled under this program.

Interest rates on the majority of the Bank’s ARMs are adjusted based on changes in either (a) the London Interbank Offered Rate (“LIBOR”) of varying maturities or (b) yields on U.S. Treasury securities. The interest rate adjustment provisions of the Bank’s ARMs may contain limitations on the frequency and/or maximum amount of interest rate adjustments. These limitations are determined by a variety of factors, including mortgage loan competition in the Bank’s markets.

In recent years, the Bank has significantly expanded its origination of residential ARMs with interest rates that adjust monthly, semi-annually and annually, most of which provide a borrower with a variety of monthly payment options. Certain of these loans have a payment option that could result in interest being added to the principal of the loan, or “negative amortization.” Certain other of these loans have a payment option that allows the borrower to make an interest only payment. During fiscal years 2007 and 2006, the Bank originated $5.9 billion and $6.7 billion, respectively, of mortgage loans, of which $3.8 billion and $4.3 billion, respectively, contained terms that permit negative amortization and, $751.2 million and $1.3 billion, respectively, contain terms which allow the borrower to make an interest only payment but do not permit negative amortization.

Loans with a negative amortization option totaled $3.9 billion and $2.8 billion at September 30, 2007 and 2006, respectively, including approximately $93.3 million and $32.8 million of cumulative deferred interest at September 30, 2007 and 2006, respectively. The amount of deferred interest has increased significantly in recent periods as the rise in short-term interest rates has led more borrowers with

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payment option ARMs to elect to make monthly payments that are less than the amount of interest accrued for that month. During September 2007, approximately 68% of the Bank’s borrowers with loans permitting negative amortization opted to make a payment for an amount which resulted in negative amortization. Each loan contains terms which limit the amount of negative amortization to a percentage of the original loan amount, generally 10% to 15%. Once these negative amortization limits are reached, the borrower’s required monthly payments adjust or are “recast” to an amount sufficient to amortize the loan over its then-remaining term. If all borrowers choose to make the minimum payment, approximately 600 loans with aggregate outstanding balances of $323.8 million, would reach this payment recast ceiling during fiscal year 2008 (assuming LIBOR rates remain unchanged from levels at November 10, 2007) and, as a result, the payment amount would increase to a fully amortizing payment.

The Bank also originates construction permanent loans, which are loans to individuals who are in the process of building their single family homes. During fiscal years 2007 and 2006, the Bank originated $505.5 million and $434.8 million, respectively, of these loans, the principal amount of which the Bank disburses as construction progresses. During the construction phase, these loans permit the borrower to make an interest-only payment but do not permit negative amortization. Upon completion of construction, the loan will convert to a permanent mortgage, which may permit the borrower to make an interest-only payment or incur negative amortization.

The Bank has enhanced its monitoring of the risks associated with these interest-only and payment option mortgage products, and has established terms for loans it originates (including caps on the amount of negative amortization) designed to minimize credit risk without adversely affecting the Bank’s competitive position. The Bank has also adjusted its underwriting policies in response to recent market conditions. Increased emphasis of these ARM products continues to be a key part of management’s efforts to focus on originating mortgage loans with interest rates that adjust more frequently in order to reduce the Bank’s interest-rate risk. At September 30, 2007, 96.9% of the Bank’s single-family residential loans were comprised of ARMs and, of this amount, 46.8% of the Bank’s single-family residential loans were comprised of ARMs that have interest rates which adjust annually or more frequently.

The OTS and the other federal banking regulators have issued guidance concerning “non-traditional mortgage products” such as interest-only and payment option ARMs, and Congress is currently considering legislation that, if not revised before enactment, could require further adjustments to the Bank’s loan policies and products and aversely affect its production volumes of loans containing certain features. See “Business – Regulation—Safety and Soundness Standards” and “Business-Regulation-Other Regulations and Legislation.”

Loan securitizations and/or sales provide the Bank with liquidity and additional funds for lending; enabling the Bank to increase the volume of loans originated and thereby increase loan interest and fee income as well as gains on sales of loans. Sales of mortgage loans totaled $3.9 billion and $5.4 billion during the fiscal years ended September 30, 2007 and 2006, respectively. The marketability of loans, loan participations and mortgage-backed securities depends on purchasers’ investment limitations, general market and competitive conditions, mortgage loan demand and other factors. As a result of recent market conditions, the Bank did not securitize any loans during the quarter ended September 30, 2007. See “Recent Developments.”

The Bank’s conforming fixed-rate, single-family loans are originated on terms which conform to Freddie Mac, Fannie Mae or Ginnie Mae guidelines in order to facilitate the securitization and/or sale of those loans. In order to manage its exposure to interest rate risk, the Bank hedges its fixed rate held for sale mortgage loan pipeline by entering into whole loan and mortgage-backed security forward sale commitments. Sales of residential mortgage loans are generally made without recourse to the Bank.

From time to time, as part of its capital and liquidity management plans, the Bank may consider “swapping” loans held in its portfolio for lower risk-weighted mortgage-backed securities and retaining those securities in its portfolio rather than selling them. During fiscal year 2007, the Bank did not exchange and retain in its portfolio any single-family residential loans for mortgage-backed securities. During fiscal years 2006, and 2005, the Bank exchanged $486.0 million and $364.6 million, respectively, of single-family residential loans held in its portfolio for mortgage-backed securities, which the Bank retained for its own portfolio.

When the Bank sells a residential loan or loan participation and retains servicing, or purchases mortgage servicing assets from third parties, it collects and remits loan payments, makes certain insurance and tax payments on behalf of borrowers and otherwise services the loans. The servicing fee generally ranges from 0.25% to 0.50% per year of the outstanding loan principal amount. The Bank also typically derives income from temporary investment for its own account of loan collections pending remittance to the participation or loan purchaser. At September 30, 2007 and 2006, the Bank was servicing residential loans totaling $13.1 billion and $13.7 billion, respectively, for other investors. See “Loan Servicing.”

Sales of Mortgage-Backed Securities. The Bank originates and sells mortgage-backed securities pursuant to its normal mortgage banking operations. The securities are generally sold in the same month as they are issued. The securities are formed from conforming mortgage loans originated for sale or from conforming mortgage loans resulting from the borrower’s election to convert from an adjustable-rate loan to a fixed-rate loan. Mortgage-backed securities held for sale in conjunction with mortgage banking activities are classified as trading securities. During the years ended September 30, 2007 and 2006, the Bank originated and sold $568.9 million and $224.9 million, respectively, of mortgage-backed securities and recognized gains of $1.0 million and $1.8 million, respectively. As a result of the sale of trading securities in the month such securities are formed, the Consolidated Statements of Cash Flows in this report reflect proceeds from the sales of trading securities, even though there are no balances of such securities at September 30, 2007.

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Home Equity Lending. The Bank makes home equity loans and credit line loans, the majority of which are secured by a first or a second mortgage on the borrower’s home. Home equity credit line loans provide revolving credit, bear interest at a variable rate that adjusts monthly based on changes in the applicable interest rate index and generally are subject to a maximum annual interest rate of between 18.0% and 24.0%. Generally, except for any amortization of principal that may occur as a result of monthly payments, there are no required payments of principal until maturity. Home equity loans have fixed rates of interest and amortize over their term, which ranges from five to 20 years.

From time to time, the Bank securitizes and sells home equity credit line receivables to enhance liquidity and to maintain compliance with regulatory capital requirements. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition.”

Commercial Real Estate and Real Estate Construction Lending. Commercial real estate, real estate construction and ground loans are originated directly by the Bank. The Bank also participates in loans originated by other banks. Aggregate balances of residential and commercial construction, ground and commercial real estate and multifamily loans were $814.7 million and $607.5 million at September 30, 2007 and 2006, respectively. The Bank provides financing, at market rates, to certain purchasers of real estate owned by the Bank. Additionally, the Bank finances the construction of residential real estate, principally single-family detached homes and townhouses, with generally a specified number of pre-sales required. Loan concentrations among types of real estate are reviewed and approved by the Bank’s Credit Risk Management Committee.

At September 30, 2007, the Bank held $225.6 million (27.7% of total commercial real estate and real estate construction loans) of participations or syndications in commercial real estate and real estate construction loans originated by other financial institutions, compared to $211.1 million (34.7% of total commercial real estate and real estate construction loans) at September 30, 2006.

Commercial Lending. The Bank makes loans to business entities for a variety of purposes, including working capital and acquisitions of real estate, machinery and equipment or other assets. A wide variety of products are offered, including revolving lines of credit, term loans, cash management services and other deposit and investment products. Concentrations among industries and structure types, such as syndications, are reviewed and approved by the Bank’s Credit Risk Management Committee.

Business development efforts of the Bank’s Commercial Banking Group have been concentrated in the major industry groups in the metropolitan Washington, DC and Baltimore areas, as well as a broad base of businesses and community service organizations. The Bank also has an active commercial lending program which includes offering small business loans through its deposit branches. In addition, management believes that the ability to offer a broader variety of investment products and fiduciary services to institutional customers through the Bank’s subsidiaries, ASB Capital Management LLC and Chevy Chase Trust Company, will continue to enhance the operations of the Commercial Banking Group. Commercial loans totaled $936.0 million and $987.9 million at September 30, 2007 and 2006, respectively.

At September 30, 2007, the Bank held $68.8 million (7.3% of total commercial loans) of participations or syndications in commercial loans originated by other financial institutions, a decrease from $103.8 million (10.5% of total commercial loans) at September 30, 2006.

Federal laws and regulations limit the Bank’s commercial loan portfolio to 20% of assets, with any excess over 10% consisting of small business loans. At September 30, 2007, the Bank’s commercial loan portfolio represented 6.2% of its assets, with 1.1% consisting of small business loans.

Other Consumer Lending Activities. In addition to the types of loans described above, Chevy Chase currently offers a variety of other consumer loans, including overdraft lines of credit and other unsecured loans for traditional consumer purchases and needs. The Bank does not offer its own credit card loans, but has an agreement with another financial institution pursuant to which that institution issues credit cards in the Bank’s name to the Bank’s local customers. The Bank offers direct prime automobile loans through its branch network, and in December 2006, resumed origination of indirect prime automobile loans from local dealers. The Bank’s portfolios of automobile loans and other consumer loans totaled $128.9 million and $43.8 million, respectively, at September 30, 2007, which accounted for a combined 1.5% of total loans at that date.

Federal laws and regulations limit the Bank’s secured and unsecured consumer loans to 35% of its total assets. Home improvement, secured deposit account and educational loans are not included in the 35% limit. At September 30, 2007, the Bank complied with this limit.

Automobile Leasing. Effective March 2003, the Bank stopped originating indirect automobile leases and the Bank continues its collection efforts on that existing portfolio. At September 30, 2007 and 2006, the Bank’s portfolio of automobiles subject to lease totaled $7.0 million and $55.4 million, respectively. In addition to credit risk associated with a lessee’s possible default under the lease, the Bank is exposed to the risk that the value of the vehicle at maturity of the lease may be less than the future residual value as estimated by the Bank at the inception of the lease. To reduce that risk, the Bank (a) purchased insurance in the full amount of the estimated residual value to protect the Bank against possible future decreases in residual values, and (b) used estimates of residual value that did not exceed published industry estimates unless that excess was also insured. Although the Bank insured residual values, limitations in the insurance policy and other factors have resulted and may continue to result in losses at lease maturity that may not be fully covered by that insurance.

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Real Estate Loan Underwriting. In the loan approval process, Chevy Chase assesses both the borrower’s ability to repay the loan and the adequacy of the proposed security. The Board of Directors has delegated credit approval authority to the Officers Loan Committee, Executive Loan Committee and certain senior officers. Generally, all construction and commercial real estate loans originated by the Bank’s commercial lending group are reviewed and approved by either the Officers Loan Committee or the Executive Loan Committee, or both, depending on the size of the loan. Any significant loan not conforming to the Bank’s approved policies must be approved by the Executive Loan Committee or the Chief Executive Officer. All credit exposures in excess of $30 million are presented to the Board of Directors for final approval.

The approval process for all types of real estate loans includes appraisals or evaluations of the properties securing the loans and a review of all applicants’ and guarantors’ financial information and credit and payment history. In the case of certain residential mortgage loans, the Bank’s policies permit use of reduced documentation, including reliance on the borrower’s representations of his or her income without independent verification. See “Risk Factors – Our “payment option” and “interest-only” mortgage loans subject us to additional risks.”

In an effort to minimize the increased risk of loss associated with construction and development loans, Chevy Chase considers the reputation of the borrower and the contractor, reviews pre-construction sale and leasing information, and requires an independent inspecting engineer or architect to review the progress of multifamily and commercial real estate projects. In addition, the Bank generally requires personal guarantees of developers for all development loans and, if a general contractor is used by the developer, may require the posting of a performance bond.

The Bank generally makes residential mortgage loans in amounts up to 95% of the value of owner-occupied single-family homes. In some circumstances, the Bank originates a first and second residential mortgage loan simultaneously, provided that the aggregate loan amount does not exceed 100% of the value of the residential property. The Bank generally lends up to 95% of the lesser of the acquisition cost or the appraised value of the completed project to finance the construction of homes. The loan-to-value (“LTV”) ratio generally applied by the Bank to commercial real estate loans and multifamily residential loans has been 80% of the appraised value of the completed project. Currently, the Bank offers home equity loans and credit line loans up to 100% maximum LTV ratio. However, it is the Bank’s policy to insure all newly originated home equity loans and credit lines with an LTV ratio equal to or greater than 90%.

LTV ratios are determined at the time a loan is originated. Consequently, subsequent declines in the value of a loan’s collateral or increases in the balance of the loan, or both, could expose the Bank to losses. Loans with LTV ratios which exceed the established supervisory LTV limits, without mortgage insurance, may not exceed 100 percent of the Bank’s total risk-based capital.

OTS regulations require institutions to adopt internal real estate lending policies, including LTV limitations conforming to specific guidelines established by the OTS. The Bank’s current lending policies conform to these regulations. The OTS has issued guidance for nontraditional mortgage loans of the type made by the Bank. See “Business – Regulation—Safety and Soundness Standards.”

On all loans secured by real estate, other than home improvement and related loans and certain home equity credit line loans, Chevy Chase requires title insurance policies protecting the priority of the Bank’s liens. The Bank requires fire and casualty insurance for permanent loans, including home equity credit line loans, and fire, casualty and builders’ risk insurance for construction loans. The borrower selects the insurance carrier, subject to Chevy Chase’s approval. Flood insurance is also required for all loans secured by properties in designated flood zones. Generally, for any residential first mortgage loan in an amount exceeding 80% of the value of the security property, Chevy Chase requires mortgage insurance from an unaffiliated mortgage insurance company. The majority of the Bank’s mortgage insurance is currently placed with five carriers.

Substantially all fixed-rate mortgage loans originated by the Bank contain a due-on-sale clause which provides that the Bank may declare a loan immediately due and payable in the event, among other things, that the borrower sells the property securing the loan without the consent of the Bank. The Bank’s ARMs generally are assumable, subject to certain conditions.

Commercial Loan Underwriting.All commercial loan applications are underwritten and approved under authorities granted to specified committees and individuals as outlined in the Bank’s credit policies. All credit exposures in excess of $30 million are presented to the Board of Directors for final approval. The scope and depth of the underwriting for a particular request are generally dictated by the size and complexity of the proposed transaction. Generally, commercial loans for amounts greater than $100,000 are assigned a risk rating at inception, based on a risk-rating system established in the Bank’s credit policies.

Subsequent to origination, all commercial loans with credit exposures of $1 million or more are reviewed at least annually. Changes in the credit quality of the loans are noted and the risk ratings are modified as appropriate.

Other Consumer Loan and Lease Underwriting.Other consumer loans, which include direct and indirect automobile loans, home improvement and related loans and overdraft lines of credit are originated or purchased by the Bank after a review in accordance with established underwriting procedures.

The underwriting procedures are designed to provide a basis for assessing the borrower’s ability and willingness to repay the loan. In conducting this assessment, the Bank considers the borrower’s ratio of debt to income, various credit scoring models and an evaluation of

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the borrower’s credit history through a review of a credit report compiled by a recognized consumer credit reporting bureau. The borrower’s equity in the collateral and the terms of the loan are also considered. The Bank’s guidelines are intended only to provide a basis for lending decisions, and exceptions to the guidelines may, within certain limits, be made based upon the credit judgment of the Bank’s lending officer. The Bank periodically conducts audits to ensure compliance with its established underwriting policies and procedures.

Loan Originations, Securitizations and Sales – Retained Interest and Servicing Assets.

During fiscal year 2007, the Bank securitized and sold $1.9 billion in residential mortgage loans, compared to $4.2 billion during fiscal 2006. The decrease reflects recent developments in the credit markets and, more specifically, in the mortgage markets, that have resulted in reduced investor demand and less favorable terms and pricing in the capital markets for securitizations and sales of residential mortgage loans. Those developments have led the Bank to modify its operations to deemphasize securitization activities. Outstanding trust certificate balances decreased by 18.9% to $6.9 billion at September 30, 2007. 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 certificates and/or interest-only strips receivable (collectively, “interest-only assets”). The Bank sometimes retains a limited amount of recourse relating to securitized loans through one or more means, most often through the establishment of reserve accounts. The Bank records those interests as assets on its financial statements and determines the carrying value of the assets based on future cash flows expected to be received by the Bank from the underlying assets. Periodically, the Bank obtains independent valuations as confirmation of management’s estimates of its values for interest-only and servicing assets. Most of these cash flows are payable to the Bank before the claims of others, while a small portion are subordinated to those claims. The Bank’s policy is to limit the aggregate amount of mortgage servicing rights and interest-only assets arising out of the securitization and sale of certain of the Bank’s ARMs to 75% of the Bank’s core capital. At September 30, 2007, those assets totaled 44% of the Bank’s core capital. The tables below summarize the carrying value of these assets at September 30, 2007 and 2006.

	September 30, 2007
	Not		Subordinated		Total
	(in thousands)
Interest-only certificates	$	277,715	$	—	$	277,715
Interest-only strips receivable		36,396		—		36,396
Total interest-only assets		314,111		—		314,111
Servicing assets		155,680		—		155,680
Reserve accounts		2,982		—		2,982
Total	$	472,773	$	—	$	472,773
	September 30, 2006
	Not		Subordinated		Total
	(in thousands)
Interest-only certificates	$	294,597	$	—	$	294,597
Interest-only strips receivable		49,595		125		49,720
Total interest-only assets		344,192		125		344,317
Servicing assets		168,059		—		168,059
Reserve accounts		17,960		2,540		20,500
Total	$	530,211	$	2,665	$	532,876

The Bank serviced loans owned by others amounting to $13.1 billion and $13.7 billion at September 30, 2007 and 2006, respectively. Primarily as a result of using a higher discount rate to value its servicing assets and interest-only assets, the Bank reduced the carrying value of its servicing assets and interest-only assets by $8.5 million during fiscal 2007. During fiscal year 2006, the Bank reduced the carrying value of its servicing assets and interest-only assets by $90.0 million, primarily as a result of higher actual prepayments and an increase in estimated future prepayments of loans underlying those assets. Historical experience has shown that prepayment speeds on adjustable rate loans are generally correlated to the steepness of the slope of the yield curve, that is, the difference between short-term interest rates on the one hand, which determine interest rates on the adjustable rate mortgages generated by the Bank, and long-term interest rates on the other hand, which determine the interest rates on mortgages with interest rates fixed for longer periods. The steeper the yield curve, the less likely the loan will prepay. The flatter or more inverted the yield curve, the less attractive adjustable rate loans

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are to consumers and prepayments tend to increase. In addition, as prepayment penalty periods expire, buyers are more likely to prepay their loans. For further information concerning the Bank’s loan servicing rights and loan securitization transactions, see Notes 16 and 17 to the Consolidated Financial Statements in this report.

The Bank’s securitization transactions contain provisions that allow it to purchase the remaining assets and terminate the transaction when the remaining balance of the certificates reaches a specified percentage of the original balance (which is often referred to as a “clean up call”). During 2007, the Bank purchased $329.4 million in loans from six transactions that reached their clean up call. Management anticipates that two transactions will reach that threshold during fiscal 2008 and, if the Bank exercises its option, the Bank will purchase loans with aggregate values of approximately $200 million. To the extent the loans meet the eligibility criteria for future securitization transactions, subsequent to purchase they may be included in the pool from which loans are selected for securitization.

Loan Servicing.Effective with the adoption of SFAS 156 on October 1, 2006, the Bank’s servicing assets are carried at fair value with changes in fair value recognized in earnings. The Bank estimates fair value using either third party market prices or discounted cash flow analysis using market-based assumptions for servicing fee income, servicing costs, prepayment rates, default rates and discount rates. The primary variables used in the computation of the fair value are prepayment speeds and a discount rate.

If actual prepayment or default rates significantly exceed the estimates used to calculate the value of the servicing assets, the actual future cash flow could be less than expected and the value of the servicing assets, as well as the Bank’s earnings, could decline. No assurance can be given that underlying loans will not experience significant increases in prepayment or default rates or that the Bank may not have to write down the value of its servicing assets. See Notes 3 and 16 to the Consolidated Financial Statements in this report.

The Bank receives income through servicing of loans and fees in connection with loan origination, loan modification, late payments, prepayments, changes of property ownership and miscellaneous services related to its loans. Servicing income, earned on single-family residential mortgage loans owned by third parties is a source of substantial earnings for the Bank. Income from these activities varies with the volume and type of loans originated and sold.

The following table sets forth certain information relating to the Bank’s servicing portfolio and servicing income as of or for the years indicated.

	As of or for the Year Ended September 30,
	2007		2006		2005
	(in thousands)
Residential	$	13,127,925	$	13,666,622	$	13,445,665
Home equity		3,408		4,758		7,244
Automobile		—		—		27,494
Total amount of loans serviced for others(1)	$	13,131,333	$	13,671,380	$	13,480,403
Servicing and securitization income	$	90,363	$	94,623	$	150,739

⁽¹⁾ The carrying value of the Bank’s servicing assets and interest-only strips receivable at September 30, 2007, 2006 and 2005 was $469.8 million, $512.4 million and $512.8 million, respectively.

The Bank’s level of servicing and securitization income varies based in large part on the amount of the Bank’s securitization activities with respect to these loan types and with changes in prepayment speeds on the underlying loans. As the Bank securitizes and sells assets, acquires servicing assets either through origination or purchase, or sells mortgage loans and retains the servicing rights on those loans, the level of servicing and securitization income generally increases. During fiscal year 2007, the Bank securitized and sold $1.9 billion of loan receivables through new securitization trusts compared to $4.2 billion during fiscal year 2006. Gains recognized from these securitizations historically have represented a significant portion of the Bank’s earnings. However, as a result of recent market conditions, the Bank has been unable to securitize assets on sufficiently favorable terms and has modified its operations to deemphasize securitization activities. See “Recent Developments” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations—Other Income.”

Interest-Only Strips Receivable.Interest-only strips receivable are carried at fair value. The Bank estimates fair value by computing the present value of estimated future cash flows to be generated by the underlying loans. The carrying value is adjusted and the adjustment is recognized as a gain or loss in the statement of operations in the period the change occurs. The primary variables used in the computation of the present value are loan prepayment speeds and a discount rate.

If actual prepayments significantly exceed the estimates used to calculate the values of the interest-only strips receivable, the future cash flow could be less than expected and the value of the interest-only strips receivable, as well as the Bank’s earnings, could decline. See Notes 3 and 17 to the Consolidated Financial Statements in this report.

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Reserve Accounts.Reserve accounts represent assets of the Bank which have been pledged to certain securitization trusts and which may be subordinated to the interests of the investors in those trusts. The Bank carries these assets at their estimated fair value, which is equal to the net present value of the future cash flows expected to be received from these assets.

Delinquencies, Foreclosures and Allowances for Losses

Delinquencies and Foreclosures.When a borrower fails to make a required payment on a mortgage loan, the loan is considered delinquent and, after expiration of the applicable cure period, the borrower is charged a late fee. The Bank follows practices customary in the banking industry in attempting to cure delinquencies and in pursuing remedies upon default. Generally, if the borrower does not cure the delinquency within 90 days, the Bank initiates foreclosure action. If the loan is not reinstated, paid in full or refinanced, the security property is sold. In some instances, the Bank may be the purchaser. Thereafter, the acquired property is treated as real estate acquired in settlement of loans until it is sold. Deficiency judgments generally may be enforced against borrowers in Maryland, Virginia and the District of Columbia, but may not be available or may be subject to limitation in other jurisdictions in which loans are originated by the Bank.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Asset Quality – Delinquent Loans” for a discussion of the Bank’s delinquent loan portfolio at September 30, 2007.

Allowance for Losses.The allowance for loan losses represents management’s estimate of credit losses inherent in the Bank’s loan portfolios as of the balance sheet date. The Bank’s methodology for assessing the appropriate level of the 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, delinquent status, current economic conditions, internal risk ratings and current underwriting policies and procedures.

The allocated allowance is estimated for both homogeneous and non-homogeneous loan portfolios. The range is calculated by applying loss and delinquency factors to the outstanding loan balances of these portfolios. Loss factors are based on analyses of the historical performance of each loan category and an assessment of portfolio trends and conditions, as well as specific risk factors impacting the loan portfolios. Each homogeneous portfolio is evaluated collectively. In addition, at September 30, 2007, as part of its review of the adequacy of the allowance, the Bank performed an analysis of the underlying collateral on all single-family loans that are greater than two payments delinquent.

Non-homogeneous type loans, such as commercial loans and non-residential real estate loans, are analyzed and segregated by risk according to the Bank’s internal risk rating system. These loans are reviewed by the Bank’s credit and loan review groups on an individual loan basis to assign a risk rating. Industry loss factors are applied based on the risk rating assigned to the loan. A specific allowance may be assigned to non-homogeneous type loans that have been individually determined to be impaired. Any specific allowance considers available evidence including, as appropriate, the present value of payments expected to be received or, for loans that are solely dependent on collateral for repayment, the estimated fair value of the collateral.

The unallocated allowance is based upon management’s evaluation and judgment of various conditions that are not directly measured in the determination of the allocated and specific allowances. The conditions evaluated in connection with the unallocated allowance may include existing general economic and business conditions affecting the key lending areas of the Bank, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience in particular segments of the portfolio, natural disasters, regulatory examination results and findings of the Bank’s internal credit evaluations.

The allowance for losses is based on current estimates of losses inherent in the portfolio and ultimate losses may vary from current estimates. As adjustments to the allowance become necessary, provisions for losses are reported in operations in the periods they are determined to be necessary.

REO is carried at the lower of cost or fair value, less selling costs. To date, sales of REO, non-residential mortgage loans, commercial loans and loans classified as investments in real estate have resulted in no material additional aggregate loss to the Bank above the amounts already reserved. However, these results do not necessarily assure that the Bank will not suffer losses in the future beyond its level of allowances.

The Bank’s review of its various asset portfolios takes place within the Asset Classification Committee, which meets quarterly. The Asset Classification Committee reviews risk performance trends within the Bank’s loan and REO portfolios and economic trends and conditions which might impact those portfolios. This Committee also reviews the status of individual criticized and classified assets of $500,000 or more and the allowance for loan losses.

The Federal Financial Institutions Examination Council (“FFIEC”), which is composed of the OTS and the other federal banking agencies, has issued guidelines regarding the appropriate levels of general valuation allowances that should be maintained by insured institutions and guidance on the design and implementation of loan loss allowance methodologies and supporting documentation practices. The Bank believes that its levels of general valuation allowances at September 30, 2007, and its procedures, comply with the guidelines.

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The Bank’s assets are subject to review and classification by the OTS upon examination. Based on those examinations, the Bank could be required to establish additional valuation allowances or incur additional charge-offs.

Deposits and Other Sources of Funds

General.Deposits are the primary source of the Bank’s funds for use in lending and for other general business purposes. In addition to deposits, Chevy Chase receives funds from loan repayments and loan sales. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are influenced by general interest rates and money-market conditions. Borrowings may be used to compensate for reductions in normal sources of funds, such as deposit inflows at less than projected levels or deposit outflows, or to support the Bank’s operating or investing activities, or planned growth. In recent years, the Bank has relied to a significant degree on borrowed funds, particularly FHLB advances and repurchase agreements, to fund its planned asset growth. These sources of funding are generally more expensive than traditional core deposits, but provide the Bank with an additional source of funds to grow its asset base.

Deposits.Chevy Chase offers a variety of deposit accounts with a range of interest rates and maturities designed to attract both long-term and short-term deposits. Deposit programs include money market, savings, checking, certificates of deposit, and special programs for retirement accounts.

Chevy Chase attracts deposits through its branch network and advertisements, and offers depositors access to their accounts through more than 1,080 ATMs, including more than 200 ATMs located in grocery stores. These ATMs significantly enhance the Bank’s position as a leading provider of convenient service in its primary market area. The Bank is a member of the “STAR”^®ATM network which offers nationwide access, and the “PLUS”^®ATM network, which offers worldwide access. In addition, the Bank has a partnership agreement with a regional grocery store chain that authorizes the Bank to provide in-store banking centers at potentially all of its Maryland, Virginia, Delaware and Washington, DC area stores. As of September 30, 2007, the Bank operates 54 in-store banking centers as part of this agreement.

The Bank obtains deposits primarily from customers residing in Montgomery and Prince George’s Counties in Maryland and in Northern Virginia. Approximately 62% of the Bank’s deposits at September 30, 2007 were obtained from depositors residing in Maryland, and approximately 26% from depositors residing in Virginia.

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The following table shows the amounts of Chevy Chase’s deposits by type of account at the dates indicated.

Deposit Analysis

(Dollars in thousands)

	September 30,
	2007				2006				2005				2004				2003
	Balance		% of Total		Balance		% of Total		Balance		% of Total		Balance		% of Total		Balance		% of Total
Non-interest bearing checking accounts	$	1,273,687	11.6	%	$	1,316,980	12.6	%	$	1,346,455	13.8	%	$	1,181,722	13.3	%	$	951,844	11.8	%
Interest-bearing checking accounts		2,303,615	21.1			2,313,152	22.2			2,438,147	24.9			2,244,724	25.4			1,951,281	24.0
Money market deposit accounts		2,166,489	19.8			2,403,060	23.0			2,521,949	25.8			2,364,768	26.7			2,321,026	28.7
Savings accounts		1,063,780	9.7			953,663	9.1			1,153,152	11.8			1,214,307	13.7			1,150,444	14.2
Certificate accounts, less than $100		2,479,391	22.6			2,088,368	20.0			1,520,829	15.5			1,238,733	14.0			1,207,728	14.9
Certificate accounts, $100 or more		1,662,615	15.2			1,370,541	13.1			801,236	8.2			610,864	6.9			518,182	6.4
Total deposits	$	10,949,577	100.0	%	$	10,445,764	100.0	%	$	9,781,768	100.0	%	$	8,855,118	100.0	%	$	8,100,505	100.0	%

Average Cost of Deposits

	Year Ended September 30,
	2007		2006		2005
Checking deposits	0.29	%	0.25	%	0.22	%
Money market deposits	2.68	%	2.20	%	1.42	%
Savings deposits	0.67	%	0.41	%	0.28	%
Time deposits	4.74	%	3.94	%	2.59	%
Total deposits	2.72	%	2.03	%	1.19	%

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The range of deposit account products offered by the Bank through its extensive branch and ATM network allows the Bank to be competitive in obtaining funds from its local retail deposit market. At the same time, however, as customers have increasingly responded to changes in interest rates, the Bank has experienced some fluctuations in deposit flows. Chevy Chase’s ability to attract and maintain deposits, and its cost of funds, will continue to be significantly affected by market conditions, competition and its pricing strategy.

The following table sets forth Chevy Chase’s deposit flows during the periods indicated.

	Year Ended September 30,
	2007			2006			2005
	(in thousands)
Deposits to accounts	$	96,168,357		$	83,202,385		$	72,320,724
Withdrawals from accounts		(95,916,756	)		(82,689,839	)		(71,484,397	)
Net increase		251,601			512,546			836,327
Interest credited to accounts		252,212			151,450			90,323
Net increase in deposit balances	$	503,813		$	663,996		$	926,650

Deposit growth may be moderated by the Bank from time to time either to take advantage of lower cost funding alternatives or in response to more modest expectations for loan and other asset growth.

The following table sets forth, by weighted average interest rates, the type and amounts of deposits as of September 30, 2007, which will mature during the fiscal years indicated.

Weighted Average Interest Rates of Deposits

(Dollars in thousands)

	Checking and Money Market Deposit Accounts				Savings Accounts				Certificate Accounts				Total
Maturing During Year Ending September 30,	Amount		Weighted Average Rate		Amount		Weighted Average Rate		Amount		Weighted Average Rate		Amount		Weighted Average Rate
2008	$	5,743,791	1.05	%	$	1,063,780	1.15	%	$	3,791,934	4.87	%	$	10,599,505	2.43	%
2009		—	—			—	—			295,165	4.54			295,165	4.54
2010		—	—			—	—			37,653	4.16			37,653	4.16
2011		—	—			—	—			9,075	4.04			9,075	4.04
2012		—	—			—	—			8,179	3.95			8,179	3.95
Total	$	5,743,791	1.05	%	$	1,063,780	1.15	%	$	4,142,006	4.84	%	$	10,949,577	2.35	%

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The following table summarizes maturities of certificate accounts in amounts of $100,000 or greater as of September 30, 2007.

Year Ending September 30,	Amount		Weighted Average Rate
	(Dollars in thousands)
2008	$	1,539,598	5.13	%
2009		111,698	4.95	%
2010		8,987	4.70	%
2011		1,539	4.31	%
2012		793	4.11	%
Total	$	1,662,615	5.11	%

The following table represents the amounts of deposits by various interest rate categories as of September 30, 2007 maturing during the fiscal years indicated.

Maturities of Deposits by Interest Rates
(In thousands)
	Accounts Maturing During Year Ending September 30,
Interest Rate	2008		2009		2010		2011		2012		Total
Non-interest bearing checking deposits (0%)	$	1,273,687	$	—	$	—	$	—	$	—	$	1,273,687
0.01% to 1.99%		3,799,522		—		—		—		—		3,799,522
2.00% to 2.99%		791,412		3,553		125		—		—		795,090
3.00% to 3.99%		1,343,468		95,299		22,449		5,186		5,063		1,471,465
4.00% to 4.99%		760,533		41,457		6,822		3,392		3,116		815,320
5.00% to 5.99%		2,630,883		154,856		8,257		497		—		2,794,493
Total	$	10,599,505	$	295,165	$	37,653	$	9,075	$	8,179	$	10,949,577

Borrowings.As a member of the FHLB of Atlanta, Chevy Chase may apply for advances on the security of its FHLB stock and certain of its mortgages and other assets, principally securities which are obligations of, or guaranteed by, the United States or its agencies, provided certain standards related to creditworthiness have been met.

Extensions of credit may be obtained pursuant to several different credit programs, each of which has its own rate and range of maturities. Advances must be secured by eligible collateral with a value, as determined by the FHLB of Atlanta, at least equal to 100% of Chevy Chase’s outstanding advances. The Bank had outstanding FHLB advances of $2.0 billion at September 30, 2007.

From time to time the Bank enters into repurchase agreements, which are treated as financings. The Bank sells securities, which are usually mortgage-backed securities and other investment securities, and agrees to buy back the same securities at a specified time, which is generally within one to 90 days. The Bank pays a stated interest rate for the use of the funds for the specified time period. The obligation to repurchase the securities sold is reflected as a liability and the securities underlying the agreements are included in assets in the Consolidated Statements of Financial Condition in this report. These arrangements are, in effect, borrowings by the Bank secured by the securities sold. The Bank had outstanding repurchase agreements of $120.5 million at September 30, 2007.

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The following table sets forth a summary of the repurchase agreements of the Bank as of the dates and for the years indicated.

	September 30,
	2007			2006
	(Dollars in thousands)
Securities sold under repurchase agreements:
Balance at year-end	$	120,507		$	458,307
Average amount outstanding during the year		151,466			232,824
Maximum amount outstanding at any month-end		213,124			458,307
Weighted average interest rate during the year		4.65	%		4.32	%
Weighted average interest rate on year-end balances		3.87	%		5.18	%

In December 2003, the Bank issued $175 million aggregate principal amount of its 2003 Debentures. The OTS approved the inclusion of the 2003 Debentures in the Bank’s regulatory capital.

The Bank may redeem some or all of the 2003 Debentures at any time on or after December 1, 2008 at the following redemption prices plus accrued and unpaid interest:

If redeemed during the 12-month period beginning December 1,	Redemption Price
2008	103.4375	%
2009	102.2917	%
2010	101.1458	%
2011 and thereafter	100.0000	%

Under OTS capital regulations, redemption of the 2003 Debentures prior to their stated maturity requires prior approval of the OTS unless the debentures are redeemed with the proceeds of, or replaced by, a like amount of “a similar or higher quality” capital instrument.

Subsidiaries

OTS regulations generally permit the Bank to make investments in service corporation subsidiaries in an amount not to exceed 3.0% of the Bank’s assets, provided that any investment in excess of 2.0% of assets serves primarily community, inner city or community development purposes. These regulations also permit the Bank to make “conforming loans” to those subsidiaries and joint ventures in an amount not to exceed 50% of the Bank’s regulatory capital. At September 30, 2007, 2.0% and 3.0% of the Bank’s assets was equal to $302.1 million and $453.2 million, respectively, and the Bank had $36.1 million invested in its service corporation subsidiaries.

The Bank may establish operating subsidiaries to engage in any activities in which the Bank may engage directly. There are no regulatory limits on the amount the Bank can invest in operating subsidiaries.

The Bank is required to provide 30 days advance notice to the OTS and to the FDIC before establishing a new subsidiary or conducting a new activity in an existing subsidiary.

The Bank engages in a variety of other activities through its subsidiaries, including those described below.

Real Estate Activities.Manor Investment LLC, a subsidiary of the Bank, invests in real estate projects. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Asset Quality.”

Securities Brokerage Services.Chevy Chase Securities, Inc., is a wholly owned subsidiary of Chevy Chase Financial Services Corporation (“CCFS”), which is a wholly owned direct subsidiary of Chevy Chase. Chevy Chase Securities is a licensed broker-dealer, which sells securities on a retail basis to the general public, including depositors and other customers of the Bank.

Insurance Services.Chevy Chase Insurance Agency, Inc. (“CCIA”), a wholly owned subsidiary of CCFS, is a licensed insurance broker offering a variety of “personal line” property and casualty and life insurance programs to the general public, including depositors and other customers of the Bank. CCIA’s primary programs consist of homeowner and automobile insurance in the property and casualty sector and mortgage and credit life and disability insurance in the life insurance sector.

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Lending Subsidiaries.Chevy Chase engages in significant mortgage lending activities through B.F. Saul Mortgage Company. See “Lending and Leasing Activities.” CFC – Consumer Finance Corporation previously engaged in subprime automobile lending. In November 2000, the Bank stopped the origination of subprime automobile loans. The Bank continues its collection efforts on the existing portfolio.

REIT Subsidiary.Chevy Chase Preferred Capital Corporation invests in real estate loans and issued preferred stock to outside investors, which is included as Tier 1 capital of the Bank.

Investment, Management and Fiduciary Services.The Bank offers investment, management and fiduciary services through two wholly owned subsidiaries: Chevy Chase Trust Company, a licensed fiduciary and registered investment advisor, which serves primarily high net worth individuals, and ASB Capital Management LLC, a registered investment adviser, which serves primarily institutional customers.

Special Purpose Subsidiaries.At September 30, 2007, Chevy Chase Real Estate, LLC, (“CCRE”) a wholly owned subsidiary of Chevy Chase, held 100% of the common stock of six subsidiaries, three of which are active, and a majority of which were formed for the sole purpose of acquiring title to various real estate projects pursuant to foreclosure or deed-in-lieu of foreclosure. The Bank’s aggregate investment in these subsidiaries was $35.2 million at September 30, 2007. CCRE is an operating subsidiary and, therefore, the Bank’s investment in CCRE is not subject to the 3.0% service corporation investment limit discussed above.

Employees

The Bank and its subsidiaries had 4,473 full-time and 695 part-time employees at September 30, 2007. The Bank provides its employees with a comprehensive range of employee benefit programs, including group health benefits, life insurance, disability insurance, paid sick leave, certain free deposit services and certain loan discounts. None of the Bank’s employees is represented by a collective bargaining agreement. The Bank believes that its employee relations are good.

Competition

Chevy Chase encounters strong competition both in attracting deposits and making loans in its markets. The Bank’s most direct competition for deposits comes from other thrifts, commercial banks and credit unions, as well as from money market funds and corporate and government securities. In addition to offering competitive interest rates, Chevy Chase offers a variety of services, convenient ATM locations and convenient office locations and business hours to attract deposits. Competition for real estate and other loans comes principally from other thrifts, banks, mortgage banking companies, insurance companies and other institutional lenders. Chevy Chase competes for loans through interest rates, loan fees and the variety and quality of products and services provided to borrowers and brokers.

The Bank’s major competition comes from local, regional, national and international financial institutions and other providers of financial services. The GLB Act amended federal law to permit broader affiliations among commercial banks, securities firms, insurance companies, and other financial services providers, and these and other developments have led to increasing consolidation among providers of financial services. The Bank competes with numerous depository institutions in its deposit-taking activities in the Washington, DC and Baltimore, Maryland metropolitan areas. The Bank also competes with these institutions in the origination of single-family residential mortgage loans and home equity credit line loans.

According to the most recently published industry statistics, at June 30, 2007, Chevy Chase had the fifth largest market share, with approximately 9.5% of deposits, in the Washington DC metropolitan area. At that same date, the Bank had the largest market share, with approximately 25.1% of deposits, in Montgomery County, Maryland, ranked third in market share, with approximately 13.9% of deposits, in Prince George’s County, Maryland and ranked fifth in market share, with approximately 6.5% of deposits in Fairfax County, Virginia, excluding single branch institutions. Based on publicly available information, Chevy Chase estimates that, in the Washington, DC metropolitan area, it is one of the leaders in market share of single-family residential mortgage and home equity credit line loans.

Federal Taxation

Savings institutions, such as the Bank, generally are taxed in the same manner as other corporations. There are, however, several special rules that apply principally to savings institutions and, in some cases, other financial institutions. Certain significant aspects of the federal income taxation of the Bank are discussed below:

General.The Bank and its subsidiaries are included in the consolidated federal income tax return filed by the Trust on a fiscal year basis. Each member of an affiliated group of corporations which files consolidated income tax returns is liable for the group’s federal income tax liability.

Consolidated Tax Returns; Tax Sharing Payments.Generally, the operations of the Trust have generated net operating losses and the Bank’s taxable income generally has been sufficient to fully utilize the losses of the Trust. Under the terms of a tax sharing agreement dated June 28, 1990, as amended, the Bank is obligated to make payments to the Trust based on its taxable income, as explained more fully below.

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The tax sharing agreement generally provides that each member of the Trust’s affiliated group is required to pay the Trust an amount equal to 100% of the tax liability that the member would have been required to pay to the IRS if the member had filed on a separate return basis. These amounts generally must be paid even if the affiliated group has no overall tax liability or the group’s tax liability is less than the sum of those amounts. Under the tax sharing agreement, the Trust, in turn, is obligated to pay to the appropriate tax authorities the overall tax liability, if any, of the group. In addition, to the extent the net operating losses or tax credits of a particular member reduce the overall tax liability of the group, the Trust is required to reimburse that member on a dollar-for-dollar basis, thereby compensating the member for the group’s use of its net operating losses or tax credits. Under the tax sharing agreement, the Bank and its subsidiaries are treated as a single member of the Trust’s affiliated group.

The Bank made net tax sharing payments to the Trust totaling $4.0 million in fiscal year 2007. At September 30, 2007 and 2006, the estimated net tax sharing payment payable to the Trust by the Bank was $1.8 million and $4.7 million, respectively.

In general, if the Bank has net operating losses or unused tax credits in any taxable year, under the tax sharing agreement the Trust is obligated to reimburse the Bank in an amount generally equal to (1) the tax benefit to the group of using those tax losses or unused tax credits in the group’s consolidated federal income tax return for that year, plus (2) to the extent those losses or credits are not used by the group in that year, the amount of the tax refunds which the Bank would otherwise have been able to claim if it were not included in the consolidated federal income tax return of the group, but not in excess of the net amount paid by the Bank to the Trust pursuant to the tax sharing agreement. There is no assurance that the Trust would be able to fulfill this obligation. If the Trust did not make the reimbursement, the OTS could attempt to characterize the nonpayment as an extension of credit by the Bank to the Trust which, as described above under “Holding Company Regulation,” is prohibited under current law. The tax sharing agreement itself does not provide for any specific remedies upon a breach by any party of its obligations under the agreement.

The Bank, as a member of an affiliated group of corporations filing consolidated income tax returns, is liable under the Internal Revenue Code for the group’s tax liability. Although the Bank would be entitled to reimbursement under the tax sharing agreement for income tax paid with respect to the income of other members of the affiliated group, there can be no assurance that the Trust or other members would be able to fulfill this obligation.

State Taxation

Many states, most significantly Maryland, do not allow the filing of combined or consolidated income tax returns, and thus the Trust and its subsidiaries, which includes the Bank and its subsidiaries, that are subject to income taxes in those states are required to file separately. The Trust and its subsidiaries are also subject to income taxes in certain other states, some of which allow or require combined or consolidated filings.

Item 1A. RISK FACTORS

The following discussion sets forth some of the more important risk factors that could affect our business, financial condition and results of operations. However, other factors besides those discussed below or elsewhere in this or other of our reports also could adversely affect our business, financial condition and results of operations.

Risks Relating to Our Banking Business

The current turmoil in the mortgage markets could continue to adversely affect the Bank’s business and operations.

Developments in the residential mortgage and capital markets affect the Bank and its operations. For example, the Bank uses the capital markets for securitizations and/or sales of its residential mortgage loans, which generate earnings, provide a significant source of liquidity, reduce credit risk, and facilitate regulatory capital compliance.

Recent developments in the broader credit markets and, more specifically, in the mortgage markets have resulted in reduced investor demand and less favorable terms and pricing in the capital markets for securitizations and sales of residential mortgage loans. As a result, the Bank did not securitize assets during the last quarter of its 2007 fiscal year, and is unable to predict if or when it will be able to do so in the future. Under these conditions, the Bank will be required to retain in its portfolio a greater portion of its residential mortgage production than it has historically. While the Bank believes its capital and liquidity positions are currently adequate to meet foreseeable needs, a prolonged period of capital market instability could force the Bank to further curtail mortgage production which could adversely affect future earnings.

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

Deteriorating conditions in the U.S. housing market during recent periods have resulted in increased balances of non-accrual loans and increased levels of losses reported by owners of mortgage loans. The combination of lower volumes of home sales transactions, longer marketing periods, growing inventories of unsold homes and increased foreclosure rates has exerted downward pressure on housing prices in many parts of the country, including markets such as the Washington, DC area, California, and Florida in which the Bank has a significant concentration of its residential mortgage loans. As a result, home price appreciation rates have declined in many markets and property values have declined in certain markets. Faced with these conditions, and increases in their monthly payments due to interest

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rate or other adjustments to their loans, some borrowers have been unable to either refinance or sell their properties and consequently have defaulted on their loans. In addition, as lenders tighten underwriting guidelines for loan products offered and adjust loan pricing to reflect market conditions, refinancing is made more difficult. If market conditions in the U.S. housing market continue to deteriorate, the Bank’s financial results could be further adversely impacted.

The Bank’s operating results and financial condition may be adversely affected by interest rate changes and other market conditions.

Changes in interest rates affect the Bank’s financial performance in various ways. The Bank’s operating results depend to a large extent on its net interest income, which is the difference between the interest the Bank receives from its loans, securities and other assets and the interest the Bank pays on its deposits and other liabilities. Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. If interest rates decrease, the Bank’s net interest income likely would decrease because interest earned on its loans, mortgages, and other investment securities would decrease more quickly than interest that it pays on interest-bearing liabilities, such as deposits and borrowings. Declines in market interest rates also may result in increased prepayments of loans as borrowers are able to refinance their loans at lower interest rates. Higher than anticipated prepayments could negatively affect the Bank’s financial condition and results of operations.

The Bank’s recent emphasis on shorter-term adjustable-rate loans and core deposits generally results in increased net interest income when market interest rates rise. However, rising market interest rates can adversely affect its operations in other ways, such as by reducing demand for loans, increasing defaults by borrowers who are unable to make the higher loan payments or adversely affecting the marketability and value of the real estate and other collateral securing its loans.

Changes in interest rates and other market conditions, and the relationship between short- and long-term interest rates, also can affect the value of the Bank’s loans and other interest-sensitive assets, including interests the Bank retains in its securitization transactions, mortgage and non-mortgage servicing rights, and its ability to realize gains on the sale and securitization of assets. For example, at September 30, 2007, the Bank’s assets included $155.7 million in loan servicing assets and $314.1 million in interest only assets, the value of which is based on market interest rates and depends on the accuracy of its various assumptions concerning items such as prepayment rates, credit losses and interest rates. If actual results differ from the Bank’s assumptions, the value of those assets, as well as its earnings, could be adversely affected. For example, primarily because short-term interest rates have remained close to or at times even higher than long-term rates in recent periods, prepayments of the Bank’s adjustable rate mortgage loans have been higher than it anticipated and the Bank recorded write downs in the value of its interest only assets of $8.9 million during the 2007 fiscal year and $88.3 million during the 2006 fiscal year. The Bank’s ability to originate adjustable rate mortgage loans also suffers when short-term interest rates are similar to or higher than longer-term rates.

For further discussion of interest rate risk considerations, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Asset and Liability Management” elsewhere in this Form 10-K.

The Bank’s “payment option” and “interest-only” mortgage loans subject it to additional risks.

Approximately 25.8% of the Bank’s assets consist of adjustable rate mortgage loans that permit borrowers to defer payment of principal and/or interest. During fiscal year 2007, the Bank originated $5.9 billion of mortgage loans, of which $3.8 billion contained terms that permit negative amortization. These features, coupled with the adjustable interest rates on these loans, can cause borrowers’ payments to increase substantially. In the absence of offsetting factors, such as higher wages, those increased payments could result in higher defaults and require increases in the Bank’s allowance for loan losses. If all borrowers choose to pay only the minimum payment, approximately 600 loans with aggregate outstanding balances of $323.8 million, would reach their payment recast ceiling during fiscal year 2008 (assuming LIBOR rates remain unchanged from levels at November 10, 2007) and, as a result, the payment amount would increase to a fully amortizing payment. The potential for significant increases in the payments required to be made by these borrowers, coupled with the relative complexity of these products when compared to traditional mortgage loans, could subject the Bank to increased litigation and reputation risk, particularly in an environment of rising interest rates and declining property values. These loans also can result, under certain circumstances, in the Bank’s recognition as interest income, payments that have not yet been made by the borrowers (i.e. negative amortization), which may lead to future losses if the borrowers ultimately fail to make those payments. At September 30, 2007, cumulative uncollected deferred interest totaled $93.3 million.

In addition, many of these loans were originated under Bank policies that did not require independent verification of the borrower’s income. Although the Bank imposed other requirements, such as lower maximum loan-to-value ratios, designed to reduce the risk associated with these loans, these loans are inherently more risky than comparable loans for which full documentation and verification was required. In response to recent market conditions, the Bank has recently tightened its policies with respect to income verification. However, there can be no assurances that the Bank will not suffer proportionately greater losses on these types of loans already in its portfolio.

These types of ARMs also have been subject to increasing regulatory and legislative scrutiny, which could impact the Bank’s ability to offer these products on terms or under conditions as favorable to it as it has experienced in the past.

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For a further discussion of these lending activities, refer to “Business— Lending and Leasing Activities – Single Family Residential Real Estate Lending” elsewhere in this Form 10-K.

The Bank has historically depended on asset securitizations for additional liquidity and for other purposes, and the success of these transactions depends on its ability to correctly predict prepayment rates. In addition, the Bank’s ability to access the securitization markets is dependent upon market conditions, and it cannot predict whether and when market conditions will improve.

In the Bank’s securitization transactions, it typically recognize gain on the sale and a related retained interest in a securitized pool of loans that it sells (sometimes through another entity that it establishes) to a special purpose vehicle, typically a trust, which, in turn, sells securities backed by interests in the pool. The value of the retained interest that the Bank recognizes depends on several assumptions regarding the future performance of the securitized pool. The value of its retained interest may increase or decrease materially if actual prepayment rates differ from its original assumptions or if market interest rates change. As a result, the Bank’s financial condition has been and may continue to be adversely affected by its inability to make accurate assumptions regarding the future performance of a securitized pool.

As a result of recent market conditions, the Bank did not access the securitization markets, and it has had to adjust its operations to reduce its reliance on securitizations. The Bank’s ability to access the asset-backed securitization markets in the future depends on several factors, including:

• its ability to originate additional loans for securitization and sale;

• conditions in the securities markets, generally;

• conditions in the asset-backed securitization markets;

• its ability to obtain third-party credit enhancement;

• its ability to adequately service the securitized loans; and

• the absence of any material downgrading or withdrawal of ratings given to securities previously issued in its securitizations.

If the Bank is not able to reduce its reliance on asset securitizations and it is not able to access the securitization markets, its financial condition and results of operations could be adversely affected.

The Bank is highly regulated and failure to satisfy constantly evolving requirements, including minimum regulatory capital ratios, could adversely affect its business and operations.

As a federal savings bank, the Bank is subject to extensive and frequently changing legislative, regulatory and accounting requirements. Many of these requirements place restrictions on its operations. In addition, failure to comply with these requirements can subject it to regulatory enforcement actions, including monetary penalties, and can hurt its reputation with its existing and potential customers.

The requirement to meet minimum regulatory capital ratios is particularly important to the Bank’s operations. The Bank’s capital ratios at September 30, 2007 satisfied the regulatory requirements and were sufficient to meet the standards for classification as a “well capitalized” institution, the highest of five categories under the OTS’s “prompt corrective action” regulations. For further information about the Bank’s regulatory capital levels, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition –Capital” elsewhere in this Form10-K.

The Bank’s ability to maintain its regulatory capital at appropriate levels depends on many factors, including general economic conditions, discretion of its regulators and the performance of its loan and lease portfolios. Also, the Bank has historically relied on preferred stock and subordinated debt as significant components of its regulatory capital. Those instruments require significant fixed payments to holders, which increase its expenses and make it more difficult for is to generate additional core capital through retained earnings. In addition, the Bank is a privately held company and as a result it may not be able to access the capital markets as easily and on terms as favorable as if we were a public company.

Failure to meet these capital requirements can subject the Bank to a series of regulatory actions that generally become more severe as its capital levels decline. Those actions can include restricting the Bank’s payment of dividends, limiting its asset growth, restricting its activities, requiring it to raise additional capital, restricting payments on its subordinated debt or, if its “tangible capital” level is reduced below 2%, placing it into conservatorship or receivership.

For further information about the Bank’s regulatory capital requirements, including potential changes to those requirements, refer to “Business – Regulation – Regulatory Capital” elsewhere in this Form 10-K.

Recent reform of the federal deposit insurance system will increase the Bank’s cost of FDIC insurance in future years. For further information about the Bank’s FDIC insurance premiums, refer to “Business – Regulation – Deposit Insurance Premiums” in this report.

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The Bank operates in a highly competitive environment, which could adversely impact its ability to attract and retain customers, as well as the pricing of its loans, deposits and other products, causing it to lose market share, deposits and revenues.

The Bank is subject to intense competition from various financial institutions and from non-bank entities that engage in similar activities without being subject to the same regulatory supervision and restrictions. In making loans, the Bank competes with traditional banking institutions as well as consumer finance companies, leasing companies and other non-bank lenders. Loan pricing and credit standards are under competitive pressure as lenders seek to deploy capital and a broader range of borrowers have access to other sources of funding.

Traditional deposit activities are subject to pricing pressures and customer migration as a result of intense competition for consumer investment dollars. The Bank competes for deposits with other commercial banks, savings banks, savings and loan associations, credit unions, insurance companies, and issuers of commercial paper and other securities, including mutual funds.

Many of the Bank’s competitors are substantially larger and have substantially more resources than it.

For further information about the Bank’s competitive environment, please see “Business—Competition” in this report.

A substantial amount of the Bank’s revenue is derived from non-interest income, which can be less predictable than net interest income.

In recent years, non-interest income, which is reflected as “Other Income” on the consolidated statements of operations, has been an important source of the Bank’s revenues. The Bank has earned non-interest income primarily from loan servicing and deposit servicing fees, gains on securitizations or sales of loans and mortgage-backed securities, and automobile rental income. For the fiscal years ended September 30, 2007, 2006 and 2005, the Bank recognized non-interest income of approximately $370.8 million, $392.6 million and $440.2 million, respectively. The Bank’s ability to generate non-interest income depends upon market interest rates, consumer preferences, the demand for mortgage and other loans and leases, conditions in the loan sale market, the level of securitized receivables and other factors, many of which are beyond its control. The amount of this income, therefore, can fluctuate substantially. This can be a particular problem for the Bank because of its relatively high proportion of fixed costs such as the payments required on our preferred stock and subordinated debt. A significant decrease in the Bank’s non-interest income could adversely affect its results of operations and financial condition.

If the Bank’s allowance for losses is not sufficient to absorb losses in its loan and real estate portfolios, it will adversely affect the Bank’s financial condition and results of operations.

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

The Bank’s business is concentrated in the metropolitan Washington, DC area and would be negatively impacted by an economic downturn in the local economy.

The Bank’s principal deposit and lending market is concentrated in the metropolitan Washington, DC area. Accordingly, a disproportionate economic downturn in the local economy would have a greater negative impact on the Bank’s overall financial performance than on the overall financial performance of larger financial institutions whose borrowers and real estate portfolios are more geographically diverse. In addition, a significant percentage of the Bank’s mortgage loans are secured by properties in California, and as a result it is subject to risks relating to the California markets.

Risks Relating to Our Real Estate Business

If we do not receive dividends and tax sharing payments from the Bank over an extended period our business and financial condition could be adversely affected.

To meet our cash needs, we rely, in part, on dividends paid on the common stock of the Bank, of which we own 80%, and payments made by the Bank under the tax sharing agreement. The availability and amount of tax sharing payments and/or dividends in the future depends primarily on:

• The Bank’s operating performance and income, which may be adversely affected by the risk factors under “Risks Relating to Our Banking Business”;

• restrictions imposed by the Bank’s regulators, including the fact that the regulators may not permit the Bank to pay dividends if it does not remain “well capitalized”;

• restrictions on the Bank’s ability to pay dividends imposed by the indentures for its outstanding subordinated debt; and

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• in the case of tax sharing payments, the continued consolidation of the Bank and its subsidiaries with the Real Estate Trust for federal income tax purposes.

If the Bank does not pay sufficient dividends or make sufficient payments under the tax sharing agreement, we may need to raise funds from other sources. In fiscal 2007 and 2006, the Bank paid us $16.0 million and $32.0 million, respectively, in dividends and $4.0 million and $2.0 million, respectively, in tax sharing payments.

The Real Estate Trust has historically experienced losses, before taking into account asset sales, which could adversely affect our business and financial condition.

Historically, we have had operating losses before accounting for gains from the sale of properties and before the consolidation of the Bank into our financial statements. For fiscal 2007 and 2006, the loss from continuing operations was $2.5 million and $2.0 million, respectively. If we continue to operate at a loss and we do not receive dividends and tax sharing payments from the Bank or funds from other sources, our business and financial condition could be adversely affected.

Historically, the fixed expenses of our real estate operations have been greater than our earnings generated by our real estate operations available to pay those expenses, which could adversely affect our business and financial condition.

During the past five fiscal years, we had sufficient funds available to pay our required interest, debt and ground rent expenses. On a consolidated basis, our total available earnings exceeded our fixed charges by $94.5 million, $125.0 million, $172.0 million, $185.3 million and $122.3 million in fiscal years 2007, 2006, 2005, 2004 and 2003, respectively. However, the fixed charges of our real estate operations exceeded the earnings generated by our real estate operations for four of our last five fiscal years. We cannot assure that, in future fiscal years, the revenues generated by our real estate operations will exceed the fixed charges of our real estate operations. As a result, during four of the past five fiscal years the Real Estate Trust depended on other sources of financing, including the receipt of dividends and tax sharing payments from the Bank to pay its fixed charges, including payment of principal and interest on the notes. Excluding the dividend and tax sharing payments from the Bank, the Real Estate Trust’s fixed charges would have exceeded its available earnings by $900,000, $2.3 million, $17.9 million and $8.8 million in fiscal years 2007, 2005, 2004 and 2003, respectively. If the Real Estate Trust is unable to fund any future shortfall between available earnings and required payments with payments from the Bank or from other sources, our business and financial condition could be adversely affected.

Many real estate costs are fixed, even if income from our properties decreases.

Many of our operating expenses and almost all of our debt service payments associated with the operation of our income-producing properties are fixed, while the income generated from these properties can significantly fluctuate, for example by reductions in occupancy and rental rates. In addition, the operating expenses of income-producing properties can increase due to inflation, increases in real estate taxes and other general economic factors or governmental actions outside our control. As a result, our ability to pay the fixed costs with cash flow produced by our income-producing properties is highly dependent on our ability to maintain or increase rental income and hotel sales revenue.

Adverse trends in the hotel industry may affect some of our properties.

A number of our properties are hotels. The success of these properties depends largely on the property operators’ ability to adapt to dominant trends in the hotel industry, including greater competitive pressures, increased consolidation, industry overbuilding, dependence on business and consumer spending patterns and changing demographics, the introduction of new concepts and products, the availability of labor, price levels and general economic conditions. The success of a particular hotel chain, the ability of a hotel chain to fulfill any obligations to operators of its business, and trends in the hotel industry may affect our results of operations.

Our performance is subject to general risks associated with the real estate industry.

Our economic performance is subject to the risk that if our properties do not generate revenues sufficient to meet our operating expenses, including debt service and capital expenditures, our cash flow and ability to pay our fixed costs will be adversely affected. We are susceptible to the following real estate industry risks:

• economic downturns in the areas where our properties are located;

• adverse changes in local real estate market conditions, such as oversupply or reduction in demand;

• changes in tenant preferences that reduce the attractiveness of our properties to tenants;

• zoning or regulatory restrictions;

• decreases in market rental rates;

• decreased demand by the general public for the services of the businesses located in our properties, which could, for example, reduce the income we receive from hotel properties, as advance bookings represent only a small portion of overall revenues and can be cancelled;

• costs associated with the need to periodically repair, renovate and re-lease space; and

• increases in the cost of adequate maintenance, insurance and other operating costs, including real estate taxes, associated with one or more properties, which may occur even when circumstances such as market factors and competition cause a reduction in revenues from one or more properties, although real estate taxes typically do not increase upon a reduction in such revenues.

40

Our development activities are inherently risky.

The ground-up development of improvements on real property, as opposed to the renovation and redevelopment of existing improvements, presents substantial risks. If our development projects are not successful, it may adversely affect our financial condition and results of operations.

In addition to the risks associated with real estate investment in general as described elsewhere, the risks associated with our development activities include:

• Significant time lag between commencement and completion subjects us to greater risks due to fluctuation in the general economy;

• Failure or inability to obtain construction or permanent financing on favorable terms;

• Expenditure of money and time on projected rental rates or anticipated pace of lease-up;

• Higher-than-estimated construction costs, including labor and material costs; and

• Possible delay in completion of the project because of a number of factors, including weather, labor disruptions, construction delays or delays in receipt of zoning or other regulatory approvals, or acts of God (such as fires, earthquakes or floods).

We may be unable to sell properties when appropriate because real estate investments are illiquid.

Real estate investments, including ours, tend to be relatively illiquid, meaning that they can not be sold quickly for cash. This lack of liquidity limits our ability to promptly change the types of properties we own in response to changes in economic, demographic, social, financial and investment conditions. Our inability to respond quickly to adverse changes in the performance of our investments could have an adverse effect on our operations and ability to service our fixed costs.

The amount of debt we have and the restrictions imposed by that debt could adversely affect our business and financial condition.

As of September 30, 2007, we had approximately $579.6 million of mortgage debt outstanding, secured by the majority of our operating properties, $250.0 million of notes secured by our investment in the Bank and $14.0 million in line of credit borrowings secured by our investments in Saul Centers and Saul Holdings.

The amount of our debt outstanding from time to time could have important consequences to our operations. For example, it could:

• require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing funds available for operations, property acquisitions and other appropriate business opportunities that may arise in the future;

• limit our ability to obtain any additional financing we may need in the future for working capital, debt refinancing, capital expenditures, acquisitions, development or other general corporate purposes;

• make it difficult to satisfy our debt service requirements;

• limit our ability to make distributions on our outstanding common and preferred stock;

• require us to dedicate increased amounts of our cash flow from operations to payments on our variable rate, unhedged debt, if applicable, if interest rates rise;

• limit our flexibility in planning for, or reacting to, changes in our business and the factors that affect the profitability of our business, which may place us at a disadvantage compared to competitors with less debt or debt with less restrictive terms; and

• limit our ability to obtain any additional financing we may need in the future for working capital, debt refinancing, capital expenditures, acquisitions, development or other general corporate purposes.

Our ability to make scheduled payments of the principal of, to pay interest on, or to refinance, our indebtedness will depend primarily on our future performance, which to a certain extent is subject to economic, financial, competitive and other factors described in this section. If we are unable to generate sufficient cash flow from our business in the future to service our debt or meet our other cash needs, we may be required to refinance all or a portion of our existing debt, sell assets or obtain additional financing to meet our debt obligations and other cash needs. Our ability to refinance, sell assets or obtain additional financing may not be possible on terms that we would find acceptable.

We are obligated to comply with financial and other covenants in our debt that could restrict our operating activities, and the failure to comply could result in defaults that accelerate the payment under our debt.

Our secured debt generally contains customary covenants, including, among others, provisions:

• relating to the maintenance of the property securing the debt;

• relating to the implementation of lockboxes or change in management if debt service coverage ratios are not met;

• restricting our ability to assign or further encumber the properties securing the debt; and

• restricting our ability to enter into certain new leases or to amend or modify certain existing leases without obtaining consent of the lenders.

Our ability to meet some of the covenants in our debt, including covenants related to the condition of the property or payment of real estate taxes, may be dependent on the performance by our tenants under their leases.

In addition, our line of credit requires us to satisfy financial covenants. The material financial covenant requires us, on a consolidated basis, to:

• limit the amount of debt so that interest expense coverage is not less than 1.15 to 1 on a trailing four quarter basis;

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As of September 30, 2007, we were in compliance with all such covenants. If we were to breach any of our debt covenants and did not cure the breach within any applicable cure period, our lenders could require us to repay the debt immediately, and, if the debt is secured, could immediately begin proceedings to take possession of the property securing the loan. Some of our debt arrangements are cross-defaulted, which means that the lenders under those debt arrangements can put us in default and require immediate repayment of their debt if we breach and fail to cure a covenant under certain of our other debt obligations. As a result, any default under our debt covenants could have an adverse effect on our financial condition, our results of operations and our ability to meet our obligations.

Environmental laws and regulations could reduce the value or profitability of our properties.

All real property and the operations conducted on real property are subject to federal, state and local laws, ordinances and regulations relating to hazardous materials, environmental protection and human health and safety. Under various federal, state and local laws, ordinances and regulations, we and our tenants may be required to investigate and clean up certain hazardous or toxic substances released on or in properties we own or operate, and also may be required to pay other costs relating to hazardous or toxic substances. This liability may be imposed without regard to whether we or our tenants knew about the release of these types of substances or were responsible for their release. The presence of contamination or the failure properly to remediate contamination at any of our properties may adversely affect our ability to sell or lease those properties or to borrow using those properties as collateral. The costs or liabilities could exceed the value of the affected real estate. We are not aware of any environmental condition with respect to any of our properties that management believes would have a material adverse effect on our business, assets or results of operations taken as a whole. The uses of any of our properties prior to our acquisition of the property and the building materials used at the property are among the property-specific factors that will affect how the environmental laws are applied to our properties. If we are subject to any material environmental liabilities, the liabilities could adversely affect our results of operations and our ability to meet our obligations.

We cannot predict what other environmental legislation or regulations will be enacted in the future, how existing or future laws or regulations will be administered or interpreted or what environmental conditions may be found to exist on the properties in the future. Compliance with existing and new laws and regulations may require us or our tenants to spend funds to remedy environmental problems. Our tenants, like many of their competitors, have incurred, and will continue to incur, capital and operating expenditures and other costs associated with complying with these laws and regulations, which will adversely affect their potential profitability.

Generally, our tenants must comply with environmental laws and meet remediation requirements. Our leases typically impose obligations on our tenants to indemnify us from any compliance costs we may incur as a result of the environmental conditions on the property caused by the tenant. If a lease does not require compliance or if a tenant fails to or cannot comply, we could be forced to pay these costs. If not addressed, environmental conditions could impair our ability to sell or re-lease the affected properties in the future or result in lower sales prices or rent payments.

Our insurance coverage on our properties may be inadequate.

We carry comprehensive insurance on all of our properties, including insurance for liability, fire, flood and rental loss. We also carry environmental insurance on most of our properties. These environmental policies contain coverage limitations. We believe this coverage is of the type and amount customarily obtained for or by an owner of real property assets. We intend to obtain similar insurance coverage on subsequently acquired properties.

In recent years the availability of insurance coverage has decreased and the prices for insurance have increased. As a result, we may be unable to renew or duplicate our current insurance coverage in adequate amounts or at reasonable prices. In addition, insurance companies may no longer offer coverage against certain types of losses, such as losses due to terrorist acts and toxic mold, or, if offered, the expense of obtaining these types of insurance may not be justified. We therefore may cease to have insurance coverage against certain types of losses and/or there may be decreases in the limits of insurance available. If an uninsured loss or a loss in excess of our insured limits occurs, we could lose all or a portion of the capital we have invested in a property, as well as the anticipated future revenue from the property, but still remain obligated for any mortgage debt or other financial obligations related to the property. We cannot guarantee that material losses in excess of insurance proceeds will not occur in the future. If any of our properties were to experience a catastrophic loss, it could seriously disrupt our operations, delay revenue and result in large expenses to repair or rebuild the property. Also, due to inflation, changes in codes and ordinances, environmental considerations and other factors, it may not be feasible to use insurance proceeds to replace a building after it has been damaged or destroyed. Events such as these could adversely affect our results of operations and our ability to meet our obligations.

The homebuilding industry is significantly affected by changes in general and local economic conditions, real estate markets and weather conditions, which could affect our ability to build homes at prices our customers are willing or able to pay, could reduce profits that may not be recaptured and could result in cancellation of sales contracts.

The Real Estate Trust is currently developing a 107 unit townhome development in the metropolitan Atlanta, Georgia market. As of December 14, 2007, 32 of the 107 units have been sold. Although market conditions in the housing industry were strong in recent years, the market has significantly slowed in 2006 and 2007 in our market, as new contracts have declined and cancellation rates have increased. The homebuilding industry is cyclical, has from time to time experienced significant difficulties and is significantly affected by changes in general and local economic conditions such as:

• employment levels and job growth;

• availability of financing for home buyers;

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• interest rates;

• costs of raw materials and labor;

• consumer confidence;

• housing demand; and

• population growth.

We may be required to make payments to the Bank.

If, in any fiscal year, the Bank has a net operating loss, we would be required under the tax sharing agreement with the Bank to make payments to the Bank if we or any of our affiliated companies use all or a portion of that loss to offset our taxable income. If the Bank has a net operating loss that is not used by us in that year to offset our taxable income, the Bank can use those losses to obtain a refund from the IRS of taxes paid in previous years or to obtain a refund from us of tax sharing payments paid by the Bank to us, or both, depending on the amount of losses and the taxable year in which they occurred.

As of September 30, 2007, the amount of the tax sharing payments that the Real Estate Trust received from the Bank and that is subject to recapture should the Bank have future tax losses is $7.6 million. In future years, the amount of the tax sharing payments that is subject to recapture will vary based on the actual amounts of taxable income and losses generated by the Real Estate Trust and by the Bank.

In addition, we may, if the Bank’s regulatory capital falls below certain levels, be required to contribute capital to the Bank.

Other Risks

We are controlled by B. Francis Saul II, whose interests may conflict with those of the holders of our secured notes.

B. Francis Saul II, members of his family, and entities controlled by or otherwise affiliated with him, directly or indirectly, own all of the outstanding shares of our common stock. As a result, Mr. Saul exercises significant influence over our affairs, which influence might not be consistent with the interests of some, or a majority, of the holders of our secured notes or the holders of the Bank’s debentures or preferred stock.

ITEM 1B. UNRESOLVED STAFF COMMENTS

The Trust has not received any written comments from the Securities and Exchange Commission staff regarding its periodic or current reports in the 180 days preceding September 30, 2007 that remain unresolved.

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ITEM 2. PROPERTIES

REAL ESTATE

A list of the investment properties of the Real Estate Trust is set forth under “Item 1. Business—Real Estate—Real Estate Investments.”

The Trust conducts its principal business from its executive offices at 7501 Wisconsin Avenue, Suite 1500, Bethesda, Maryland. The Saul Company leases all office facilities on behalf of the Trust.

BANKING

At September 30, 2007, the Bank conducted its business from its home office at 7926 Jones Branch Drive, McLean, Virginia and its executive offices at 7501 Wisconsin Avenue, Bethesda, Maryland; its operations centers at 6151 and 6200 Chevy Chase Drive, and 14601 Sweitzer Lane, Laurel, Maryland; and 284 full-service offices located in Maryland, Virginia, Delaware and the District of Columbia. On that date, the Bank owned the building and land for 47 of its branch offices and leased its remaining 237 branch offices. Chevy Chase leases the office facilities at 7926 Jones Branch Drive, 6200 Chevy Chase Drive and 14601 Sweitzer Lane. Chevy Chase leases office facilities at 1919 M Street, NW, Washington, DC, which previously housed a subsidiary that relocated to the Bank’s executive offices during 2005. Chevy Chase owns the building and leases the land at 7501 Wisconsin Avenue. In addition, the Bank leases office space in which its subsidiaries are housed. The office facility leases have various terms expiring from fiscal years 2008 to 2033 and the ground leases have terms expiring from fiscal years 2029 to 2081. The Bank owns the building and land for its operations center at 6151 Chevy Chase Drive, Laurel, Maryland. The Bank also leases the office facilities at 7735 Old Georgetown Road, Bethesda, Maryland. See Note 20 to the Consolidated Financial Statements in this report for lease expense and commitments, and Management’s Discussion And Analysis—Of Financial Condition And Results Of Operations—Capital” in this report for a discussion of the regulatory treatment of one of the Bank’s office buildings.

At September 30, 2007, the net book value of the Bank’s office facilities, including leasehold improvements, was $353.7 million, net of accumulated depreciation of $165.6 million. The Bank owns additional assets, including furniture and data processing equipment. At September 30, 2007, these other assets had a book value of $291.8 million, net of accumulated depreciation of $179.1 million. The Bank also has operating leases, primarily for certain data processing equipment and software. Those leases have month-to-month or year-to-year terms. See Note 18 to the Consolidated Financial Statements in this report.

The Bank also owns automobiles which are leased to third parties. The leases are accounted for as operating leases with lease payments recognized as rental income. At September 30, 2007, automobiles subject to lease had a book value $7.0 million, net of accumulated depreciation of $9.9 million. See Note 19 to the Consolidated Financial Statements in this report.

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ITEM 3. LEGAL PROCEEDINGS

In the normal course of business, the Real Estate Trust is involved in litigation, which may include disputes with tenants and certain employment claims, and litigation arising from the continued development and marketing of certain of its real estate properties. In the opinion of management, litigation which is currently pending will not have a material adverse impact on the financial condition or future operations of the Trust.

BANKING

During the normal course of business, the Bank is involved in litigation, which may include litigation arising out of its lending activities, the enforcement or defense of the priority of its security interests, the continued development and marketing of certain of its real estate properties and certain employment claims. Although the amounts claimed in some of these suits in which the Bank is a defendant may be material, the Bank denies liability and, in the opinion of management, litigation which is currently pending will not have a material impact on the financial condition or future operations of the Trust.

On January 16, 2007, in the case of Andrews v. Chevy Chase Bank in the U.S. District Court for the Eastern District of Wisconsin, the court ruled that the Bank’s disclosures relating to certain residential mortgage loans violated the federal Truth-in-Lending (“TIL”) Act. The mortgage loans in question have a feature which permits a borrower to elect monthly, for up to five years, to make either (i) a minimum payment based on a payment rate less than the variable interest rate; (ii) a payment equal to all accrued interest; (iii) a fully amortizing payment based on a 15-year term; or (iv) a fully amortizing payment based on the original term of the loan (“five year option ARMs”).

All of the mandated TIL disclosures (APR, Finance Charges and Payment Amounts) were accurate. However, the TIL document provided to Andrews and certain other borrowers (the number of which is unknown at this time) had optional loan tracking nomenclature which inadvertently had been truncated when printed on the form. (The Bank stopped using the optional language at issue in 2005.) The court found that the inadvertently truncated language rendered the correct TIL disclosures capable of misinterpretation and therefore helped create three separate TIL disclosure violations. The court also found that the Bank failed to clearly disclose that “monthly” payments were required, despite language in the disclosures indicating that payment options must be chosen “each month.”

The case was brought by the named plaintiff as a class action on behalf of borrowers of five-year option ARMs for the period April 20, 2004 to the date of class certification who had received the same disclosure documents as the named plaintiff. The court granted class status to those plaintiffs. With respect to a remedy, no actual damages were alleged and the court concluded that the violations did not give rise to statutory damages. However, the court said that the affected borrowers were entitled to be given the option under the TIL Act to rescind their loans.

The rescission remedy is available only for certain loans that are secured by a principal residence but were not used to purchase the residence, principally refinancings. The court further excluded borrowers who had received a different version of the TIL disclosure document than had been received by the Andrews. The precise parameters and members of the class will depend upon further court proceedings.

The Bank has appealed the availability of a class-wide rescission remedy to the U.S. Court of Appeals for the Seventh Circuit, which held oral argument on the matter on September 26, 2007. Several major bank trade associations have filed a brief supporting the Bank’s position. The only two federal courts of appeal that have considered the question have ruled unanimously that a class wide rescission remedy is not available. The question has not yet been addressed by the Seventh Circuit.

The District Court has suspended further proceedings in the case pending a ruling on the Bank’s appeal. However, subsequent to that action, the District Court issued an opinion finding that the filing of the class action lawsuit tolled the running of the three-year rescission period under the Truth in Lending Act. The Bank plans to appeal that ruling, as well as the ruling that the Bank’s disclosures violated the Truth in Lending Act, at the proper time.

Management believes that the resolution of this litigation will not have a material adverse effect on the operations or financial condition of the Bank. However, management recognizes the inherent uncertainties in litigation. If all appeals eventually were resolved adversely to the Bank and the size of the class were ultimately determined to be significant and if a material percentage of the borrowers to whom rescission was offered elected to rescind, the outcome would adversely affect the income of the Bank.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended September 30, 2007.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

There currently is no established public trading market for Common Shares. At December 14, 2007, there were seven corporate holders of record of Common Shares. All holders of Common Shares at such date were affiliated with the Trust. The Trust has no common share equivalents. The Trust declared the following common dividends during fiscal 2007. On January 18, 2007, the Trust declared a dividend on its common shares of $0.248 per share, totaling approximately $1.2 million, payable on January 19, 2007, to holders of record on December 29, 2006. On March 8, 2007, the Trust declared a dividend on its common shares of $0.4362 per share, totaling approximately $2.1 million, payable on March 13, 2007, to holders of record on March 9, 2007. On June 28, 2007, the Trust declared a dividend on its common shares of $0.342 per share, totaling approximately $1.6 million, payable on June 29, 2007, to holders of record on June 22, 2007. On September 20, 2007, the Trust declared a dividend on its common shares of $0.342 per share totaling approximately $1.6 million, payable on September 25, 2007, to holders of record on September 20, 2007. The Trust declared the following common dividends during fiscal 2006. On January 19, 2006, the Trust declared a dividend on its common shares of $0.248 per share, totaling approximately $1.2 million, payable on January 20, 2006, to holders of record on December 30, 2005. On March 9, 2006, the Trust declared a dividend on its common shares of $0.4362 per share, totaling approximately $2.1 million, payable on March 17, 2006, to holders of record on March 10, 2006. On June 22, 2006, the Trust declared a dividend on its common shares of $0.342 per share, totaling approximately $1.6 million, payable on June 23, 2006, to holders of record on June 19, 2006. On September 21, 2006, the Trust declared a dividend on its common shares of $0.342 per share, totaling $1.6 million, payable on September 22, 2006, to holders of record on September 18, 2006. See “Item 12. Security Ownership of Certain Beneficial Owners and Management.”

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data of the Trust herein have been derived from the Consolidated Financial Statements of the Trust. The data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements included elsewhere in this report.

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SELECTED FINANCIAL DATA

	Year Ended September 30,
(In thousands, except per share amounts and other data)	2007			2006			2005			2004			2003
STATEMENT OF OPERATIONS DATA:
Real Estate:
Revenues	$	199,545		$	169,637		$	139,504		$	123,646		$	112,628
Operating expenses		216,117			182,134			155,381			156,851			141,602
Equity in earnings of unconsolidated entities, net		12,540			10,051			8,246			7,788			7,248
Impairment loss on investments		—			—			—			—			(998	)
Gain on sales of property		1,534			416			263			2,769			9,079
Real estate operating loss		(2,498	)		(2,030	)		(7,368	)		(22,648	)		(13,645	)
Banking:
Interest income		826,819			737,346			575,133			443,436			454,680
Interest expense		388,291			318,171			207,193			163,022			205,479
Net interest income		438,528			419,175			367,940			280,414			249,201
(Provision) credit for loan losses		(3,383	)		9,004			11,569			14,522			(18,422	)
Net interest income after (provision) credit for loan losses		435,145			428,179			379,509			294,936			230,779
Other income:
Deposit servicing fees		153,574			144,548			136,279			129,107			122,473
Servicing, securitization and mortgage banking income		145,757			156,438			169,472			213,887			141,029
Automobile rental income		8,309			35,196			81,963			157,034			235,360
Asset management fees		38,927			33,291			18,803			14,857			12,949
Other		24,212			23,103			33,713			22,444			24,901
Total other income		370,779			392,576			440,230			537,329			536,712
Operating expenses		695,120			681,952			630,044			601,050			621,301
Banking operating income		110,804			138,803			189,695			231,215			146,190
Total Company:
Income from continuing operations before income taxes and minority interest		108,306			136,773			182,327			208,567			132,545
Income tax provision		35,435			39,663			59,141			70,480			46,658
Income from continuing operations before minority interest		72,871			97,110			123,186			138,087			85,887
Minority interest held by affiliates		(9,041	)		(13,597	)		(19,516	)		(23,070	)		(13,926	)
Minority interest — other		(29,213	)		(29,141	)		(29,071	)		(37,195	)		(26,160	)
Income from continuing operations		34,617			54,372			74,599			77,822			45,801
Discontinued real estate operations, net of income taxes		—			2,590			(1,001	)		(1,122	)		(811	)
Cumulative effect of change in accounting principle, net of income taxes		—			—			—			—			897
Total company net income	$	34,617		$	56,962		$	73,598		$	76,700		$	45,887
Net income available to common shareholders	$	29,199		$	51,544		$	68,180		$	71,282		$	40,469
Net income (loss) per common share:
Income from continuing operations	$	6.07		$	10.18		$	14.39		$	15.06		$	8.38
Discontinued operations		—			0.54			(0.21	)		(0.23	)		(0.17	)
Cumulative effect of change in accounting principle		—			—			—			—			0.19
Net income per common share (Basic and Diluted)	$	6.07		$	10.72		$	14.18		$	14.83		$	8.40

Continued on following page.

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SELECTED FINANCIAL DATA

(Continued)

	Year Ended September 30,
(In thousands, except per share amounts and other data)	2007			2006			2005			2004			2003
BALANCE SHEET DATA:
Assets:
Real estate assets	$	751,886		$	662,812		$	465,830		$	458,169		$	429,285
Income-producing properties, net (1)		417,853			373,093			270,828			273,360			275,005
Land parcels		43,354			44,582			48,029			41,654			42,425
Construction in progress		83,756			34,946			—			—			—
Banking assets		15,089,063			14,141,121			14,244,961			13,270,847			11,779,440
Total company assets		15,840,949			14,803,933			14,710,791			13,729,016			12,208,725
Liabilities:
Real estate liabilities		923,172			832,379			660,219			676,301			652,856
Mortgage notes payable (1)		579,639			488,339			294,328			311,316			322,437
Notes payable—secured		250,000			250,000			250,000			250,000			203,800
Notes payable—unsecured		—			21,398			57,760			56,428			55,349
Revolving credit facilities		14,000			—			—			—			—
Banking liabilities		14,101,524			13,192,459			13,324,284			12,400,167			11,039,425
Minority interest held by affiliates		138,305			130,529			124,932			114,933			98,062
Minority interest—other		296,013			296,013			296,013			296,013			249,698
Total company liabilities		15,459,014			14,451,380			14,405,448			13,487,414			12,040,041
Shareholders’ equity		381,935			352,553			305,343			241,602			168,684
OTHER DATA (1):
Hotels:
Number of hotels		18			17			17			18			18
Number of guest rooms		3,267			3,110			3,383			3,573			3,574
Average occupancy		71	%		70	%		68	%		66	%		61	%
Average room rate	$	136.54		$	128.88		$	106.81		$	91.67		$	85.93
Office properties:
Number of properties		15			14			14			13			13
Leasable area (square feet)		2,168,056			1,990,147			1,990,147			1,978,016			1,978,016
Leasing percentages		86	%		92	%		91	%		89	%		85	%
Land parcels:
Number of parcels		10			11			12			10			10
Total acreage		370			439			452			381			381

(1) Includes real estate held for sale for fiscal 2005 and earlier.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Trust has prepared its financial statements and other disclosures on a consolidated basis. The term “Trust” used in the text and the financial statements included herein refers to the combined entity, which includes B. F. Saul Real Estate Investment Trust and its subsidiaries, including Chevy Chase and its subsidiaries. The term “Real Estate Trust” refers to B. F. Saul Real Estate Investment Trust and its subsidiaries, excluding Chevy Chase and its 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.”

CRITICAL ACCOUNTING POLICIES

The Trust’s accounting policies are in conformity with accounting principles generally accepted in the United States (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the Trust’s financial statements and the reported amounts of revenue and expenses during the reporting periods. If judgment or interpretation of the facts and circumstances relating to the various transactions had been different, it is possible that different accounting policies would have been applied resulting in a different presentation of the financial statements. Below is a discussion of accounting policies which the Trust considers critical in that they may require judgment in their application or require estimates about matters which are inherently uncertain. Additional discussion of accounting policies which the Trust considers significant, including further discussion of the critical accounting policies described below, can be found in the Notes to the Consolidated Financial Statements.

REAL ESTATE

Real Estate Properties: Income-producing properties are stated at the lower of depreciated cost (except those which were acquired through foreclosure or equivalent proceedings, the carrying amounts of which are based on the lower of cost or fair value at the time of acquisition) or net realizable value. Management believes that these assets have generally appreciated in value and, accordingly, the aggregate current value exceeds their aggregate net book value and also exceeds the value of the Real Estate Trust’s liabilities as reported in these financial statements. Because these financial statements are prepared in conformity with GAAP, they do not report the current value of the Real Estate Trust’s real estate assets. The purchase price of real estate assets is allocated between land, building, in-place acquired leases and other intangibles based on the relative fair values of the components at the date of acquisition. Buildings are depreciated on a straight-line basis over their estimated useful lives of 28 to 50 years. Intangibles associated with acquired leases are amortized over the remaining lease terms.

Long-lived assets and certain identifiable intangibles to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, the Real Estate Trust recognizes an impairment loss. Measurement of an impairment loss for long-lived assets and identifiable intangibles that the Real Estate Trust expects to hold and use is based on the fair value of the asset. Long-lived assets and certain intangibles to be disposed of are generally reported at the lower of carrying amount or fair value less the cost to sell.

Interest, real estate taxes and other carrying costs are capitalized on projects under construction. Once construction is completed and the assets are placed in service, rental income, direct operating expenses, and depreciation associated with such properties are included in current operations. The Real Estate Trust considers a project to be substantially complete and held available for occupancy upon completion of tenant improvements, but no later than one year from the cessation of major construction activity. Substantially completed portions of a project are accounted for as separate projects. Expenditures for repairs and maintenance are charged to operations as incurred.

Depreciation is calculated using the straight-line method and the estimated useful lives of 28 to 50 years for buildings and up to 20 years for certain other improvements. Tenant improvements are amortized on a straight-line basis over the lesser of their estimated useful lives or the term of the related lease.

Income Recognition:The Real Estate Trust derives room and other revenues from the operations of its hotel portfolio. Hotel revenue is recognized as earned. The Real Estate Trust derives rental income under noncancelable long-term leases from tenants at its commercial properties. Commercial property rental income is recognized on a straight-line basis. When rental payments due under leases vary from a straight-line basis because of free rent periods or scheduled rent increases, income is recognized on a straight-line basis throughout the initial term of the lease. Expense recoveries represent a portion of property operating expenses billed to tenants, including common area maintenance, real estate taxes and other recoverable costs. Expense recoveries are recognized in the period when the expenses are incurred. For townhome sales, in accordance with SFAS No. 66, “Accounting for Sales of Real Estate” (“SFAS 66”), revenue is recognized and costs of sales are recorded when each townhome sale is closed and title is conveyed to the buyer, adequate cash payment is received and there is no continued involvement by the Real Estate Trust.

BANKING

General:The Bank’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), which requires the Bank to make certain estimates and assumptions that affect its reported results. See Note 3 to the Consolidated Financial Statements in this report. The Bank has identified four particular policies that, due to estimates and assumptions inherent in those policies, involve a relatively high degree of judgment and complexity.

49

Allowance for Losses:The Bank maintains allowances for possible losses on its loans at levels it believes to be adequate to absorb inherent losses in the loan portfolio at the balance sheet date. Management reviews the adequacy of the allowance for losses using a variety of measures and tools appropriate for the asset type, including historical loss performance, delinquent status, current economic conditions, internal risk ratings, current underwriting policies and practices and market values for similar assets.

Derivative Instruments:The Bank uses a variety of derivative financial instruments in order to mitigate its exposure to changes in market interest rates. To mitigate the risk that the value of fixed rate mortgage loans held for sale will change as interest rates change, the Bank generally enters into mortgage-backed security forward sales contracts. In addition, the Bank issues commitments to make fixed-rate mortgage loans in which the customer “locks in” the interest rate before closing on the loan. These interest rate locks are treated as derivative instruments in the financial statements. All derivative instruments are recorded on the balance sheet at their fair value, which generally represents the amount of money the Bank would receive or pay if the item were sold or bought in a current transaction. Fair market values are based on market quotes when they are available. If market quotes are not available, fair values are based on market or dealer prices of similar items or discounted cash flows using market estimates of interest rates, prepayment speeds and other assumptions.

When determining the extent to which interest rate exposures should be hedged, the Bank makes certain estimates and judgments relating to, among other things, the probability that the interest-rate lock will become a loan, the timing of the loan closing and the timing of the subsequent sale of the loan transaction. To the extent that the actual results are different from the Bank’s assumptions, the hedging strategy may not be effective in offsetting the changes in the values of the hedged items, and the Bank’s earnings may decline.

Interest-Only Strips Receivable and Certificates:The Bank sells loans and retains an interest-only strip receivable or receives an interest-only certificate related to the sold loans. The interest-only assets are initially recorded by allocating the previous carrying value of the assets involved in the transactions between the assets sold and the interests retained, including the interest-only strips receivable. Subsequently, the interest-only assets are carried at their estimated fair values, with changes in fair value reflected in income. Fair value of these interest-only assets is based on discounted expected future cash flows, which are determined using various assumptions, the most significant of which are discount rates and prepayment speeds. The Bank also engages independent firms with expertise in this area to evaluate these assets and determine a range of fair values. If actual prepayment or default rates significantly exceed the estimates, the actual amount of future cash flow could be less than the expected amount and the value of the interest-only assets, as well as the Bank’s earnings, could decline. The Bank did not have any credit enhancing interest-only strips receivables at September 30, 2007 or 2006.

Mortgage Servicing Rights (“MSR”):The Bank sells mortgage loans and retains the right to service those loans. Also, the Bank has purchased the right to service mortgage loans originated by third parties. Effective with the adoption of SFAS 156, on October 1, 2006, the Bank’s MSRs are carried at fair value. Fair value of MSR is based on discounted expected future income, net of related expenses, to be generated by servicing the underlying loans. When determining fair value, the Bank uses several assumptions, the most significant of which are the estimated rate of repayment of the underlying loans and a discount rate. The Bank also engages independent firms with expertise in this area to evaluate these assets and determine a range of fair values. If actual repayment rates significantly exceed the estimates, the actual amount of future cash flow could be less than the expected amount and the value of the MSR, as well as the Bank’s earnings, could decline.

The Bank believes that the judgments, estimates and assumptions used in the preparation of the Consolidated Financial Statements are appropriate given the factual circumstances at the time. However, given the sensitivity of the Consolidated Financial Statements to these items, the use of other judgments, estimates and assumptions, as well as differences between actual results and the estimates and assumptions, could result in material differences in the Bank’s results of operations and financial condition.

FINANCIAL CONDITION

REAL ESTATE

The Real Estate Trust’s investment portfolio at September 30, 2007, consisted primarily of hotels, office and industrial projects, and land parcels. At September 30, 2007, the Real Estate Trust’s hotel portfolio, which includes the 158 room hotel in Northern Virginia which was placed into service upon completion of construction on January 8, 2007, is comprised of 18 properties containing 3,267 available rooms. The office and industrial property portfolio consisted of 15 properties with a total gross leasable area of 2,168,000 square feet. . On March 29, 2007 the Real Estate Trust completed the purchase, from the Bank, of an approximately 178,000 square foot office building located in Bethesda, Maryland. The square footage of the building is included in the Real Estate Trust’s gross leasable area. See “Item 1. Business — Real Estate — Real Estate Investments.”

The hotel portfolio, excluding the property acquired in March 2006 and the newly constructed property placed in service in January 2007, (“Same hotel properties”) experienced an average occupancy of 71.2% and an average room rate of $121.90 during fiscal 2007, compared to an average occupancy of 70.6% and an average room rate of $122.92 during the prior fiscal year. REVPAR (revenue per available room) for the same hotel properties was $86.83 for fiscal 2007, flat compared to REVPAR for fiscal 2006 of $86.82.

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In fiscal 2007, the Real Estate Trust’s hotel portfolio experienced a slight increase in occupancy which was offset by a slight decrease in average room rates resulting in relatively flat REVPAR for the period when compared to fiscal 2006.

The Real Estate Trust’s office and industrial property portfolio, excluding the property purchased on March 29, 2007, which is 100% leased (“Same office properties”) was 85.0% leased at September 30, 2007, compared to a leasing rate of 92.0% at September 30, 2006. The majority of the decrease in occupancy was caused by the March 31, 2007 lease expiration of a 100,207 square foot tenant that was the sole occupant of one of the Real Estate Trust’s industrial buildings located in Northern Virginia. Rental revenue was received from this tenant through the end of their lease term. The Real Estate Trust signed a lease for 100% of this space with a single tenant in October 2007 with rent commencing later in fiscal 2008. At September 30, 2007, of the total gross leasable area of 2,168,000 square feet, 260,767 square feet (12.0%) and 316,461 square feet (14.6%) were subject to leases expiring in fiscal 2008 and fiscal 2009, respectively. Expiring leases, by property, are detailed in Part I, Item I of this Form 10-K. The Real Estate Trust is actively marketing all expiring space, both through possible renewals or new tenants.

BANKING

General.The Bank’s assets increased by $947.9 million to $15.1 billion during fiscal year 2007. The Bank recorded operating income of $110.8 million during fiscal year 2007, compared to operating income of $138.8 million during fiscal year 2006. The decrease in operating income was primarily attributable to increases in salaries and employee benefits expense, a decrease in servicing, securitization and mortgage banking income, an increase in provision for loan losses, and decreased automobile rental income as a result of the Bank’s prior decision to exit that business. Partially offsetting these items were increases in net interest income and a decrease in depreciation and amortization. See “Results of Operations.”

During fiscal year 2007, the Bank securitized and sold $1.9 billion of loans and recognized gains of $48.6 million. During fiscal year 2006, the Bank securitized and sold $4.2 billion of loans and recognized gains of $112.6 million. Recent developments in the broader credit markets and, more specifically, in the mortgage markets have resulted in reduced investor demand and less favorable terms for securitizations and sales of residential mortgage loans. As a result, the Bank did not securitize and sell any loans during the quarter ended September 30, 2007.

At September 30, 2007, the Bank’s tangible, core, tier 1 risk-based and total risk-based regulatory capital ratios were 5.97%, 5.97%, 8.85% and 10.85%, respectively. The Bank’s capital ratios exceeded regulatory requirements as well as the standards established for well-capitalized institutions under OTS prompt corrective action regulations. See “Capital.”

During fiscal year 2007, the Bank declared and paid, out of the retained earnings of the Bank, cash dividends on its Common Stock in the aggregate amount of $2,000 per share.

The Bank’s assets are subject to review and classification by the OTS upon examination. The OTS concluded its most recent safety and soundness examination of the Bank in October 2007.

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Asset Quality.Non-Performing Assets. The Bank’s overall level of non-performing assets increased during fiscal year 2007 due primarily to increased levels of non-accrual residential mortgage loans and higher levels of REO due to increased foreclosures of residential mortgage properties and development expenditures on one project. The following table sets forth information concerning the Bank’s non-performing assets at the dates indicated. The figures shown are after charge-offs and, in the case of real estate acquired in settlement of loans, after all valuation allowances.

Non-Performing Assets

(Dollars in thousands)

	September 30,
	2007			2006			2005			2004			2003
Non-performing assets:
Non-accrual loans:
Residential mortgage	$	76,675		$	27,352		$	20,874		$	8,993		$	6,567
Home equity		5,559			1,858			1,443			1,767			1,480
Other real estate		3,972			1,481			—			—			1,004
Total non-accrual real estate loans		86,206			30,691			22,317			10,760			9,051
Commercial		571			13			30			242			249
Subprime automobile		—			14			375			1,164			4,372
Prime automobile		211			505			768			1,069			1,484
Other consumer		126			202			216			472			444
Total non-accrual loans (1)		87,114			31,425			23,706			13,707			15,600
Real estate acquired in settlement of loans, net		48,443			32,310			20,265			20,357			21,820
Total non-performing assets	$	135,557		$	63,735		$	43,971		$	34,064		$	37,420
Troubled debt restructurings	$	—		$	—		$	—		$	—		$	—
Allowance for losses on loans	$	29,000		$	25,000		$	28,640		$	37,750		$	58,397
Allowance for losses on real estate held for investment		—			—			—			202			202
Total allowances for losses	$	29,000		$	25,000		$	28,640		$	37,952		$	58,599
Interest income recorded on:
Non-accrual assets	$	2,690		$	1,488		$	449		$	180		$	39
Restructured loans	$	—		$	—		$	—		$	—		$	—
Interest income that would have been recorded had non performing and restructured loans been current in accordance with their original terms:
Non-accrual assets	$	4,578		$	1,801		$	1,034		$	1,206		$	2,098
Restructured loans	$	—		$	—		$	—		$	—		$	—
Ratios:
Non-performing assets to total assets		0.90	%		0.45	%		0.31	%		0.26	%		0.32	%
Allowance for losses on real estate loans to non-accrual real estate loans (1)		19.28	%		36.33	%		47.48	%		91.02	%		75.65	%
Allowance for losses on loans to non-accrual loans (1)		33.29	%		79.55	%		120.81	%		275.41	%		374.34	%
Allowance for losses on loans to total loans receivable (2)		0.24	%		0.24	%		0.26	%		0.36	%		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.

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Non-performing assets include non-accrual loans and REO, acquired either through foreclosure or deed-in-lieu of foreclosure, or pursuant to in-substance foreclosure. Non-accrual loans consist of loans contractually past due 90 days or more or with respect to which other factors indicate that full payment of principal and interest is unlikely.

Non-performing assets totaled $135.6 million at September 30, 2007, compared to $63.7 million, at September 30, 2006. The Bank maintained valuation allowances of $29.0 million and $25.0 million on its loan portfolio at September 30, 2007 and 2006, respectively. The $71.8 million increase in non-performing assets reflected a net increase in non-accrual loans of $55.7 million coupled with an increase in REO of $16.1 million.

Non-accrual Loans. The Bank’s non-accrual loans totaled $87.1 million at September 30, 2007, an increase from $31.4 million at September 30, 2006. At September 30, 2007, non-accrual loans consisted of $86.2 million of non-accrual real estate loans and $0.9 million of non-accrual prime automobile, commercial and other consumer loans compared to non-accrual real estate loans of $30.7 million and non-accrual prime automobile, subprime automobile, commercial and other consumer loans of $0.7 million at September 30, 2006.

Non-performing assets and delinquencies (discussed below) related to residential mortgage and home equity loans have increased due to continued softening in the housing market. Non-performing assets and delinquencies may increase in future periods as interest rates and required payments adjust on payment-option and interest-only loans in the Bank’s portfolio. In addition, stricter underwriting standards and weakening property values have made refinancing more difficult.

REO. At September 30, 2007, the Bank’s REO totaled $48.4 million compared to $32.3 million at September 30, 2006. The increase in REO during the year is a result of increasing foreclosures and development expenditures in one large property designed to facilitate its eventual sale. Lower volumes of sales transactions, longer marketing periods, growing inventories of unsold homes and increased foreclosure rates continue to exert downward pressure on home prices in many parts of the country. In addition, stricter underwriting guidelines for loan products has made refinancing more difficult for many borrowers.

The Bank continues to monitor closely its major non-performing and potential problem assets in light of current and anticipated market conditions. The Bank’s asset workout group focuses its efforts on resolving these problem assets as expeditiously as possible.

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. Potential problem assets totaled $4.1 million and $4.0 million, at September 30, 2007 and 2006, respectively.

The Bank’s Watch List Committee meets quarterly and reviews all commercial lending relationships which are rated vulnerable, criticized or classified and have commitments of $1.0 million or greater. This committee reviews the current status of each relationship, recent changes, performance against the corrective action plan presented at the prior meeting, and the current action plan for the relationship.

Delinquent Loans. At September 30, 2007, delinquent loans totaled $90.3 million, or 0.8% of loans, compared to $42.9 million, or 0.4% of loans, at September 30, 2006. The following table sets forth information regarding the Bank’s delinquent loans at September 30, 2007.

	Principal Balance (Dollars in thousands) Loans Delinquent for
	30-59 days			60-89 days			Total
Residential Mortgage	$	52,927		$	17,682		$	70,609
Home Equity		1,624			3,028			4,652
Other Real Estate		9,863			1,584			11,447
Commercial		325			—			325
Consumer		2,444			846			3,290
Total	$	67,183		$	23,140		$	90,323
Total as a Percentage of Loans(1)		0.6	%		0.2	%		0.8	%

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

Total residential mortgage loans delinquent 30-89 days increased to $70.6 million at September 30, 2007 from $23.8 million at September 30, 2006, primarily due to deterioration in the United States housing market conditions as discussed above.

Total delinquent consumer loans decreased to $3.3 million at September 30, 2007, from $5.1 million at September 30, 2006, primarily as a result of the Bank’s prior decision to discontinue origination of indirect consumer loans.

Troubled Debt Restructurings. A troubled debt restructuring occurs when the Bank agrees to modify significant terms of a loan in favor of a borrower experiencing financial difficulties. The Bank had no troubled debt restructurings at September 30, 2007 and 2006.

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Deferred Interest. Most of the Bank’s payment option residential mortgage loans have a payment option that could result in interest being added to the principal of the loan, or “negative amortization.” See “BUSINESS—Lending and Leasing Activities—Single-Family Residential Real Estate Lending (Excluding Home Equity Lending)” in this report. During fiscal year 2007, the Bank recognized $93.4 of interest income when borrowers made payments less than the amount of interest accrued, some of which was subsequently paid. As of September 30, 2007 and 2006, cumulative net deferred interest, which is included in loans receivable, totaled $93.3 million and $32.8 million, respectively.

The following table summarizes deferred interest activity:

	Year Ended September 30, 2007
	(Dollars in thousands)
Balance at beginning of year	$	32,797
Additions		93,405
Sales		(11,528	)
Repayments		(2,054	)
Payoffs		(19,300	)
Balance at end of year	$	93,320

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Allowances for Losses. The following tables show loss experience by asset type and the components of the allowance for losses on loans and the allowance for losses on real estate held for investment or sale. These tables reflect charge-offs taken against assets during the years indicated and may include charge-offs taken against assets, which the Bank disposed of during such years.

Analysis of Allowance for and Charge-offs of Loans

(Dollars in thousands)

	Year Ended September 30,
	2007			2006			2005			2004			2003
Balance at beginning of year	$	25,000		$	28,640		$	37,750		$	58,397		$	66,079
Provision (credit) for loan losses		3,383			(9,004	)		(11,569	)		(14,522	)		18,422
Charge-offs:
Residential mortgage		(3,194	)		(880	)		(752	)		(279	)		(273	)
Home equity		(1,990	)		(365	)		(818	)		(786	)		(759	)
Commercial		—			(26	)		(720	)		—			(382	)
Automobile		(920	)		(3,834	)		(9,934	)		(22,292	)		(39,296	)
Other consumer		(1,483	)		(1,444	)		(2,298	)		(3,201	)		(4,247	)
Total charge-offs		(7,587	)		(6,549	)		(14,522	)		(26,558	)		(44,957	)
Recoveries:
Home equity		135			260			321			340			248
Commercial		564			192			317			—			14
Automobile		6,129			9,421			13,778			18,374			17,251
Other consumer		1,376			2,040			2,565			1,719			1,340
Total recoveries		8,204			11,913			16,981			20,433			18,853
Net (charge-offs) recoveries		617			5,364			2,459			(6,125	)		(26,104	)
Balance at end of year	$	29,000		$	25,000		$	28,640		$	37,750		$	58,397
Provision (credit) for loan losses to average loans (1)		0.03	%		(0.08	)%		(0.10	)%		(0.14	)%		0.22	%
Net loan charge-offs (recoveries) to average loans (1)		(0.01	)%		(0.05	)%		(0.02	)%		0.06	%		0.31	%
Ending allowance for losses on loans to total loans (1) (2)		0.24	%		0.24	%		0.26	%		0.36	%		0.65	%

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

(2) Before deduction of allowance for losses.

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During the year ended September 30, 2007, the Bank foreclosed on 41 residential mortgage properties and 20 home equity properties and charged-off $3.2 million and $2.0 million of mortgage loans and home equity loans, respectively. During fiscal year 2006, the Bank foreclosed on 17 residential mortgage properties and three home equity properties and charged-off $0.9 million and $0.4 million of mortgage loans and home equity loans, respectively.

Components of Allowance for Losses on Loans by Type

(Dollars in thousands)

	September 30,
	2007				2006				2005				2004				2003
	Amount		Percent of Loans to Total Loans		Amount		Percent of Loans to Total Loans		Amount		Percent of Loans to Total Loans		Amount		Percent of Loans to Total Loans		Amount		Percent of Loans to Total Loans
Balance at end of year allocated to:
Residential mortgage	$	11,000	70.1	%	$	5,085	67.7	%	$	5,100	68.9	%	$	4,275	68.6	%	$	2,161	64.7	%
Home equity		3,400	13.5			3,095	16.1			3,570	16.4			3,350	16.5			2,426	15.0
Other real estate		2,223	6.9			2,969	5.8			1,925	3.3			2,169	2.5			2,260	2.8
Commercial		2,827	8.0			6,371	9.4			6,775	9.5			7,361	8.8			14,400	10.0
Automobile		950	1.1			2,470	0.6			3,610	1.4			10,320	2.9			23,013	6.6
Other consumer		1,500	0.4			1,225	0.4			2,005	0.5			3,415	0.7			3,069	0.9
Unallocated		7,100	—			3,785	—			5,655	—			6,860	—��			11,068	—
Total	$	29,000			$	25,000			$	28,640			$	37,750			$	58,397

The Bank’s total allowances for losses on loans increased to $29.0 million at September 30, 2007, from $25.0 million at September 30, 2006. Management reviews the delinquent status of loans, current economic conditions, internal risk ratings of loans and current underwriting policies and procedures. Using this analysis, management computes its estimate of the allowance for losses on loans.

The allowance for losses on loans secured by real estate totaled $16.6 million at September 30, 2007, a $5.5 million increase from the September 30, 2006 level of $11.1 million. The allowance represented 19.3% and 36.3% of the amount of non-performing real estate loans at September 30, 2007 and 2006, respectively. Management performed an analysis of the underlying collateral values for all loans that were greater than two payments delinquent at September 30, 2007. As a result, management increased the allowance for losses on mortgage loans to $11.0 million at September 30, 2007 from $5.1 million at September 30, 2006.

The allowance for losses on commercial loans decreased to $2.8 million at September 30, 2007, from $6.4 million at September 30, 2006. The reduction reflects the low level of losses historically experienced on this portfolio.

The allowance for losses on other consumer loans, including automobile, home improvement, overdraft lines of credit and other consumer loans, decreased to $2.5 million at September 30, 2007 from $3.7 million at September 30, 2006. The decrease in the allowance for prime automobile loans was a result of the Bank’s prior decision to discontinue origination of indirect automobile loans.

The unallocated allowance for losses increased to $7.1 million at September 30, 2007 from $3.8 million at September 30, 2006, reflecting the current uncertainty in the mortgage markets. The unallocated allowance is based upon management’s evaluation and judgment of various conditions that are not directly measured in the determination of the allocated and specific allowances. 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 values, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience in particular segments of the portfolio, natural disasters, regulatory examination results and findings of the Bank’s internal credit evaluations. At September 30, 2007 and 2006, most of the unallocated allowance related to risks inherent in the mortgage loan portfolio, including, for example, geographic concentration and negative amortization features.

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Asset and Liability Management.A key element of banking is the monitoring and management of liquidity risk and interest-rate risk. The process of planning and controlling asset and liability mix, volume and maturity to stabilize the net interest spread is referred to as asset and liability management. The objective of asset and liability management is to maximize the net interest yield within the constraints imposed by prudent lending and investing practices, liquidity needs and capital planning.

The Bank’s assets and liabilities are inherently sensitive to changes in interest rates. These movements can result in variations to the overall level of income and market value of equity. Based on the characteristic of a specific asset or liability (including maturity, repricing frequency and interest rate caps), a change in interest rates can significantly affect the contribution to net income by, and market value of, the instrument. If, in the aggregate, the Bank’s assets mature or reprice more quickly or to a greater extent than its liabilities, the Bank is termed “asset sensitive” and will tend to experience an increase in interest income and market value during periods of rising interest rates and declining interest income and market value during periods of falling interest rates. Conversely, if the Bank’s liabilities mature or reprice more quickly or to a greater extent than its assets, the Bank is considered to be “liability sensitive” and will tend to experience a decrease in interest income and market value during periods of rising interest rates and increased interest income and market value during periods of falling interest rates.

The Bank pursues an asset-liability management strategy designed both to control risk from changes in market interest rates and to maximize interest income in its investment and loan portfolios. To achieve this strategy, the Bank emphasizes the origination and retention of a mix of both adjustable-rate and fixed-rate loan products.

Throughout fiscal year 2007, the Bank continued to originate and hold in its portfolio adjustable-rate loan products at a greater volume than those with fixed interest rates. At September 30, 2007, adjustable-rate loans accounted for 80.3% of total loans, compared to 81.5% at September 30, 2006.

A traditional measure of interest-rate risk within the banking industry is the interest sensitivity “gap,” which is the sum of all interest-earning assets minus all interest-bearing liabilities subject to repricing within the same period. Gap analysis is a tool used by management to evaluate interest-rate risk which results from the difference between repricing and maturity characteristics of the Bank’s assets and those of the liabilities that fund them. By analyzing these differences, management can attempt to estimate how changes in interest rates may affect the Bank’s future net interest income. The Bank views control over interest rate sensitivity as a key element in its financial planning process and monitors interest rate sensitivity through its forecasting system. The Bank manages interest rate exposure and will narrow or widen its gap depending on its perception of interest rate movements and the composition of its balance sheet.

A number of asset and liability management strategies are available to the Bank in structuring its balance sheet. These include selling or retaining certain portions of the Bank’s current residential mortgage loan production; altering the Bank’s pricing on certain deposit products to emphasize particular maturity categories; altering the type and maturity of securities acquired for the Bank’s investment portfolio when replacing securities following normal portfolio maturation and turnover; lengthening or shortening the maturity or repricing terms for any current period asset securitizations; and altering the maturity or interest rate reset profile of borrowed funds, if any, including funds borrowed from the FHLB of Atlanta.

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The following table presents the Bank’s interest rate sensitivity gap at September 30, 2007. Balances of interest-earning assets and interest-bearing liabilities are shown in the earlier of the period where contractual payments are due, interest rates adjust or prepayment is anticipated to occur. Adjustable and floating rate loans are included in the period in which their interest rates are next scheduled to adjust, and prepayment rates are assumed for all of the Bank’s loans based on management’s estimates. The Bank’s deposits with no stated maturity, including savings and transaction accounts, have interest rates that may reprice at any time. However, market experience has proven that these deposits adjust to market prices over a much longer period of time. The Bank considers these deposits to be relatively insensitive to interest rate changes. The table contains information of the Bank only and does not include consolidation or elimination entries required for the Trust’s financial presentation.

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 September 30, 2007
Real estate loans:
Adjustable-rate	$	5,567,871		$	683,231		$	1,777,328		$	650,862		$	173			8,679,465
Fixed-rate		25,485			31,640			37,543			45,046			4,200			143,914
Home equity credit lines and second mortgages		1,204,071			144,395			154,334			116,706			115,339			1,734,845
Commercial		702,500			21,228			87,585			62,701			60,844			934,858
Consumer and other		57,934			33,414			55,051			23,135			4,174			173,708
Loans held for securitization and/or sale		202,268			—			—			—			—			202,268
Mortgage-backed securities		340,698			137,164			484,227			89,378			1,966			1,053,433
Other investments		138,248			—			210,363			—			—			348,611
Total interest-earning assets		8,239,075			1,051,072			2,806,431			987,828			186,696			13,271,102
Total non-interest earning assets		—			—			—			—			1,817,961			1,817,961
Total assets	$	8,239,075		$	1,051,072		$	2,806,431		$	987,828		$	2,004,657		$	15,089,063
Deposits:
Fixed maturity deposits	$	3,128,068		$	663,922		$	332,761		$	17,255		$	—		$	4,142,006
Checking and savings accounts		—			73,418			146,835			146,835			3,002,160			3,369,248
Money market deposit accounts		2,166,489			—			—			—			—			2,166,489
Borrowings:
Capital notes—subordinated		—			—			—			—			175,000			175,000
Other		2,264,644			107,536			109,665			14,571			74,756			2,571,172
Total interest-bearing liabilities		7,559,201			844,876			589,261			178,661			3,251,916			12,423,915
Total non-interest bearing liabilities		—			—			—			—			1,677,609			1,677,609
Minority interest		—			—			—			—			175,391			175,391
Stockholders’ equity		—			—			—			—			812,148			812,148
Total liabilities & stockholders’ equity	$	7,559,201		$	844,876		$	589,261		$	178,661		$	5,917,064		$	15,089,063
Gap	$	679,874		$	206,196		$	2,217,170		$	809,167		$	(3,065,220	)
Cumulative gap	$	679,874		$	886,070		$	3,103,240		$	3,912,407		$	847,187
Cumulative gap as a percentage of total assets		4.5	%		5.9	%		20.5	%		25.9	%		5.6	%

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The Bank’s one-year gap, as a percentage of total assets, was 5.9% at September 30, 2007, compared to 2.0% at September 30, 2006.

In addition to gap measurements, the Bank measures and manages interest-rate risk with the extensive use of computer simulation. This simulation includes calculations of Market Value of Portfolio Equity and Net Interest Margin. The Bank established limits on the sensitivity of its net interest income and net portfolio value (“NPV”) to parallel changes in interest rates. Parallel changes in interest rates are defined as instantaneous and sustained movements of interest rates in 100 basis point increments. The Bank calculates its ratio of NPV to the present value of total assets (“NPV Ratio”) for each interest rate shock scenario. The following table shows the estimated impact of parallel shifts in interest rates at September 30, 2007.

(Dollars in thousands)
(Basis Points) Change in Interest Rates	Changes in Net Interest Income (1)					Change in Net Portfolio Value(2)					NPV Ratio
	Percent		Amount			Percent		Amount
+200	2.4	%	$	11,905		(16.2	)%	$	(259,575	)	8.7	%
+100	1.7	%		8,670		(6.3	)%		(100,384	)	9.6	%
-100	(1.3	)%		(6,237	)	9.0	%		144,039		11.0	%
-200	(0.1	)%	$	(338	)	11.9	%		190,048		11.2	%

⁽¹⁾ Represents the difference between net interest income for 12 months in a stable interest rate environment and the various interest rate scenarios.

⁽²⁾ Represents the difference between net portfolio value (NPV) of the Bank’s equity in a stable interest rate environment and the NPV in the various rate scenarios. NPV is defined as the present value of expected net cash flows from existing assets minus the present value of expected net cash flows from existing liabilities plus the present value of expected net cash flows from existing off-balance sheet contracts.

Computations of prospective effects of hypothetical interest rate changes are based on many assumptions, including relative levels of market interest rates, prepayments and deposit runoff and, therefore, should not be relied upon as indicative of actual results. Certain limitations are inherent in these computations. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react at different times and in different degrees to changes in the market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgage loans, may have features which restrict interest rate changes on a short-term basis and over the life of the asset. In the event of a change in market interest rates, loan prepayments and early deposit withdrawal levels could deviate significantly from those assumed in making the calculations set forth above. Additionally, credit risk may increase if an interest rate increase adversely affects the ability of borrowers to service their debt.

Inflation.The impact of inflation on the Bank is different from the impact on an industrial company because substantially all of the assets and liabilities of the Bank are monetary in nature. The most direct impact of an extended period of inflation would be to increase interest rates and to place upward pressure on the operating expenses of the Bank. However, the actual effect of inflation on the net interest income of the Bank would depend on the extent to which the Bank was able to maintain a spread between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, which would depend to a significant extent on its asset-liability sensitivity. The effect of inflation on the Bank’s results of operations for the past three fiscal years has been minimal.

Deferred Taxes.At September 30, 2007, the Bank recorded a net deferred tax liability of $6.9 million, which generally represents the cumulative excess of the Bank’s income tax expense for financial reporting purposes over its actual income tax liability. See Note 35 to the Consolidated Financial Statements in this report.

Capital.At September 30, 2007, the Bank was in compliance with all of its regulatory capital requirements, and its capital ratios exceeded the ratios established for “well-capitalized” institutions under OTS prompt corrective action regulations.

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The following table shows the Bank’s regulatory capital levels at September 30, 2007, in relation to the regulatory requirements in effect at that date. The information below is based upon the Bank’s understanding of the regulations and interpretations currently in effect and may be subject to change. 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	$	829,729
Minority interest in REIT Subsidiary(1)		144,000
		973,729
Adjustments for tangible and core capital:
Intangible assets		(63,762	)
Non-includable subsidiaries		(2,965	)
Non-qualifying purchased/originated loan servicing rights		(9,411	)
Total tangible capital		897,591		5.97	%	$	225,487	1.50	%	$	672,104	4.47	%
Total core capital(2)		897,591		5.97	%	$	601,298	4.00	%	$	296,293	1.97	%
Tier 1 risk-based capital(2)		897,591		8.85	%	$	404,178	4.00	%	$	493,413	4.85	%
Adjustments for total risk-based capital:
Subordinated capital debentures		175,000
Allowance for general loan losses		29,000
Total supplementary capital		204,000
Total available capital		1,101,591
Equity investments(3)		(2,456	)
Total risk-based capital(2)	$	1,099,135		10.85	%	$	808,357	8.00	%	$	290,778	2.85	%

(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) 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%.

(3) Includes one property classified as real estate held for sale which is treated as an equity investment for regulatory capital purposes.

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Under the OTS prompt corrective action regulations, an institution is categorized as well capitalized if it has a leverage, or core, capital ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0%, a total risk-based capital ratio of at least 10.0% and is not subject to any written agreement, order, capital directive or prompt corrective action directive to meet and maintain a specific capital level. At September 30, 2007, the Bank’s leverage, tier 1 risk-based and total risk-based capital ratios were 5.97%, 8.85% and 10.85%, respectively, which exceeded the ratios established for well-capitalized institutions. The OTS may reclassify an institution from one category to the next lower category, for example from well capitalized to adequately capitalized, if, after notice and an opportunity for a hearing, the OTS determines that the institution is in an unsafe or unsound condition or has received and has not corrected a less than satisfactory examination rating for asset quality, management, earnings or liquidity. The Bank has not received notice from the OTS of any potential downgrade.

OTS capital regulations provide a five-year holding period, or such longer period as may be approved by the OTS, for REO to qualify for an exception from treatment as an equity investment. If an REO property is considered an equity investment, its then-current book value is deducted from total risk-based capital. Accordingly, if the Bank is unable to dispose of any REO property, whether through bulk sales or otherwise, prior to the end of its applicable five-year holding period and is unable to obtain an extension of the five-year holding period from the OTS, the Bank could be required to deduct the then-current book value of such REO property from total risk-based capital. In August 2007, the Bank received from the OTS an extension of the holding periods for certain of its REO properties through August 13, 2008. The following table sets forth the Bank’s REO at September 30, 2007, by the fiscal year in which the property was acquired through foreclosure.

Fiscal Year	(In thousands)
1990	$	2,456	(1)
1991		7,618	(2)
1995		23,577	(2)
2007		14,792
Total REO	$	48,443

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

⁽²⁾ The Bank received an extension of the holding periods for these properties through August 13, 2008.

Failure to obtain further REO extensions could adversely affect the Bank’s regulatory capital ratios. The Bank’s ability to maintain or increase its capital levels in future periods also will be subject to general economic conditions, particularly in the Bank’s local markets. Adverse general economic conditions or a prolonged or sharper downturn in local real estate markets could require further additions to the Bank’s allowances for losses and further charge-offs. Any of those developments would adversely affect the Bank’s earnings and thus its regulatory capital levels.

The Bank has historically relied on preferred stock and subordinated debt as significant components of its regulatory capital. Those instruments require significant fixed payments to holders, which increase the Bank’s expenses and reduce the amount of core capital that can be generated through retained earnings.

Failure by the Bank to remain well capitalized could have a material adverse effect on certain aspects of the Bank’s operations, including its ability to pay dividends. See “Dividends and Other Capital Distributions.”

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 source 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. The Real Estate Trust receives quarterly distributions from its investment in Saul Holdings and dividends from its investment in Saul Centers. These amounts totaled $16.2 million in fiscal 2007. Historically these amounts have been reinvested in the paying entities and the Real Estate Trust has received additional partnership units and common shares in lieu of cash. The Real Estate Trust has the ability, at its own option, to receive these distributions and dividends in cash. The availability and amount of distributions and dividends in future periods is dependent upon, among other things, Saul Holdings’ and Saul Centers’ operating performance and income. Although cash flows from operating activities have improved during the two most recent fiscal years, for the

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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 other than the sale of unsecured notes. 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. See also the discussion of potential limitations on the payment of dividends by the Bank contained in “Item 1. Business—Banking—Dividends and Other Capital Distributions.”

The Real Estate Trust believes that the long term financial condition and operating results of the Bank should allow the Real Estate Trust to receive dividend payments from the Bank. During the fiscal year ended September 30, 2007, the Bank made dividend payments totaling $16.0 million and net tax sharing payments totaling $4.0 million to the Real Estate Trust. Dividend and tax sharing payments received by the Real Estate Trust are presented as cash flows from operating activities in the Consolidated Statements of Cash Flows.

Although operations have shown significant improvement in fiscal 2007 and 2006, in recent years the operations of the Real Estate Trust have generated net operating losses while the Bank has reported net income. The Trust’s consolidation of the Bank’s operations into the Trust’s federal income tax return has resulted in the use of the Real Estate Trust’s net operating losses to reduce the federal income taxes the Bank would otherwise have owed. If in any future year, the Bank has taxable losses or unused credits, the Trust would be obligated to reimburse the Bank for the greater of (1) the tax benefit to the group using such tax losses or unused tax credits in the group’s consolidated federal income tax returns or (2) 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 fiscal 2007, the Real Estate Trust purchased, through dividend reinvestment and direct purchase, approximately 628,000 shares of common stock of Saul Centers, and as of September 30, 2007, owned approximately 5,348,000 shares representing 30.2% of such company’s outstanding common stock. As of September 30, 2007, the market value of these shares was approximately $275.4 million. Substantially all of these shares have been pledged as collateral with the Real Estate Trust’s revolving credit lenders.

As the owner, directly and through two wholly-owned subsidiaries, of a limited partnership interest in Saul Holdings, the Real Estate Trust shares in cash distributions from operations and from capital transactions involving the sale of properties. The partnership agreement of Saul Holdings provides for quarterly cash distributions to the partners out of net cash flow. See “Item 1. Business — Real Estate — Investment in Saul Holdings Limited Partnership and Saul Centers, Inc.” In fiscal 2007, the Real Estate Trust received total cash distributions of $7.5 million from Saul Holdings. Substantially all of the Real Estate Trust’s ownership interest in Saul Holdings has been pledged as collateral with the Real Estate Trust’s two revolving credit lenders.

The Real Estate Trust repaid the remaining $21.4 million of outstanding unsecured notes during the first quarter of fiscal 2007.

Effective July 2, 2007, the Real Estate Trust amended and restated its $60.0 million secured revolving credit line with an unrelated bank, expanding the facility to $75.0 million and extending the maturity date two years to January 31, 2010, with provisions for extending the term for an additional year. 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 with the current interest rate spread, effective June 29, 2007, at 150 basis points over the index. At September 30, 2007, the Real Estate Trust had $6.0 million in outstanding borrowings and unrestricted availability of $69.0 million.

Effective June 14, 2007, the Real Estate Trust amended and restated its additional $60.0 million revolving credit line with an unrelated bank, expanding the facility to $75.0 million and extending the maturity date two years to June 30, 2010, with provisions for extending the term for an additional year. 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 with the current interest rate spread, effective June 14, 2007, at 150 basis points over the index. At September 30, 2007, the Real Estate Trust had $8.0 million in outstanding borrowings and unrestricted availability of $61.5 million. The Real Estate Trust was issued a $6.0 million letter of credit, which was reduced to $5.5 million during fiscal 2007, for the benefit of a mortgage lender as part of one of the mortgage financings completed during fiscal 2006. The letter of credit will continue to be reduced annually based on the amount of capital expended at the subject property. The letter of credit reduces the availability under the revolving credit facility.

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The maturity schedule for the Real Estate Trust’s outstanding debt, including mortgage notes payable for real estate held for sale, at September 30, 2007 for fiscal years commencing October 1, 2007 is set forth in the following table:

Debt Maturity Schedule

Fiscal Year	Mortgage Notes		Notes Payable— Secured		Total
(In thousands)
2008	$	7,531	$	—	$	7,531
2009		17,667		—		17,667
2010		13,108		14,000		27,108
2011		23,790		—		23,790
2012		31,415		—		31,415
Thereafter (1)		486,128		250,000		736,128
Total	$	579,639	$	264,000	$	843,639

Of the $579.6 million of mortgage notes outstanding at September 30, 2007, $539.2 million are non-recourse to the Real Estate Trust.

(1) Includes 100%, $26.7 million, of the Tysons Park Place II construction/permanent loan balance drawn to date.

On June 21, 2007, the Real Estate Trust placed a $37.0 million mortgage note on the office building located in Bethesda, Maryland which was purchased on March 29, 2007. The proceeds from the financing were used to pay down the Real Estate Trust’s revolving credit facilities.

On May 25, 2007, the Real Estate Trust closed on a $105.0 million construction/permanent loan for its Tysons Park Place II development. The loan will be used to fund the majority of the construction costs for the Tysons Park Place II development. The Real Estate Trust received loan draws of $26.7 million during fiscal 2007, which amounted to the balance outstanding under this loan at September 30, 2007.

On May 18, 2007, the Real Estate Trust placed a $21.4 million mortgage note on the newly constructed SpringHill Suites Hotel located in Loudoun County, Virginia. A portion of the proceeds from the financing were used to repay and retire the $14.9 million interest only construction loan on the property which was obtained on May 2006, the remainder of the proceeds were used to pay down the Real Estate Trust’s revolving credit facilities.

On March 29, 2007, the Real Estate Trust closed on a $21.2 million construction loan which will be used to finance the construction of the Hampton Inn Dulles located in Loudoun County, Virginia. The loan balance as of September 30, 2007 is $13.7 million, all of which was drawn during fiscal 2007.

On January 31, 2007, the Real Estate Trust placed an $8.5 million mortgage note on an industrial property located in Northern Virginia. The majority of the proceeds from the refinancing were used to repay a $5.7 million variable rate construction loan which was secured by the subject property.

On June 16, 2006, the Real Estate Trust placed a $31.2 million mortgage note on an office property located in Atlanta, Georgia. The note, which is due on July 1, 2021, bears interest at 6.353% and requires monthly interest only payments for the initial three years. Beginning in year four, monthly principal and interest payments of $194,000 are required with a balloon payment of $25.6 million due at maturity. The proceeds from the financing were used to fund development projects and general corporate purposes.

On May 26, 2006, the Real Estate Trust closed two mortgage financings, a $44.8 million mortgage note secured by a hotel property located in Loudoun County, Virginia and a $22.2 million mortgage note, also secured by a hotel property located in Gaithersburg, Maryland. The $44.8 million note, which is due on June 1, 2016, bears interest at 6.101% and requires monthly interest only payments for the initial three years. Beginning in year four, monthly principal and interest payments of $272,000 are required with a balloon payment of $40.8 million due at maturity. The $22.2 million note, which is due on June 1, 2018, bears interest at 6.258% and requires interest only payments for the initial three years. Beginning in year four, monthly principal and interest payments of $137,000 are required with a balloon payment of $19.5 million due at maturity. The proceeds from these financings were used to pay down the Real Estate Trust’s line of credit borrowings, fund development projects and for general corporate purposes.

On May 23, 2006, the Real Estate Trust placed a $40.0 million mortgage note on a hotel property located in McLean, Virginia. The note, which is due on May 1, 2021, bears interest at 6.1% and requires monthly principal and interest payments of $260,000 with a balloon payment of $23.7 million due at maturity. The proceeds from the financing were used to repay the bridge loan, which financed the purchase of the 145 room historic hotel, and pay down the Real Estate Trust’s line of credit borrowings.

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On March 24, 2006, the Real Estate Trust closed on an $86.2 million unsecured bridge loan to fund the acquisition, along with cash on hand, of the 145 room historic hotel located in Washington, D. C. The loan bore interest at LIBOR plus 175 basis points and had a term of six months, with five six-month extension options. On April 21, 2006, a $65.0 million permanent mortgage loan, which bears interest at 6.199%, was placed on the hotel and $61.0 million of the bridge loan was repaid. The balance of the bridge loan was repaid, from proceeds of permanent financings, on May 24, 2006.

On January 19, 2006, the Real Estate Trust defeased a $5.8 million mortgage loan that secured the hotel property which was sold on the same day. The Real Estate Trust paid $7.6 million into an escrow fund with which United States government securities were purchased to satisfy the loan defeasance. The defeasance was funded with proceeds from the sale and line of credit borrowings.

On December 29, 2005, the Real Estate Trust placed a $9.5 million mortgage note on the hotel property that was acquired on November 1, 2005. The note, which is due on January 1, 2016, bears interest at 5.92%. In connection with the same hotel asset the Real Estate Trust, on December 21, 2005, defeased the $5.8 million loan that was assumed with the acquisition of the property. The Real Estate Trust paid $6.6 million into an escrow fund with which United States government securities were purchased to satisfy the loan defeasance. The defeasance was funded by available cash and line of credit borrowings.

On December 2, 2005, the Real Estate Trust refinanced one of six properties that were secured by an approximately $88.0 million portfolio mortgage note which was due on March 31, 2006. The property was refinanced with a new 10 year mortgage note of $76.0 million. The proceeds from this refinancing, along with available cash and line of credit borrowings were used to repay the portfolio loan. The loan, which is due on January 11, 2016, bears interest at 5.3%.

Real Estate Acquisition, Disposition, Development and Capital Expenditures

On June 22, 2007 the Real Estate Trust was notified that its appeal regarding additional proceeds from a February 2006 condemnation of a 3.71 acre parcel had been approved by the Loudoun County Circuit Court. Additional proceeds of $325,000 were received on July 10, 2007 and the remainder of the gain was recorded in fiscal 2007. The initial gain of $416,000, on proceeds of $708,000, was recorded in fiscal 2006.

On March 29, 2007, the Real Estate Trust acquired an approximately 178,000 square foot office building located in Bethesda, Maryland from the Bank for a purchase price of $46.0 million. The acquisition was funded by the Real Estate Trust’s revolving credit facilities and with cash on hand. The purchase price for the acquisition was established using independent appraisals.

On November 22, 2006, the Real Estate Trust received additional proceeds of approximately $1.6 million as final settlement of the February 2004 condemnation of 7.93 acres of land by the Commonwealth of Virginia. The proceeds of $1.6 million include approximately $300,000 in interest income and $8,000 of cost reimbursements. The Real Estate Trust recorded the final gain of approximately $1.2 million, net of approximately $400,000 of related expenses during the nine-month period ended June 30, 2007. The initial gain on this condemnation of $2.7 million was recorded in fiscal 2004.

On March 24, 2006, the Real Estate Trust acquired a 145 room historic hotel located in Washington, D. C. for $100.0 million.

On February 23, 2006, the sale of one of the Real Estate Trust’s other real estate assets located in Metairie, LA was finalized and the Real Estate Trust received proceeds of approximately $4.0 million resulting in a gain of approximately $2.9 million in fiscal 2006.

On January 19, 2006, the sale of a hotel property, which was the second of two hotel properties placed on the market during fiscal year 2005, was finalized and the Real Estate Trust received proceeds from the sale of approximately $5.5 million resulting in a gain of $2.2 million in fiscal 2006. The Real Estate Trust financed an additional $500,000 through the issuance of a note by the purchaser.

On December 16, 2005, the sale of a hotel property, which was one of two hotel properties placed on the market during fiscal year 2005, was finalized and the Real Estate Trust received proceeds from the sale of approximately $7.9 million resulting in a gain of $1.3 million in fiscal 2006.

On November 1, 2005, the Real Estate Trust acquired a 137 room hotel property located in Fairfax County, Virginia for a purchase price of approximately $12.7 million, which included the assumption of a mortgage note of $5.8 million.

On September 13, 2005, the Real Estate Trust closed on a $6.2 million purchase of a land parcel from the Bank located in Loudoun County, VA. The purchase was funded from cash on hand.

On July 25, 2005, the Real Estate Trust closed on a $1.9 million purchase of a land parcel from the Bank located in Loudoun County, VA. The purchase was funded from available cash on hand.

On July 11, 2005, approximately 22 acres of the Real Estate Trust’s 159 acre land parcel in Overland Park, Kansas was acquired by the Kansas Department of Transportation through a condemnation proceeding. The Real Estate Trust was awarded approximately $1.2 million which resulted in a gain of $263,000 in fiscal 2005.

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During fiscal 2005, the Real Estate Trust placed two of its hotel properties on the market for sale, as these properties no longer meet its investment criteria. No adjustment to the carrying value of the properties was required. Sales of both properties closed in fiscal 2006.

On May 25, 2005, the Real Estate Trust acquired an approximately 12,000 square foot office building located in Montgomery County, Maryland for approximately $5.3 million.

On January 31, 2005, the Real Estate Trust sold one of its other real estate properties because the property no longer met the Real Estate Trust’s investment criteria. No adjustment to the carrying value of the property was required. The Real Estate Trust received proceeds from the sale of approximately $1.4 million, resulting in a gain of $900,000 in fiscal 2005.

The Real Estate Trust owns various land parcels with approximately 450 acres of available land. These parcels offer potential development opportunities for the Real Estate Trust. On January 8, 2007 the construction of the 158 room SpringHill Suites Hotel in Northern Virginia was completed and the hotel commenced operation. During fiscal 2006 the Real Estate Trust commenced the ground-up development of a second hotel property, a 170 room Hampton Inn Hotel, on a land parcel owned in Northern Virginia which opened on October 18, 2007. The Real Estate Trust also commenced the development of for-sale residential townhomes and the related infrastructure on land parcels owned in Atlanta, Georgia. The first sales of townhome units closed during the second quarter of fiscal 2007. The Trust is exploring other development scenarios on several other land parcels.

The Real Estate Trust believes that the capital improvement costs for its income-producing properties will be in the range of $20.0 to $29.0 million per year for the next several years.

Liquidity Requirements – Real Estate Trust

The table below specifies the total contractual payment obligations as of September 30, 2007.

(In thousands)	Total Cost		Less than 1 Year		1-3 Years		4-5 Years		After 5 Years
Contractual Obligations
Mortgage Notes Payable	$	579,639	$	7,531	$	30,775	$	55,205	$	486,128
Notes Payable – Secured		264,000		—		14,000		—		250,000
Ground Leases		52,048		296		622		666		50,464
Development Obligations		41,554		41,554		—		—		—
Advisory Fee		1,830		1,830		—		—		—
Capital Leases		366		226		140		—		—
Other Obligations		115		115		—		—		—
Total Contractual Cash Obligations	$	939,552	$	51,552	$	45,537	$	55,871	$	786,592

As of September 30, 2007, the Real Estate Trust’s current contractual obligations, excluding recurring operating obligations, due within one year total approximately $51.6 million. In addition to these contractual obligations the Real Estate Trust has other short-term liquidity requirements consisting primarily of normal recurring operating expenses, regular debt service requirements (including debt service relating to additional and replacement debt), recurring corporate expenditures, non-recurring corporate expenditures (such as tenant improvements and hotel improvements) and dividends to common and preferred shareholders. Overall capital requirements in fiscal year 2008 will depend on any acquisition and development opportunities as well as the level of improvements and redevelopments on existing properties.

The Real Estate Trust expects to fund these capital requirements and normal recurring operating costs through a combination of cash provided by operating activities, cash on hand, credit line availability, new financings, current in-place construction loan financings, refinancing of maturing debt, proceeds from asset sales and to a lesser extent, dividends and tax sharing payments from the Bank.

BANKING

Liquidity.The Bank is required to maintain sufficient liquidity to ensure its safe and sound operation. A standard measure of liquidity in the savings industry is the ratio of cash and short-term U.S. Government and other specified securities to net withdrawable accounts and borrowings payable in one year or less. See “BUSINESS – Regulation – Liquidity Requirements.”

The Bank’s primary sources of funds historically have consisted of:

• principal and interest payments on loans and mortgage-backed securities;

• savings deposits;

• sales of loans and trading securities;

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• securitizations and sales of loans; and

• borrowed funds, including funds borrowed from the FHLB of Atlanta.

The Bank’s holdings of readily marketable securities and eligible loans constitute another important source of liquidity. Approximately $1.1 billion of these assets are pledged to the Federal Reserve Bank of Richmond, although there were no outstanding borrowings during fiscal year 2007. As of September 30, 2007, the estimated remaining borrowing capacity, after market value and other adjustments, against that portion of those assets that may be pledged to the FHLB of Atlanta and various securities dealers totaled $4.7 billion.

The Bank accesses the capital markets when conditions are favorable as an additional means of funding its operations and managing its capital ratios and asset growth. Specifically, the Bank has securitized financial assets, including home equity, home loan and automobile loan receivables, as well as single-family residential loans, because the securitizations have provided the Bank with a cost effective means to fund loans while maintaining compliance with regulatory capital requirements. Additionally, the securitizations have permitted the Bank to limit the credit risk associated with these assets while continuing to earn servicing fees and other income associated with the securitized assets.

Recent developments in the broader credit markets and, more specifically, in the mortgage markets have resulted in reduced investor demand and less favorable terms and pricing in the capital markets for securitizations and sales of residential mortgage loans. As a result, the Bank did not securitize and sell any residential mortgage loans in the quarter ended September 30, 2007.

Since 1988, the Bank has securitized approximately $35.0 billion of loan receivables. At September 30, 2007, the Bank continues to service $6.9 billion of securitized residential mortgages. Chevy Chase derives fee-based income from servicing these securitized portfolios. However, that fee-based income has been adversely affected in this and prior periods by increases in prepayments, delinquencies and charge-offs related to the receivables in these securitized pools.

The Bank securitized and sold $1.9 billion and $4.2 billion of loan receivables during fiscal year 2007 and 2006, respectively. At September 30, 2007 and 2006, the Bank had $202.3 million and $467.6 million, respectively, of loan receivables held for securitization and/or sale. The decrease in securitization and sale activity reflects recent developments in the credit markets and, more specifically, in the mortgage markets. Due to reduced investor demand and less favorable terms and pricing in the capital markets for securitizations and sales of residential mortgage loans, the Bank chose not to engage in securitization transactions during the last quarter of fiscal 2007 and is unable to predict if or when current market conditions will improve so that securitization can once again serve as a significant source of liquidity. As a result, the Bank has modified its operations and reduced loan production levels to deemphasize securitization activities.

The Bank uses its liquidity primarily to meet its commitments to fund maturing savings certificates and deposit withdrawals, fund loan commitments, repay borrowings and meet operating expenses. During fiscal year 2007, the Bank used the cash provided by operating, investing and financing activities primarily to (i) fund maturing savings certificates and deposit withdrawals of $95.7 billion, (ii) fund loan commitments, including real estate held for investment or sale, of $295.6 million, (iii) purchase investments and loans of $2.0 billion, (iv) meet operating expenses, before depreciation and amortization, of $642.8 million and (v) repay borrowings of $405.2 million, net of proceeds from borrowings. These commitments were funded primarily through (i) proceeds from customer deposits and sales of certificates of deposit of $96.2 billion, (ii) proceeds from sales of loans, trading securities and real estate of $4.0 billion and (iii) principal and interest collected on investments, loans, and securities of $6.4 billion.

At September 30, 2007, repayments of borrowed money scheduled to occur during the next 12 months were $2.4 billion. In addition, certificates of deposit maturing during the next 12 months amounted to $3.8 billion. The Bank expects that a significant portion of these maturing certificates of deposit will remain with the Bank. In the event that deposit withdrawals are greater than anticipated, the Bank may have to increase deposit interest rates or rely on alternative and potentially higher cost sources of funds in order to meet its liquidity needs.

The Bank’s liquidity requirements in years subsequent to fiscal year 2007 will continue to be affected both by the asset size of the Bank, the growth of which may be constrained by capital requirements, accessibility to the capital markets and the composition of the asset portfolio. Management believes that the Bank’s primary sources of funds, described above, will be sufficient to meet the Bank’s liquidity needs for the foreseeable future. The mix of funding sources utilized from time to time will be determined by a number of factors, including capital planning objectives, lending and investment strategies and market conditions.

Commitments and Contingencies.The Bank periodically transfers loan receivables to special purpose entities that issue securities to investors. These investors are entitled to a return of cash flows, based on the principal and interest provided by the loan receivables transferred. This process is referred to as securitization. Since 1988, the Bank has securitized approximately $35.0 billion of loan receivables.

The Bank transfers receivables from time to time to a special purpose entity commonly referred to as a depositor. The depositor then establishes a trust for each particular securitization, and transfers the related loans to that particular trust. The trust uses proceeds from the sale of the securities to pay the depositor for the loans sold to the trust, and the depositor in turn pays the proceeds over to the Bank. These securitization vehicles are not consolidated within the Bank’s consolidated financial statements because they satisfy the criteria established by Statement of Financial Accounting Standards No. 140, “Accounting for the Transfers and Servicing of Financial Assets

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and Extinguishments of Liabilities,” to be treated as sales. In general, these criteria require the securitization vehicles to be legally isolated from the transferor (the Bank), be limited to permitted activities, and have defined limits on the assets they can hold and the permitted sales, exchanges or distribution of its assets.

When the Bank sells or securitizes loans, it generally retains the right to service the loans. At September 30, 2007, the Bank continues to service $13.1 billion of residential mortgages. In addition, when the Bank sells or securitizes loans, the Bank may, from time to time, retain a limited amount of recourse. At September 30, 2007, the Bank had no recourse related to loan securitization transactions. At September 30, 2006, total recourse to the Bank related to loan securitization transactions was $2.7 million. See Note 17 to the Consolidated Financial Statements for additional information concerning loan securitization transactions.

The Bank is also obligated under recourse provisions related to the servicing of certain of its residential mortgage loans. At September 30, 2007 and 2006, the recourse to the Bank under these arrangements totaled $3.0 million and $2.9 million, respectively.

The Bank’s commitments to extend credit at September 30, 2007 are set forth in the following table.

	(In thousands)
Commitments to originate loans	$	251,094
Loans in process (collateralized loans):
Home equity		1,879,281
Real estate construction and ground		398,519
Commercial		597,911
Subtotal		2,875,711
Loans in process (unsecured loans):
Overdraft lines		155,703
Commercial		499,224
Subtotal		654,927
Total commitments to extend credit	$	3,781,732

Based on historical experience, the Bank expects to fund substantially less than the total amount of its outstanding overdraft line and home equity credit line commitments, which together accounted for 53.8% of commitments to extend credit at September 30, 2007.

In connection with the securitization and sale of certain payment option residential mortgage loans, the Bank is obligated to fund a portion of any “negative amortization,” resulting from the borrowers electing their option to make monthly payments that are not sufficient to cover the interest accrued for the payment period. For each dollar of negative amortization funded by the Bank, the balances of certain highly-rated mortgage-backed securities received by the Bank as part of the securitization transaction increase accordingly. When the borrowers ultimately make the principal payments, the Bank receives its pro rata portion of those payments in cash, and the balances of those securities held by the Bank are reduced accordingly. During the year ended September 30, 2007, the Bank funded $141.6 million of negative amortization under these obligations, and received $105.0 million in principal payments representing previously funded negative amortization.

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The following table summarizes certain material contractual cash obligations associated with operating, investing and financing activities as of September 30, 2007:

	Payments due by period (in thousands)
	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Long term debt obligations	$	1,504,081	$	835,683	$	387,313	$	31,329	$	249,756
Operating lease obligations		438,261		36,248		62,875		53,674		285,464
Total	$	1,942,342	$	871,931	$	450,188	$	85,003	$	535,220

Additionally, the Bank’s 8% Preferred Stock pays quarterly dividends in arrears at a yearly rate of $2.00 per share, totaling $10.0 million in preferred stock dividends to be paid by the Bank on an annual basis. The preferred stock is redeemable for cash, at $25.00 per share plus any accrued and unpaid dividends, at the Bank’s option on or after October 1, 2008. The preferred stock has no stated maturity.

There were no material commitments for capital expenditures at September 30, 2007.

RESULTS OF OPERATIONS

The Real Estate Trust’s ability to generate revenues from property ownership and development is significantly influenced by a number of factors, including national and local economic conditions, the level of mortgage interest rates, government actions, such as changes in real estate tax rates, and the type, location size and stage of development of the Real Estate Trust’s properties. Debt service payments and most of the operating expenses associated with income-producing properties do not decrease by reductions in occupancy or rental income. Therefore, the ability of the Real Estate Trust to produce net income in any year from its income-producing activities is highly dependent on the Real Estate Trust’s ability to maintain or increase the properties’ levels of gross income. The relative illiquidity of real estate investments tends to limit the ability of the Real Estate Trust to vary its portfolio promptly in response to changes in economic, demographic, social, financial and investment conditions. See “Financial Condition – Real Estate.”

The Bank’s operating results historically have depended primarily on its “net interest spread,” which is the difference between rates of interest earned on its loans and securities investments and the rates of interest paid on its deposits and borrowings. In recent periods, the Bank has generated significant income from loan servicing and securities activities and deposit fees. In addition to interest paid on its interest-bearing liabilities, the Bank’s principal expenses are operating expenses.

FISCAL 2007 COMPARED TO FISCAL 2006

REAL ESTATE

The Real Estate Trust recorded an operating loss from continuing operations of $2.5 million for fiscal 2007 compared to an operating loss from continuing operations of $2.0 million for fiscal 2006. The change reflects increased interest and debt amortization, depreciation, advisory, management and leasing fees and general and administrative expenses which were slightly offset by improved operating results in the hotel portfolio, the contribution from the March 29, 2007 office building acquisition, higher equity earnings from unconsolidated entities, income generated from the sale of townhomes and $1.5 million of gains on sales of land parcels. Also included in fiscal 2006 is a $416,000 gain on sale of land as a result of a condemnation.

Income after direct operating expenses from hotels, which excludes two hotels which were sold during fiscal 2006, increased $3.0 million, or 6.0%, in fiscal 2007 from the level achieved in fiscal 2006. Total revenue increased $17.4 million, or 13.7%, as occupancy, exclusive of the hotel purchased in March 2006 and the newly constructed hotel which was placed in service in January 2007 (“Same hotel properties”), increased to 71.2% in fiscal 2007 from 70.6% in fiscal 2006 offsetting a slight decrease in the average room rate for the same hotel properties from $122.92 for fiscal 2006 to $121.90 for fiscal 2007. Room sales for fiscal 2007 increased $11.5 million, or 11.2%, from fiscal 2006, while food, beverage and other sales increased $5.9 million, or 23.8%. The hotel purchased in March 2006 contributed approximately $12.9 million to the increase in overall revenue. The newly constructed hotel contributed approximately $3.2 million to the increase in overall revenue. The same hotel properties revenue increased approximately $1.3 million, or 1.2%. Direct operating expenses increased $14.4 million, or 18.5%, reflecting increased operating costs, such as payroll costs, hotel franchise and marketing costs and other operating costs associated with the increased hotel revenue as well as increased repair and maintenance costs, food and beverage costs and property taxes. In addition, operating costs associated with the hotel purchased in March 2006 and the newly constructed hotel are fully integrated into the fiscal 2007 results.

Income after direct operating expenses from office and industrial properties increased $809,000, or 3.0%, in fiscal 2007 compared to fiscal 2006. Total revenue increased $3.5 million, or 8.7%, in fiscal 2007. The property purchased on March 29, 2007 contributed $3.4 million to revenue in fiscal 2007. Occupancy levels, excluding the property purchased on March 29, 2007, which is 100% leased (“Same office properties”), have decreased in fiscal 2007 from 92.0% at September 30, 2006 to 85.1% at September 30, 2007. The majority of the decrease in occupancy was

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caused by the March 31, 2007 lease expiration of a 100,207 square foot tenant that was the sole occupant of one of the Real Estate Trust’s industrial buildings located in Northern Virginia. Rental revenue was received from this tenant through the end of their lease term. Increased revenue generated by the remainder of the Real Estate Trust’s metropolitan Washington, D.C. portfolio is offset by lower revenue and occupancy from its other office and industrial properties. Overall direct operating expenses increased $2.7 million, or 20.1%, due to higher utility costs, ground rent, property taxes and lower repair and maintenance costs. Direct operating expenses for the same office properties increased $339,000, or 2.5%.

The first townhome sales at the Real Estate Trust’s Circle 75 Development, located in Atlanta, Georgia, closed during the second quarter of fiscal 2007. Income from the sale of townhomes, after deducting the cost of sales, totaled $1.5 million for fiscal 2007. Twenty-eight units, out of a total of 107 units, were sold during the fiscal year for a total sales value of $9.8 million. All direct costs and allocated infrastructure and soft costs, totaling $8.3 million, associated with these units were expensed during fiscal 2007.

Other income, which includes interest income, income from other real estate properties and other miscellaneous income, decreased $830,000, or 34.4%, due to lower interest income in fiscal 2007 reflecting decreased cash balances in the fiscal year. In addition easement income, relating to a land parcel in Northern Virginia, of $90,000 and $120,000 were received in fiscal 2007 and 2006, respectively

Land parcels and other expense increased $159,000, or 13.5%, in fiscal 2007 when compared to fiscal 2006 reflecting increased property tax expenses throughout the entire portfolio of land holdings.

Interest and amortization of debt expense increased $3.5 million in fiscal 2007 when compared to fiscal 2006. The increase is due to higher mortgage interest and debt amortization of approximately $8.7 million, reflecting the Real Estate Trust’s refinancing activity during fiscal 2007 and 2006 and higher line of credit interest of $383,000 which was partially offset by lower unsecured note interest of $3.7 million and increased capitalized interest of $925,000. Also, included in fiscal 2006 are one-time charges consisting of a write-off of unamortized debt costs of $106,000 associated with the early pay-off of a mortgage that had secured six operating properties and a defeasance premium of $829,000 associated with the payoff of the mortgage assumed by the Real Estate Trust with the November 1, 2005 hotel property purchase. The average balance of outstanding borrowings increased to $791.9 million in fiscal 2007 from $684.1 million in fiscal 2006, reflecting higher mortgage balances which offset lower unsecured note balances. The average cost of borrowings decreased from 7.44% in fiscal 2006 to 7.10% in fiscal 2007.

Depreciation expense increased $2.4 million or 11.6%, reflecting recent hotel and office acquisitions, developments and capital improvements in both the hotel and office and industrial portfolios that have been placed in service during fiscal 2007 and 2006.

Advisory, management and leasing fees paid to related parties increased $1.2 million, or 7.9%, in fiscal 2007 when compared to fiscal 2006. The advisory fee in fiscal 2007 increased $507,000 over fiscal 2006 due to a contractual increase in the monthly payments. The remainder of the increase, totaling $709,000, was due mainly to higher hotel and office management fees reflecting the overall increase in hotel and office revenue in fiscal 2007.

General and administrative expense increased $1.3 million, or 41.4%, in fiscal 2007 compared to fiscal 2006. The increase is due to marketing costs incurred for new development projects, both residential and hotel, and increased legal costs which were partially offset by lower write-offs of acquisition and development costs for projects that the Real Estate Trust has determined not to pursue.

Equity in earnings of unconsolidated entities reflected net earnings of approximately $12.5 million in fiscal 2007 as compared to $10.0 million in fiscal 2006, an increase of $2.5 million, or 24.8%. Earnings from Saul Holdings Partnership and Saul Centers were higher by $2.0 million in fiscal 2007 primarily due to an increase in operating income generated from development and redevelopment activity, as well as successful leasing activity in the core properties of those entities. Losses from other investments totaled $503,000 in fiscal 2006. These losses are a result of a write-down of a non-public investment accounted for under the equity method. There were no losses from other investments in fiscal 2007.

On June 22, 2007 the Real Estate Trust was notified that its appeal regarding additional proceeds from a February 2006 condemnation of a 3.71 acre parcel had been approved by the Loudoun County Circuit Court. Additional proceeds of $325,000 were received on July 10, 2007 and the remainder of the gain was recorded in fiscal 2007. The initial proceeds of approximately $708,000 were originally placed in escrow then received by the Real Estate Trust on August 8, 2006. An initial gain of $416,000 was recorded in fiscal 2006.

On November 22, 2006, the Real Estate Trust received additional proceeds of approximately $1.6 million as final settlement of the February 2004 condemnation of 7.93 acres of land by the Commonwealth of Virginia. The proceeds of $1.6 million include approximately $300,000 in interest income and $8,000 of cost reimbursements. The Real Estate Trust recorded the final gain of approximately $1.2 million, net of approximately $400,000 of related expenses in fiscal 2007. The initial gain on this condemnation of $2.7 million was recorded in fiscal 2004.

Included in income from operations of discontinued real estate assets for fiscal 2006 are two hotel properties and an other real estate property asset. The sales of the hotel properties closed in December 2005 and January 2006, respectively. The sale of the other real estate asset closed in February 2006. There were no assets held for sale during fiscal 2007.

Income from operations of discontinued real estate assets totaled $4.2 million in fiscal 2006. Net operating results for the two hotel properties for fiscal 2006 produced income from operations of discontinued real estate assets of approximately $1.3 million, which includes a combined gain

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on sale of approximately $3.4 million, and a loss from operations of discontinued real estate assets of $2.1 million. Included in the loss from operations is $1.8 million of costs associated with the defeasance of a mortgage which secured one of the hotel properties. Also included in income from operations of discontinued real estate assets in fiscal 2006 is a gain on the sale of one of the Real Estate Trust’s other real estate assets of $2.9 million and income from operations of the other real estate asset of approximately $47,000. This asset was sold in February 2006.

BANKING

Overview. The Bank recorded operating income of $110.8 million for fiscal year 2007, compared to operating income of $138.8 million for fiscal year 2006. The decrease in income was primarily attributable to an increase in salaries and employee benefits expense, a decrease in servicing, securitization and mortgage banking income, an increase in the provision for loan losses as a result of the deterioration in the mortgage markets and a decrease in automobile rental income. An increase in net interest income and a decrease in depreciation and amortization due to the Bank’s prior decision to discontinue automobile lease origination partially offset the decreased income. The Bank’s net income in future periods will continue to be affected by increased operating expenses associated with expansion of the Bank’s branch network and other areas of business and the fixed payments associated with the REIT preferred stock and 2003 debentures.

Net Interest Income. Net interest income, before the provision for loan losses, increased $19.4 million (or 4.6%) in fiscal year 2007. The Bank recorded $2.7 million of interest income on non-accrual and restructured loans during fiscal year 2007. The Bank would have recorded additional interest income of $1.9 million during fiscal year 2007 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)

	Year Ended September 30,
	2007						2006						2005
	Average Balances		Interest		Yield/ Rate		Average Balances		Interest		Yield/ Rate		Average Balances		Interest		Yield/ Rate
Assets:
Interest-earning assets:
Loans receivable, net (1)	$	11,156,697	$	743,264	6.66	%	$	11,235,149	$	669,154	5.96	%	$	11,047,463	$	531,859	4.81	%
Mortgage-backed securities		1,208,902		57,738	4.78			959,247		45,581	4.75			575,297		27,285	4.74
Federal funds sold and securities purchased under agreements to resell		60,041		3,220	5.36			73,685		3,465	4.70			84,134		2,296	2.73
Trading securities		31,166		1,806	5.79			6,666		441	6.62			6,534		364	5.57
Investment securities		208,665		8,862	4.25			201,572		6,964	3.45			182,794		4,741	2.59
Other interest-earning assets		181,677		11,929	6.57			204,586		11,741	5.74			231,111		8,588	3.72
Total		12,847,148		826,819	6.44			12,680,905		737,346	5.81			12,127,333		575,133	4.74
Non-interest earning assets:
Cash		388,334						403,645						347,513
Real estate held for investment or sale		38,856						23,597						22,079
Property and equipment, net		621,046						563,978						510,716
Automobiles subject to lease, net		25,063						113,557						294,198
Goodwill and other intangible assets, net		42,308						39,004						25,580
Other assets		746,804						718,524						696,546
Total assets	$	14,709,559					$	14,543,210					$	14,023,965
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits	$	2,317,823		6,756	0.29		$	2,373,370		6,047	0.25		$	2,323,065		5,040	0.22
Savings deposits		958,765		6,402	0.67			1,069,300		4,423	0.41			1,209,376		3,407	0.28
Time deposits		3,799,140		179,961	4.74			2,897,776		114,058	3.94			2,027,324		52,419	2.59
Money market deposits		2,379,568		63,794	2.68			2,502,723		55,035	2.20			2,456,603		34,765	1.42
Total deposits		9,455,296		256,913	2.72			8,843,169		179,563	2.03			8,016,368		95,631	1.19
Borrowings		2,635,723		131,378	4.98			3,102,238		138,608	4.47			3,443,406		111,562	3.24
Total liabilities		12,091,019		388,291	3.21			11,945,407		318,171	2.66			11,459,774		207,193	1.81
Noninterest-bearing items:
Noninterest bearing deposits		1,382,066						1,414,449						1,373,432
Other liabilities		265,991						246,548						293,797
Minority interest		175,391						175,391						175,391
Stockholders’ equity		795,092						761,415						721,571
Total liabilities and stockholders’ equity	$	14,709,559					$	14,543,210					$	14,023,965
Net interest income			$	438,528					$	419,175					$	367,940
Net interest spread (2)					3.23	%					3.15	%					2.93	%
Net yield on interest-earning assets (3)					3.41	%					3.31	%					3.03	%
Interest-earning assets to interest-bearing liabilities					106.25	%					106.16	%					105.83	%

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

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

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

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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

(In thousands)

	Year Ended September 30, 2007 Compared to Year Ended September 30, 2006 Increase (Decrease) Due to Change in (1)									Year Ended September 30, 2006 Compared to Year Ended September 30, 2005 Increase (Decrease) Due to Change in (1)
	Volume			Rate			Total Change			Volume			Rate		Total Change
Interest income:
Loans (2)	$	(4,703	)	$	78,813		$	74,110		$	9,179		$	128,116	$	137,295
Mortgage-backed securities		11,923			234			12,157			18,244			52		18,296
Federal funds sold and securities purchased under agreements to resell		(693	)		448			(245	)		(315	)		1,484		1,169
Trading securities		1,426			(61	)		1,365			7			70		77
Investment securities		253			1,645			1,898			525			1,698		2,223
Other interest-earning assets		(1,398	)		1,586			188			(1,079	)		4,232		3,153
Total interest income		6,808			82,665			89,473			26,561			135,652		162,213
Interest expense:
Deposit accounts		13,144			64,206			77,350			10,750			73,182		83,932
Borrowings		(22,206	)		14,976			(7,230	)		(11,922	)		38,968		27,046
Total interest expense		(9,062	)		79,182			70,120			(1,172	)		112,150		110,978
Increase in net interest income	$	15,870		$	3,483		$	19,353		$	27,733		$	23,502	$	51,235

(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 fiscal year 2007 increased $89.5 million (or 12.1%) from fiscal year 2006 primarily as a result of higher average yields on loans receivable which more than offset the reduction in interest income from lower average balances. An increase in interest income on mortgage-backed securities caused by higher average balances also contributed to the increased income.

The Bank’s net interest spread increased to 3.23% in fiscal year 2007 from 3.15% in fiscal year 2006. The eight basis point increase primarily resulted from a 70 basis point increase in the average yield on loans which was partially offset by a 55 basis point increase in the cost of deposits and borrowings. The ratio of average interest-earning assets to average interest-bearing liabilities was 106.25% for fiscal year 2007, essentially unchanged from fiscal year 2006.

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Interest income on loans, the largest category of interest-earning assets, increased 11.1% to $743.3 million for fiscal year 2007 from $669.2 million for fiscal year 2006, because of higher average yields. The average yield on the loan portfolio increased to 6.66% for fiscal year 2007 from 5.96% for fiscal year 2006, reflecting increases in the various indices on which interest rates of adjustable rate loans are based. Interest income on residential mortgage loans increased $56.1 million primarily due to a 77 basis point increase in the average yield (to 6.25% from 5.48%) during fiscal year 2007. Lower residential mortgage loan average balances of $60.6 million partially offset the increased interest income on those loans. Higher average yields on home equity loans resulted in a $1.9 million (or 1.6%) increase in interest income on those loans. Higher average balances of and average yields on residential construction loans resulted in a $19.9 million (or 54.7%) increase in interest income on those loans.

Interest income on mortgage-backed securities increased $12.2 million (or 26.7%) primarily due to a $249.7 million increase in average balances coupled with an increase in the average yields on those securities.

Interest expense on deposits increased $77.4 million (or 43.1%) during fiscal year 2007. The increase resulted primarily from a 69 basis point increase in the average rate on deposits (to 2.72% from 2.03%) due to increased rates paid by the Bank in response to higher market interest rates. A $612.1 million increase in average deposit balances also contributed to the increase in interest expense.

Interest expense on borrowings decreased $7.2 million (or 5.2%) in fiscal year 2007 compared to fiscal year 2006. Interest expense on advances from the FHLB of Atlanta decreased $10.5 million (or 10.2%) due primarily to lower average balances which were partially offset by higher average rates paid on the advances. Interest expense on other borrowings increased $6.3 million (or 46.7%) due to higher average balances and higher average rates paid on those borrowings.

Provision for Loan Losses. During fiscal year 2007, the Bank recorded a provision for loan losses of $3.4 million, compared to a credit for loan losses of $9.0 million in fiscal year 2006. The provision reflects increased delinquencies and losses in the Bank’s portfolio of residential real estate loans. See “Financial Condition – Asset Quality – Allowances for Losses.”

Other income. Other income decreased to $370.8 million in fiscal year 2007 from $392.6 million in fiscal year 2006. The $21.8 million (or 5.6%) decrease was primarily attributable to decreases, in servicing, securitization and mortgage banking income, and automobile rental income which were partially offset by an increase in deposit servicing fees.

Servicing, securitization and mortgage banking income decreased to $145.8 million in fiscal year 2007, from $156.4 million in fiscal year 2006, a 1.2% decrease. During fiscal year 2007, the Bank securitized and/or sold $3.9 billion of loans and recognized gains of $59.7 million. During fiscal year 2006, the Bank securitized and/or sold $5.4 billion of loans and recognized gains of $118.8 million. Recent developments in the broader credit markets and, more specifically, in the mortgage markets have resulted in reduced investor demand and less favorable terms and pricing in the capital markets for securitizations and sales of residential mortgage loans. As a result, the Bank did not securitize and sell any residential mortgage loans in the quarter ended September 30, 2007. Offsetting the lower gain was a reduction in the amount of fair value write-downs of interest-only assets to $8.9 million in 2007 from $88.3 million in 2006. Primarily as a result of higher estimated future prepayments of securitized mortgage loans, the Bank recorded a fair value write-down on its interest-only assets totaling $88.3 million in fiscal year 2006. Due to several factors, including reductions in interest rates and availability of credit, prepayment levels slowed in the quarter ended September 30, 2007, which led to a significantly lower fair value write-down on interest-only assets in fiscal year 2007 as compared to 2006. However, in fiscal year 2007, the Bank recorded a fair value write-down of $12.6 million on its loans held for sale and reclassified $1.3 billion of loans held for sale to loans receivable.

Automobile rental income decreased to $8.3 million in fiscal year 2007 from $35.2 million in fiscal year 2006, a 76.4% decrease as a result of the Bank’s prior decision to discontinue origination of automobile leases.

Deposit servicing fees increased $9.0 million (or 6.2%) during fiscal year 2007 primarily due to fees generated from the continued expansion of the Bank’s branch and ATM network.

Operating Expenses. Operating expenses during fiscal year 2007 increased $13.2 million (or 1.9%) from fiscal year 2006. The increase was largely due to increases in salaries and employee benefits and property and equipment expenses which were partially offset by reductions in depreciation and amortization and other expenses. Management anticipates a decline in operating expenses in future periods due to decreased originations of loans due to current market conditions and as staffing levels are reduced to limit extended hours in the deposit branch network.

Salaries and employee benefits increased $40.7 million (or 13.2%) in fiscal year 2007 due primarily to the increased number of retail branches and the increased number of hours those branches are open.

73

Property and equipment expense increased $11.2 million (or 20.0%) during fiscal year 2007 primarily due to rent expense on the increased number of retail branches.

Depreciation and amortization expense decreased $17.2 million (or 24.7%) in fiscal year 2007. Depreciation expense related to automobiles subject to lease decreased $17.7 million, to $5.6 million for fiscal year 2007, due to lower levels of outstanding leases resulting from the Bank’s prior decision to discontinue origination of automobile leases.

Other expenses decreased to $68.3 million (or 17.4%) in fiscal year 2007 primarily due to the Bank’s settlement of a lawsuit for $16.1 million related to its former credit card operations during fiscal year 2006.

FISCAL 2006 COMPARED TO FISCAL 2005

REAL ESTATE

The Real Estate Trust recorded an operating loss from continuing operations of $2.0 million for fiscal 2006 compared to an operating loss from continuing operations of $7.4 million for fiscal 2005. The change reflects improved operating results in the hotel portfolio, higher interest and other real estate income and higher equity earnings from unconsolidated entities which were partially offset by declining results in the office and industrial portfolio, increased interest and debt amortization, depreciation, and advisory, management and leasing fees.

Income after direct operating expenses from hotels, which excludes the two hotels which were sold during fiscal 2006, increased $10.6 million, or 27.4%, in fiscal 2006 from the level achieved in fiscal 2005. Total revenue increased $28.6 million, or 29.0%, as the average room rate, exclusive of the hotel purchased in March 2006, for the hotel properties increased $10.51, or 9.3%, as occupancy levels increased to 70.6% in fiscal 2006 from 69.5% in fiscal 2005. This increase in average room rate while increasing occupancy levels reflects the strong demand at the Real Estate Trust’s hotel properties, particularly the Northern Virginia and Florida properties. Room sales for fiscal 2006 increased $21.7 million, or 26.9%, from fiscal 2005, while food, beverage and other sales increased $6.9 million, or 38.5%. The hotel purchased on November 1, 2005 contributed approximately $3.6 million to the increase in overall revenue. The hotel purchased on March 24, 2006 contributed approximately $14.0 million to the increase in overall revenue. Exclusive of the two hotels purchased and the two hotels sold during the 2006 period, revenues increased approximately $11.0 million, or 11.2%. Direct operating expenses increased $18.0 million, or 30.1%, reflecting increased operating costs, such as payroll costs, utility costs, hotel franchise and marketing costs and other operating costs associated with the increased hotel revenue. In addition, operating costs associated with the hotels purchased on November 1, 2005 and March 24, 2006 are fully integrated into hotel operating results as of the day of purchase.

Income after direct operating expenses from office and industrial properties decreased $799,000, or 2.9%, in fiscal 2006 compared to fiscal 2005. Total revenue increased $518,000, or 1.3%, in fiscal 2006. Occupancy levels have increased slightly in fiscal 2006 period from 91.0% at September 30, 2005 to 92.0% at September 30, 2006. Increased revenue generated by the Real Estate Trust’s metropolitan Washington, D.C. portfolio is slightly offset by lower revenue and occupancy from its other office and industrial properties. In addition the Real Estate Trust acquired an approximately 12,000 square foot office building on May 25, 2005 which contributed revenue of $591,000 to fiscal 2006 while contributing revenue of $200,000 to fiscal 2005. Direct operating expenses increased $1.3 million, or 10.9%, due to higher scheduled repair and maintenance costs, utilities and property taxes.

Other income, which includes interest income, income from other real estate properties and other miscellaneous income, increased $998,000, or 70.4%, principally due to higher interest income in the period reflecting both higher interest rates on invested cash and increased cash balances in fiscal 2006 and the receipt of approximately $120,000 from the Virginia Department of Transportation as an initial payment for the granting of various easements relating to a land parcel in Northern Virginia.

Land parcels and other expense increased $105,000, or 9.8%, in fiscal 2006 when compared to fiscal 2005 as a result of increased operating expenses at the Real Estate Trust’s other real estate properties, including the land parcels purchased in fiscal 2005.

Interest and amortization of debt expense increased $4.0 million in fiscal 2006 when compared to fiscal 2005. Included in fiscal 2006 is a write-off of unamortized debt costs of $106,000 associated with the early pay-off of a mortgage that had secured six operating properties and a defeasance premium of $829,000 associated with the payoff of the mortgage assumed by the Real Estate Trust with the November 1, 2005 hotel property purchase. In addition to these one-time charges other increases included additional line of credit interest of approximately $786,000, interest on the unsecured bridge loan of approximately $597,000 and increased mortgage interest, other interest and debt amortization of approximately $3.7 million which were partially offset by increased capitalized interest of $1.1 million and lower unsecured note interest of $894,000. The increase in mortgage interest and debt amortization reflects the significant refinancing activity undertaken by the Real Estate Trust during fiscal 2006. The average balance of outstanding borrowings increased to $684.1 million in fiscal 2006 from $608.9 million in fiscal 2005, due to higher mortgage balances, line of credit borrowings and the unsecured bridge loan borrowing which offset lower unsecured note balances. The average cost of borrowings decreased from 7.85% in fiscal 2005 to 7.44% in fiscal 2006.

Depreciation expense increased $1.5 million, or 8.0%, reflecting recent hotel acquisitions and capital improvements in both the hotel and office and industrial portfolios that have been placed in service during fiscal 2006 and the prior fiscal year.

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Advisory, management and leasing fees paid to related parties increased $2.0 million, or 15.1%, in fiscal 2006 when compared to fiscal 2005. The advisory fee in fiscal 2006 increased $876,000 over fiscal 2005 due to a contractual increase in the monthly payments. The remainder of the increase, totaling approximately $1.1 million, was due mainly to higher hotel management fees reflecting the 29.0% increase in hotel revenue.

General and administrative expense decreased $265,000, or 7.7%, in fiscal 2006 when compared to fiscal 2005. The decrease was mainly attributable to lower legal and accounting fees, as well as lower costs associated with the write off of development expenses for projects that the Real Estate Trust has decided not to pursue. These decreases were slightly offset by an increase in marketing costs for new development projects.

Equity in earnings of unconsolidated entities reflected net earnings of $10.0 million in fiscal 2006 as compared to $8.2 million in fiscal 2005, an increase of $1.8 million, or 21.9%. Earnings from Saul Holdings Partnership and Saul Centers were higher by $1.7 million in fiscal 2006 primarily due to increases in operating income generated as a result of the acquisition, development and redevelopment activity of those entities. Losses from other investments totaled $503,000 in fiscal 2006 compared to $582,000 in fiscal 2005. These losses are a result of a write-down of a non-public investment accounted for under the equity method.

In February 2006, the Real Estate Trust was notified that a 3.71 acre parcel of land had been condemned by the Virginia Department of Transportation. Proceeds of approximately $708,000 were originally placed in escrow then received by the Real Estate Trust on August 8, 2006. An initial gain of $416,000 was recorded.

On July 11, 2005, approximately 22 acres of the Real Estate Trust’s 159 acre land parcel in Overland Park, Kansas was acquired by the Kansas Department of Transportation through a condemnation proceeding. The Real Estate Trust was awarded approximately $1.2 million which resulted in a gain of $263,000.

Included in income (loss) from operations of discontinued real estate assets for fiscal 2006 and 2005 are three hotel properties and two other real estate properties. The sales of the hotel properties closed in December 2004, December 2005 and January 2006, respectively. The sales of the other real estate assets closed in January 2005 and February 2006, respectively.

Income from operations of discontinued real estate assets totaled $4.2 million in fiscal 2006 period. During fiscal 2005, the Real Estate Trust determined that it would sell two of its hotel properties. The sale of one of these properties closed on December 16, 2005 and the sale of the second property closed on January 19, 2006. Net operating results for these two hotels for fiscal 2006 produced income from operations of discontinued real estate assets of approximately $1.3 million for the 2006 period, which includes a combined gain on sale of approximately $3.4 million, and a loss from operations of discontinued real estate assets of $2.1 million. Included in the loss from operations is $1.8 million of costs associated with the defeasance of a mortgage which secured one of the hotel properties. Also included in income from operations of discontinued real estate assets in fiscal 2006 is a gain on the sale of one of the Real Estate Trust’s other real estate assets of $2.9 million and income from operations of that asset of approximately $47,000. This asset was sold on February 23, 2006.

Loss from operations of discontinued real estate assets totaled $1.5 million for fiscal 2005. Included, are operating losses of $920,000 for the two hotels which were sold in fiscal 2006 and an operating loss of $1.8 million for the hotel that was sold in December 2004. Included in the $1.8 million operating loss is $1.6 million of costs associated with the defeasance of the mortgage which the hotel property secured, including a $1.5 million prepayment premium and an additional loss of $17,000 which reflects the difference between the actual loss on the sale of the hotel property and the estimated loss recorded in fiscal 2004. Also included in the fiscal 2005 net loss is operating income of approximately $284,000 associated with the other real estate property sold in February 2006 and an approximately $900,000 gain on sale and $12,000 operating income from the other real estate asset sold in January 2005.

BANKING

Overview. The Bank recorded operating income of $138.8 million for the year ended September 30, 2006, compared to operating income of $189.7 million for the year ended September 30, 2005. The decrease in operating income reflects decreases in servicing, securitization and mortgage banking income and automobile rental income, as well as increases in salaries and employee benefits, servicing assets amortization and other loan expenses and other operating expenses. An increase in net interest income and a decrease in depreciation and amortization partially offset the decreased income. During fiscal year 2006, primarily as a result of higher residential mortgage loan prepayments, and anticipation that prepayment levels will remain high in the short-term as a result of the relatively small differential between short- and long-term interest rates, the Bank increased its prepayment speed assumptions and reduced the carrying value of its interest-only strips receivable and servicing assets which are included on the Condensed Consolidated Statement of Operations in servicing, securitization and mortgage banking income and servicing assets amortization and other loan expenses, respectively.

Net Interest Income. Net interest income, before the provision for loan losses, increased $51.2 million (or 13.9%) in fiscal year 2006. The Bank recorded $1.5 million of interest income on non-accrual and restructured loans during fiscal year 2006. The Bank would have recorded additional interest income of $0.3 million during fiscal year 2006 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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Interest income in fiscal year 2006 increased $162.2 million (or 28.2%) from fiscal year 2005 primarily as a result of higher average yields on loans receivable and higher average balances of mortgage-backed securities.

The Bank’s net interest spread increased to 3.14% in fiscal year 2006 from 2.91% in fiscal year 2005. The 22 basis point increase was primarily the result of a 115 basis point increase in the average yield on loans which was partially offset by an 85 basis point increase in the cost of both deposits and borrowings. The ratio of average interest-earning assets to average interest-bearing liabilities increased to 106.2% for fiscal year 2006 compared to 105.8% for fiscal year 2005.

Interest income on loans, the largest category of interest-earning assets, increased to $669.2 million for fiscal year 2006 from $531.9 million for fiscal year 2005 primarily because of higher average yields. The average yield on the loan portfolio increased to 5.96% from 4.81% from fiscal year 2005, reflecting increases in the various indices on which interest rates of adjustable rate loans are based. Interest income on residential mortgage loans increased $86.1 million due to a $132.4 million increase in average balances as well as a 102 basis point increase in the average yield (to 5.48% from 4.46%) during fiscal year 2006. Also contributing to the increased interest income on loans were higher average yields on home equity loans, which resulted in a $25.2 million (or 27.2%) increase in interest income on those loans. Higher average balances of and higher average yields on residential construction loans and commercial loans resulted in a $18.7 million (or 105.3%) and a $16.7 million (or 31.9%) increase in interest income on those loans, respectively. Lower average yields and lower average balances of automobile loans resulted in a $8.3 million (or 55.4%) decrease in interest income on those loans.

Interest income on mortgage-backed securities increased $18.3 million (or 67.1%) primarily due to an increase in the average balance of those securities.

Interest expense on deposits increased $83.9 million (or 87.8%) during fiscal year 2006. The increase resulted primarily from an 84 basis point increase in the average rate on deposits (to 2.03% from 1.19%) due to increased rates paid by the Bank in response to higher market interest rates. An $826.8 million increase in average deposit balances also contributed to the increase in interest expense.

Interest expense on borrowings increased $27.0 million (or 24.2%) in fiscal year 2006 compared to fiscal year 2005. Interest expense on advances from the FHLB of Atlanta increased $10.6 million (or 11.5%) due primarily to higher average rates paid on the advances which was partially offset by lower average balances. Higher average balances of and higher average rates paid on other borrowings increased interest expense by $16.4 million on those borrowings.

Credit for Loan Losses. During fiscal year 2006, the Bank recorded a credit for loan losses of $9.0 million, compared to a credit for loan losses of $11.6 million in fiscal year 2005. The credits reflected the improvement in the overall credit quality of the Bank’s loan portfolio resulting from further declines in the remaining subprime automobile and indirect consumer loan portfolios. See “Financial Condition – Asset Quality – Allowances for Losses.”

Other income. Other income decreased to $392.6 million in fiscal year 2006 from $440.2 million in fiscal year 2005 period. The $47.6 million (or 10.8%) decrease was primarily attributable to decreases in servicing, securitization and mortgage banking income and automobile rental income. Those decreases were partially offset by an increase in deposit servicing fees.

Servicing, securitization and mortgage banking income decreased to $156.4 million in fiscal year 2006, from $169.5 million in fiscal year 2005, a 7.7% decrease. During fiscal year 2006, the Bank securitized and/or sold $5.4 billion of loans and recognized gains of $118.8 million. During fiscal year 2005 the Bank securitized and/or sold $6.5 billion of loans and recognized gains of $185.5 million. The Bank recorded a fair value write-down on its interest-only assets of $88.3 million during the current fiscal year compared to $121.0 million in the prior fiscal year.

Automobile rental income decreased to $35.2 million in fiscal year 2006 from $82.0 million in the prior fiscal year. The $46.8 million decrease resulted primarily from a $180.6 million (or 61.4%) decrease in average outstanding leases as a result of the Bank’s prior decision to discontinue origination of automobile leases.

Deposit servicing fees increased $8.3 million (or 6.1%) in fiscal year 2006 primarily due to fees generated from the continued expansion of the Bank’s branch and ATM networks.

Operating Expenses. Operating expenses during fiscal year 2006 increased $51.9 million from fiscal year 2005. The increase was largely due to increases in salaries and employee benefits, servicing assets amortization and other loan expenses and other operating expenses which were partially offset by a reduction in depreciation and amortization.

Salaries and employee benefits increased $42.8 million (or 16.0%) in fiscal year 2006 due primarily to the opening of 16 new branches and expanded hours of operation at the Bank’s branches.

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Servicing assets amortization and other loan expenses increased to $103.7 million in fiscal year 2006 from $96.6 million in fiscal year 2005. The increase resulted primarily from an increase in servicing assets amortization to $83.4 million for fiscal year 2006 compared to $62.9 million for fiscal year 2005. Partially offsetting this increase, the mortgage servicing rights valuation allowance provision decreased to $2.6 million in fiscal year 2006 from $19.9 million in fiscal year 2005.

Depreciation and amortization expense decreased $33.9 million (or 32.8%) in the current fiscal year. Depreciation expense related to automobiles subject to lease decreased $37.5 million, to $23.3 million for fiscal year 2006, due to lower levels of outstanding leases resulting from the continued run-off of that discontinued business.

Other expenses increased $19.8 million (or 31.4%) in the current period primarily because the Bank settled for $16.1 million a lawsuit related to its former credit card operations. See Note 32 to the Consolidated Financial Statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information required by this Item is included in Item “7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Banking—Asset and Liability Management.”

77

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements of the Trust and its consolidated subsidiaries are included in this report on the pages indicated and are incorporated herein by reference:

(a)	Report of Independent Registered Public Accounting Firm.	79
(b)	Consolidated Balance Sheets—As of September 30, 2007 and 2006.	80
(c)	Consolidated Statements of Operations—For the years ended September 30, 2007, 2006 and 2005.	81-82
(d)	Consolidated Statements of Comprehensive Income and Changes in Shareholders’ Equity—For the years ended September 30, 2007, 2006 and 2005.	83
(e)	Consolidated Statements of Cash Flows—For the years ended September 30, 2007, 2006 and 2005.	84-85
(f)	Notes to Consolidated Financial Statements.	86-134

Summary financial information with respect to the Bank is also included in Part I, Item 1.

78

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TRUSTEES AND SHAREHOLDERS

B.F. SAUL REAL ESTATE INVESTMENT TRUST

We have audited the accompanying consolidated balance sheets of B.F. Saul Real Estate Investment Trust (“the Trust”) as of September 30, 2007 and 2006, and the related consolidated statements of operations, comprehensive income and changes in shareholders’ equity and cash flows for each of the three years in the period ended September 30, 2007. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These consolidated financial statements and schedules are the responsibility of the Trust’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of B.F. Saul Real Estate Investment Trust as of September 30, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 2007 in conformity with U. S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

As discussed in Note 3 to the consolidated financial statements, the Trust adopted Statement of Financial Accounting Standards No. (“FAS”) 156, “Accounting for Servicing of Financial Assets”, effective October 1, 2006.

/s/ Ernst & Young LLP

McLean, Virginia

December 5, 2007

79

Consolidated Balance Sheets

B. F. SAUL REAL ESTATE INVESTMENT TRUST

	September 30,
(In thousands, except share and per share amounts)	2007			2006
ASSETS
Real Estate
Income-producing properties
Hotel	$	387,759		$	359,805
Office and industrial		265,651			210,015
Other		1,128			1,128
		654,538			570,948
Accumulated depreciation		(236,685	)		(197,855	)
		417,853			373,093
Land parcels		43,354			44,582
Construction in progress		83,756			34,946
Investment in Saul Holdings and Saul Centers		127,079			89,802
Cash and cash equivalents		8,889			46,391
Note receivable - related party		5,400			10,300
Other assets		65,555			63,698
Total real estate assets		751,886			662,812
Banking
Cash and due from banks		357,634			394,309
Interest-bearing deposits		22,465			15,879
Loans held for securitization and/or sale		202,268			467,574
Investment securities (market value of $211,745 and $200,152, respectively)		210,363			201,455
Mortgage-backed securities (market value of $1,040,424 and $1,266,970, respectively)		1,053,433			1,289,718
Loans receivable (net of allowance for losses of $29,000 and $25,000, respectively)		11,637,789			10,120,821
Federal Home Loan Bank stock		115,327			85,449
Property and equipment, net		645,521			601,592
Automobiles subject to lease, net		6,973			55,448
Goodwill and other intangible assets, net		45,425			39,970
Mortgage interest-only assets		314,111			344,317
Mortgage servicing assets		155,680			168,059
Other assets		322,074			356,530
Total banking assets		15,089,063			14,141,121
TOTAL ASSETS	$	15,840,949		$	14,803,933
LIABILITIES
Real Estate
Mortgage notes payable	$	579,639		$	488,339
Notes payable - secured		250,000			250,000
Revolving credit facilities outstanding		14,000			—
Notes payable - unsecured		—			21,398
Other liabilities and accrued expenses		41,563			31,361
Deferred tax liability, net		37,970			41,281
Total real estate liabilities		923,172			832,379
Banking
Deposit accounts		10,949,577			10,445,764
Securities sold under repurchase agreements and other short-term borrowings		563,898			822,639
Federal Home Loan Bank advances		2,007,274			1,343,312
Custodial accounts		98,613			103,903
Amounts due to banks		60,604			64,105
Other liabilities		246,558			237,736
Capital notes - subordinated		175,000			175,000
Total banking liabilities		14,101,524			13,192,459
Commitments and contingencies
Minority interest held by affiliates		138,305			130,529
Minority interest—other		296,013			296,013
TOTAL LIABILITIES		15,459,014			14,451,380
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		325,675			296,293
		425,776			396,394
Less cost of 1,834,088 common shares of beneficial interest in treasury		(43,841	)		(43,841	)
TOTAL SHAREHOLDERS’ EQUITY		381,935			352,553
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	15,840,949		$	14,803,933

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

80

Consolidated Statements of Operations

B. F. SAUL REAL ESTATE INVESTMENT TRUST

	For the Year Ended September 30,
(In thousands, except per share amounts)	2007			2006			2005
REAL ESTATE
Income
Hotels	$	144,665		$	127,238		$	98,621
Office and industrial (including $6,229, $5,792 and $5,391 of rental income earned from banking segment, respectively)		43,475			39,984			39,466
Sales of townhomes		9,820			—			—
Other		1,585			2,415			1,417
Total income		199,545			169,637			139,504
Expenses
Direct operating expenses:
Hotels		92,499			78,041			60,002
Office and industrial properties		16,056			13,374			12,057
Land parcels and other		1,336			1,177			1,072
Cost of sales, townhomes		8,267			—			—
Interest and amortization of debt expense		54,043			50,516			46,503
Depreciation		22,758			20,390			18,878
Advisory, management and leasing fees—related parties		16,696			15,480			13,448
General and administrative		4,462			3,156			3,421
Total expenses		216,117			182,134			155,381
Equity in earnings (losses) of unconsolidated entities:
Saul Holdings and Saul Centers		12,540			10,554			8,828
Other, including impairment		—			(503	)		(582	)
Gain on sales of property		1,534			416			263
REAL ESTATE OPERATING LOSS	$	(2,498	)	$	(2,030	)	$	(7,368	)
BANKING
Interest income
Loans	$	743,264		$	669,154		$	531,859
Mortgage-backed securities		57,738			45,581			27,285
Other		25,817			22,611			15,989
Total interest income		826,819			737,346			575,133
Interest expense
Deposit accounts		256,913			179,563			95,631
Short-term borrowings		96,210			96,913			67,275
Long-term borrowings		35,168			41,695			44,287
Total interest expense		388,291			318,171			207,193
Net interest income		438,528			419,175			367,940
Provision (credit) for loan losses		3,383			(9,004	)		(11,569	)
Net interest income after credit for loan losses		435,145			428,179			379,509
Other income
Deposit servicing fees		153,574			144,548			136,279
Servicing, securitization and mortgage banking income		145,757			156,438			169,472
Automobile rental income, net		8,309			35,196			81,963
Asset management fees		38,927			33,291			18,803
Other		24,212			23,103			33,713
Total other income		370,779			392,576			440,230

Continued on following page.

81

Consolidated Statements of Operations (Continued)

B. F. SAUL REAL ESTATE INVESTMENT TRUST

	For the Year Ended September 30,
(In thousands, except per share amounts)	2007			2006			2005
BANKING (Continued)
Operating expenses
Salaries and employee benefits	$	350,047		$	309,365		$	266,601
Servicing assets amortization and other loan expenses		93,139			103,696			96,632
Property and equipment (including $6,229, $5,792 and $5,391 of rental expense paid to real estate segment, respectively)		66,990			55,832			46,615
Marketing		20,583			22,161			19,248
Data processing		43,783			38,713			34,664
Depreciation and amortization		52,273			69,465			103,319
Other		68,305			82,720			62,965
Total operating expenses		695,120			681,952			630,044
BANKING OPERATING INCOME	$	110,804		$	138,803		$	189,695
TOTAL COMPANY
Income from continuing operations before income taxes and minority interest	$	108,306		$	136,773		$	182,327
Income tax provision		35,435			39,663			59,141
Income from continuing operations before minority interest		72,871			97,110			123,186
Minority interest held by affiliates		(9,041	)		(13,597	)		(19,516	)
Minority interest — other		(29,213	)		(29,141	)		(29,071	)
INCOME FROM CONTINUING OPERATIONS		34,617			54,372			74,599
Discontinued real estate operations:
Income (loss) from operations of discontinued real estate assets (including net gain on disposal of $—, $6,286, $882, respectively)		—			4,225			(1,537	)
Income tax expense (benefit)		—			1,635			(536	)
INCOME (LOSS) ON DISCONTINUED REAL ESTATE OPERATIONS		—			2,590			(1,001	)
TOTAL COMPANY NET INCOME	$	34,617		$	56,962		$	73,598
Dividends: Real Estate Trust’s preferred shares of beneficial interest		(5,418	)		(5,418	)		(5,418	)
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS	$	29,199		$	51,544		$	68,180
NET INCOME (LOSS) PER COMMON SHARE
Income from continuing operations	$	6.07		$	10.18		$	14.39
Discontinued operations		—			0.54			(0.21	)
NET INCOME PER COMMON SHARE (BASIC AND DILUTED)	$	6.07		$	10.72		$	14.18
DISTRIBUTIONS DECLARED PER COMMON SHARE	$	1.37		$	1.37		$	1.37

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

82

Consolidated Statements of Comprehensive Income and Changes in Shareholders’ Equity

B. F. SAUL REAL ESTATE INVESTMENT TRUST

	For the Year Ended September 30,
(Dollars in thousands, except share amounts)	2007			2006			2005
COMPREHENSIVE INCOME
Net income	$	34,617		$	56,962		$	73,598
Other comprehensive income		—			—			—
TOTAL COMPREHENSIVE INCOME	$	34,617		$	56,962		$	73,598
CHANGES IN SHAREHOLDERS’ EQUITY
PREFERRED SHARES OF BENEFICIAL INTEREST
Beginning and end of year (516,000 shares)	$	516		$	516		$	516
COMMON SHARES OF BENEFICIAL INTEREST
Beginning and end of year (6,641,598 shares)		6,642			6,642			6,642
PAID-IN SURPLUS
Beginning and end of year		92,943			92,943			92,943
RETAINED EARNINGS
Beginning of year		296,293			249,083			185,342
Net income		34,617			56,962			73,598
Adjustments:
Saul Holdings investment, net of taxes of $2,913, $1,210 and $1,309, respectively		5,410			2,248			2,427
Other		(1,917	)		—			(284	)
Dividends:
Real Estate Trust preferred shares of beneficial interest		(5,418	)		(5,418	)		(5,418	)
Real Estate Trust common shares of beneficial interest		(6,582	)		(6,582	)		(6,582	)
Cumulative effect of a change in accounting principle, net of tax		3,272			—			—
End of year		325,675			296,293			249,083
TREASURY SHARES
Beginning and end of year (1,834,088 shares)		(43,841	)		(43,841	)		(43,841	)
TOTAL SHAREHOLDERS’ EQUITY	$	381,935		$	352,553		$	305,343

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

83

Consolidated Statements of Cash Flows

B. F. SAUL REAL ESTATE INVESTMENT TRUST

	For the Year Ended September 30,
(In thousands)	2007			2006			2005
CASH FLOWS FROM OPERATING ACTIVITIES
Real Estate
Net loss	$	(1,548	)	$	2,574		$	(4,465	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Net gains on sale of property		(1,534	)		(6,702	)		(1,145	)
Depreciation		22,758			20,390			19,857
Amortization of debt expense		2,346			2,672			2,197
Equity in net earnings of unconsolidated entities, net of net distributions of $—, $5,636 and $4,910, respectively		(12,540	)		(4,415	)		(3,336	)
Deferred tax expense (benefit)		72			4,121			(922	)
Increase in accounts receivable and accrued income		(1,021	)		(7,051	)		(4,438	)
Increase (decrease) in accounts payable and accrued expenses		1,368			2,318			(493	)
Dividends and tax sharing payments		20,039			34,031			41,320
Other		(2,383	)		(5,137	)		488
		27,557			42,801			49,063
Banking
Net income		36,165			54,388			78,063
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Amortization of premiums, discounts and net deferred loan fees		35,644			36,597			40,399
Decrease in income taxes payable		(4,567	)		(40,900	)		(44,853	)
Depreciation and amortization		52,273			69,465			103,319
Provision (credit) for loan losses		3,383			(9,004	)		(11,569	)
Minority interest held by affiliates		9,041			13,597			19,516
Minority interest—other		10,000			10,000			10,000
Proceeds from sales of trading securities		568,923			224,536			192,105
Purchases and net fundings of loans held for securitization and/or sale		(3,329,777	)		(4,186,104	)		(5,620,487	)
Proceeds from sales of loans held for securitization and/or sale		3,389,467			4,959,043			5,910,562
(Increase) decrease in interest-only strips receivable		30,206			3,910			(60,387	)
(Increase) decrease in servicing assets		19,102			(3,466	)		(16,737	)
(Increase) decrease in other assets		50,917			(88,792	)		(88,963	)
Increase (decrease) in custodial accounts		(5,290	)		(18,767	)		4,956
Increase in other liabilities		7,256			65,549			19,255
Other		540			(890	)		18,633
		873,283			1,089,162			553,812
Net cash provided by operating activities		900,840			1,131,963			602,875
CASH FLOWS FROM INVESTING ACTIVITIES
Real Estate
Property acquisitions		(47,187	)		(108,029	)		(13,532	)
Development/redevelopment expenditures		(58,852	)		(20,973	)		—
Capital expenditures		(19,098	)		(31,835	)		(16,414	)
Property sales, net		1,810			17,146			4,715
Note receivable and accrued interest — related party repayments/(advances), net		4,900			2,800			(5,423	)
Equity investment in Saul Holdings and Saul Centers		(16,413	)		(6,104	)		(5,901	)
Other investments		110			(431	)		(776	)
		(134,730	)		(147,426	)		(37,331	)
Banking
Purchases of investment securities		(8,350	)		—			(129,401	)
Proceeds from redemption of Federal Home Loan Bank stock		299,208			273,074			282,492
Purchases of Federal Home Loan Bank stock		(329,086	)		(222,430	)		(279,238	)
Net principal collected on loans		4,668,503			5,505,242			5,451,943
Net funding and purchases of loans receivable		(6,606,380	)		(6,770,029	)		(7,235,055	)
Proceeds from sales of loans transferred to loans held for securitization and/or sale		2,052			181,995			405,483
Principal collected on mortgage-backed securities		269,789			184,810			217,497
Purchases of mortgage-backed securities		(36,577	)		(126,788	)		(299,866	)
Proceeds from sales of automobiles subject to lease		42,888			106,333			189,540
Net purchases of property and equipment		(118,036	)		(115,036	)		(84,577	)
Net proceeds from sales of property and equipment		26,476			701			—
Net proceeds from sales of real estate		18,561			4,707			12,031
Disbursements for real estate held for sale		(15,546	)		(11,793	)		(5,895	)
Purchases of investment management companies		(5,902	)		(9,552	)		(7,019	)
		(1,792,400	)		(998,766	)		(1,482,065	)
Net cash used in investing activities		(1,927,130	)		(1,146,192	)		(1,519,396	)

Continued on following page.

84

Consolidated Statements of Cash Flows (Continued)

B. F. SAUL REAL ESTATE INVESTMENT TRUST

	For the Year Ended September 30,
(In thousands)	2007			2006			2005
CASH FLOWS FROM FINANCING ACTIVITIES
Real Estate
Proceeds from mortgage financing	$	118,142		$	294,882		$	—
Principal curtailments and repayments of mortgages		(26,842	)		(106,108	)		(15,793	)
Proceeds from secured revolving credit facilities		117,200			60,000			—
Repayments of secured revolving credit facilities		(103,200	)		(60,000	)		—
Proceeds from unsecured bridge loan		—			86,193			—
Repayments of unsecured bridge loan		—			(86,193	)		—
Proceeds from sales of unsecured notes		—			935			5,674
Repayments of unsecured notes		(21,398	)		(37,297	)		(4,342	)
Costs of obtaining financings		(2,231	)		(3,316	)		(3,193	)
Cash dividends paid on preferred stock		(5,418	)		(5,418	)		(5,418	)
Cash dividends paid on common stock		(6,582	)		(6,582	)		(6,582	)
		69,671			137,096			(29,654	)
Banking
Proceeds from customer deposits and sales of certificates of deposit		96,168,357			83,202,385			72,320,724
Customer withdrawals of deposits and payments for maturing certificates of deposit		(95,664,544	)		(82,538,389	)		(71,394,073	)
Capital contribution from parent		9,995			—			1,418
Advances from the Federal Home Loan Bank		17,036,411			19,764,354			23,046,342
Repayments of advances from the Federal Home Loan Bank		(16,372,449	)		(20,889,782	)		(23,314,541	)
Net increase in other borrowings		(258,742	)		323,725			292,334
Cash dividends paid on preferred stock		(10,000	)		(10,000	)		(10,000	)
Cash dividends paid on common stock		(20,000	)		(40,000	)		(49,000	)
		889,028			(187,707	)		893,204
Net cash provided by (used in) financing activities		958,699			(50,611	)		863,550
Decrease in cash and cash equivalents		(67,591	)		(64,840	)		(52,971	)
Cash and cash equivalents at beginning of year		456,579			521,419			574,390
Cash and cash equivalents at end of year	$	388,988		$	456,579		$	521,419
Components of cash and cash equivalents at end of year as presented in the consolidated balance sheets:
Real Estate
Cash and cash equivalents	$	8,889		$	46,391		$	13,920
Banking
Cash and due from banks		357,634			394,309			438,074
Interest-bearing deposits		22,465			15,879			69,425
Cash and cash equivalents at end of year	$	388,988		$	456,579		$	521,419
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	432,382		$	352,104		$	253,831
Income taxes paid, net		4,509			82,861			140,850
Shares of Saul Centers, Inc. common stock		32,592			9,895			12,591
Cash received during the year from:
Dividends on shares of Saul Centers, Inc. common stock		8,649			7,588			6,703
Distributions from Saul Holdings Limited Partnership		7,530			7,233			6,569
Supplemental disclosures of noncash activities:
Rollovers of notes payable—unsecured		—			823			7,247
Loans held for securitization and/or sale exchanged for trading securities		567,903			222,742			190,578
Loans receivable transferred to real estate acquired in settlement of loans		18,603			4,653			4,657
Loans receivable exchanged for mortgage-backed securities held-to-maturity		—			486,010			364,577
Loans receivable transferred to loans held for sale and/or securitization		—			—			693,567
Loans held for securitization and/or sale transferred to loans receivable		1,320,203			—			—
Assumption of debt not included in cash paid for acquisition of property		—			5,830			—

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

85

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – TRUST:

GENERAL

B.F. Saul Real Estate Investment Trust operates as a Maryland real estate investment trust. The principal business activities of B.F. Saul Real Estate Investment Trust and its consolidated subsidiaries (the “Trust” or “Total Company”) are the ownership of 80% of the outstanding common stock of Chevy Chase Bank, F.S.B., whose assets accounted for 95% of the Trust’s consolidated assets as of September 30, 2007, and the ownership and development of income-producing properties. The properties are located predominantly in the Mid-Atlantic and Southeastern regions of the United States and consist principally of hotels, office projects, and undeveloped land parcels. Chevy Chase Bank, F.S.B. is a federally chartered and federally insured stock savings bank and, as such, is subject to comprehensive regulation, examination and supervision by the Office of Thrift Supervision (“OTS”) and by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is principally engaged in the business of attracting deposits from the public and using such deposits, together with borrowings and other funds, to make loans secured by real estate, primarily residential mortgage loans, and various types of consumer loans and leases and commercial loans. The Bank’s principal deposit market is the Washington, DC metropolitan area.

“Real Estate Trust” or “Real Estate” refers to B.F. Saul Real Estate Investment Trust and its wholly owned subsidiaries. Chevy Chase Bank, F.S.B. and its subsidiaries are referred to in the consolidated financial statements and notes thereto as “Banking” or the “Bank” or the “Corporations”. The accounting and reporting practices of the Trust conform to accounting principles generally accepted in the United States and, as appropriate, predominant practices within the real estate and banking industries.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Real Estate Trust and its subsidiaries. Accordingly, the accompanying financial statements reflect the assets, liabilities, operating results, and cash flows for two business segments: Real Estate and Banking. Entities in which the Trust holds a non-controlling interest (generally 50% or less) are accounted for on the equity method, see Note 2. All significant inter-company transactions, except as disclosed elsewhere in the financial statements, including inter-company office rental agreements, 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.

USE OF ESTIMATES

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

ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS

Long-lived assets and certain identifiable intangibles to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, the Trust recognizes an impairment loss.

Measurement of an impairment loss for long-lived assets and identifiable intangibles that the Trust expects to hold and use is based on the fair value of the asset. Long-lived assets and certain identifiable intangibles to be disposed of are generally reported at the lower of carrying amount or fair value less the cost to sell.

INCOME TAXES

The Trust files a consolidated federal income tax return which includes operations of all 80% or more owned subsidiaries. It voluntarily terminated its qualification as a real estate investment trust under the Internal Revenue Code during fiscal 1978.

The Trust uses an asset and liability approach in accounting for income taxes. Deferred income taxes are recorded using currently enacted tax laws and rates. To the extent that realization of deferred tax assets is more likely than not, no valuation allowance is recorded to reduce the carrying value of the asset.

86

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NET INCOME PER COMMON SHARE

Net income per common share is determined by dividing net income, after deducting preferred share dividend requirements, by the weighted average number of common shares outstanding during the year. For fiscal years 2007, 2006 and 2005 weighted average number of shares used in the calculation was 4,807,510. The Trust has no common share equivalents.

RECLASSIFICATIONS

Certain reclassifications of prior periods’ information have been made to conform with the presentation of the consolidated financial statements for the year ended September 30, 2007, to assure comparability of all periods presented.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—REAL ESTATE TRUST:

CASH EQUIVALENTS

The Real Estate Trust considers all highly liquid, temporary investments with an original maturity of three months or less and money market accounts to be cash equivalents.

REAL ESTATE INVESTMENT PROPERTIES

Income-producing properties are stated at the lower of depreciated cost (except those which were acquired through foreclosure or equivalent proceedings, the carrying amounts of which are based on the lower of cost or fair value at the time of acquisition) or net realizable value.

The Real Estate Trust purchases real estate investment properties from time to time and allocates the purchase price to various components, such as land, buildings, personal property and intangibles related to in-place leases, customer or franchise relationships and other intangibles in accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) 141, “Business Combinations” and SFAS 142, “Goodwill and Other Intangible Assets.” The purchase price is allocated based on the relative fair value of each component. See Note 7 regarding the Real Estate Trusts purchase of an office building from the Bank.

The fair value of an office building is determined as if the building was vacant upon acquisition and subsequently leased at market rates. As such, the determination of fair value considers the present value of all cash flows to be generated from the property including the initial lease up period. The Real Estate Trust determines the fair value of above and below market intangibles associated with in-place leases by assessing the net effective rent and remaining term of the lease relative to market terms for similar leases at acquisition. In the case of below market leases, the Real Estate Trust considers the remaining contractual lease period and renewal periods, taking into consideration the likelihood of the tenant exercising its renewal options. The fair value of a below market lease component is recorded as deferred income and amortized as additional lease revenue over the remaining contractual lease period and any renewal options included in the valuation analysis. The fair value of above market lease intangibles is recorded as a deferred asset and is amortized as a reduction of lease revenue over the remaining contractual lease term. The Real Estate Trust determines the fair value of at-market in-place leases considering the cost of acquiring similar leases, foregone rents associated with the lease-up period and carrying costs associated with the lease-up period. Intangible assets associated with at-market in-place leases are amortized as additional lease expense over the remaining contractual lease term. To the extent customer relationship intangibles are present in an acquisition, the fair value of the intangibles are amortized over the life of the customer relationship.

The purchase price allocation for the acquisition of a hotel property is determined based on the relative fair vale of the components of the property, which include land, building, personal property, franchise relationships, brand names, any in-place leases and other intangibles. The valuation of the personal property is based on management’s evaluation of the value of such property. The personal property is amortized over its remaining estimated useful life. To the extent that franchise relationship, trade name or other intangibles are present in an acquisition, the fair value of the intangibles are amortized over their estimated useful life or evaluated for impairment under SFAS No. 142, if determined to have an indefinite life. An impairment charge on indefinite lived intangible assets is recognized if the fair value is less than the carrying amount. At September 30, 2007 and 2006, indefinite lived intangible assets totaled $9.0 million, equal to their fair value, and are included in Other Assets on the balance sheet.

Real estate investment properties, including properties under development and land held for future development, are reviewed for potential impairment losses quarterly or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Real Estate Trust has not recognized an impairment loss on any of its real estate.

Depreciation is calculated using the straight-line method and estimated useful lives of 28 to 50 years for buildings and up to 20 years for certain other improvements. Leasehold tenant improvements are amortized over the lesser of their estimated useful lives or the lives of the related leases using the straight-line method. Leasehold tenant improvements are capitalized when certain criteria are met including when the Real Estate Trust supervises construction and will own the improvement at the end of the lease term.

87

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Interest, real estate taxes and other carrying costs are capitalized on projects under development and construction. Once construction is substantially completed and the assets are placed in service, rental income, direct operating expenses, and depreciation associated with such properties are included in current operations. The Real Estate Trust considers a project to be substantially complete and held available for occupancy upon completion of tenant improvements, but no later than one year from the cessation of major construction activity. Substantially completed portions of a project are accounted for as separate projects. Expenditures for repairs and maintenance are charged to operations as incurred. Interest expense capitalized during fiscal 2007 and 2006 totaled $2.1 million and $1.1 million, respectively. There was no capitalization of interest during fiscal 2005.

CONSTRUCTION IN PROGRESS

Construction in progress includes preconstruction costs and development costs of active projects. Preconstruction costs associated with these active projects include legal, zoning and permitting costs and other project carrying costs incurred prior to the commencement of construction. Development costs include direct construction costs and indirect costs incurred subsequent to the start of construction such as architectural, engineering, construction management and carrying costs consisting of interest, real estate taxes and insurance. The Construction in Progress balances as of September 30, 2007 and 2006 are as follows:

Construction in Progress

(In thousands)

	September 30, 2007		September 30, 2006
Tysons Park Place II	$	34,348	$	1,805
Dulles Hampton Inn		23,817		1,864
Circle 75 Townhomes		18,525		9,153
Circle 75 Infrastructure		7,066		7,248
Dulles SpringHill Suites		—		14,876
	$	83,756	$	34,946

Construction of the Dulles SpringHill Suites was substantially completed and the project was placed in service on January 8, 2007.

Construction of the Dulles Hampton Inn was substantially completed and the project opened for business on October 18, 2007.

The decrease in the Circle 75 Infrastructure results from costs being allocated to townhome units upon sale.

INCOME RECOGNITION HOTEL AND OFFICE PORTFOLIO

The Real Estate Trust derives room and other revenues from the operations of its hotel properties. Hotel revenue is recognized as earned. The Real Estate Trust derives rental income under noncancelable long-term leases from tenants at its commercial properties. Commercial property rental income is recognized on a straight-line basis. Expense recoveries at the commercial properties represent a portion of property expenses billed to tenants, including real estate taxes and operating expense recoveries, many of which are subject to base year limits as defined in the applicable lease agreements. Expense recoveries are recognized in the period in which the related expenses are incurred.

INCOME RECOGNITION FROM THE SALE OF TOWNHOMES

The Real Estate Trust is engaged in the development, construction, marketing and sale of residential townhomes where the planned construction cycle is less than 12 months. For these townhomes, in accordance with SFAS No. 66, “Accounting for Sales of Real Estate” (“SFAS 66”), revenue is recognized and costs of sales are recorded when each townhome sale is closed and title is conveyed to the buyer, adequate cash payment is received and there is no continued involvement by the Real Estate Trust.

Cost of townhome sales are determined on an identified cost and relative sales value basis. Changes in estimates of expected sales or costs are accounted for prospectively.

ACCOUNTS RECEIVABLE AND ACCRUED INCOME

Accounts receivable and accrued income of approximately $18.8 million and $16.4 million at September 30, 2007 and 2006, respectively, included in other assets in the financial statements, primarily represents amounts due from commercial property tenants in accordance with the terms of the respective leases and hotel property accounts based on contractual payment obligations. Receivables are reviewed monthly and reserves established with a charge to current period operations when, in the opinion of management, collection of the receivable is doubtful. Accounts receivable from commercial property tenants includes minimum rental income accrued on a straight-line basis to be paid by tenants over the remaining term of their respective leases.

88

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

INVESTMENT IN SAUL HOLDINGS AND SAUL CENTERS

The Real Estate Trust accounts for its investments in Saul Holdings Limited Partnership (“Saul Holdings”) and Saul Centers, Inc. (“Saul Centers”) on the equity method of accounting because the Trust does not have effective control of the respective entities.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The following are the fair values of each class of financial instruments and the methods and assumptions used to estimate the fair values.

Cash and Cash Equivalents, Notes Receivable – Related Party and Accounts Receivable

The carrying amount approximates fair value because of the short-term maturity of these instruments.

Liabilities

The fair market value, and the current carrying amount, of notes payable—secured is $250 million, based on management’s estimate of current market rates and conditions. The fair value of mortgage notes payable, which includes real estate held for sale, is based on management’s estimate of current market rates for its debt. At September 30, 2007, and 2006, the fair value of mortgage notes payable was $582.2 and $496.1 million, respectively while the carrying amounts of the mortgage notes payable was $579.6 and $488.3 million, respectively. The fair value of notes payable—unsecured is based on the rates currently offered by the Real Estate Trust for similar notes. At September 30, 2006 the fair value of notes payable—unsecured was $21.5 million while the carrying amount was $21.4 million. There were no notes payable – unsecured outstanding at September 30, 2007.

LEGAL CONTINGENCIES

The Real Estate Trust is subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are generally covered by insurance. While the resolution of these matters cannot be predicted with certainty, the Real Estate Trust believes that final outcome of such matters will not have a material adverse effect on its financial position or results of operations. Once it has been determined that a loss is probable to occur, the estimated amount of the loss is recorded in the financial statements. Both the amount of the loss and the point at which its occurrence is considered probable can be difficult to determine.

NEW ACCOUNTING STANDARDS – THE TRUST:

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 is an interpretation of FASB Statement No. 109, “Accounting for Income Taxes,” and seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN 48 requires expanded disclosure with respect to the uncertainty in income taxes and is effective as of the beginning of the Trust’s 2008 fiscal year. The Trust is currently evaluating the impact, if any, that FIN 48 will have on the Trust’s financial statements. The Trust believes that FIN 48 will not have a material impact on its financial statements.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – THE BANK:

Cash and Cash Equivalents:

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits, federal funds sold and securities purchased under agreements to resell.

Federal Reserve Board regulations require the Bank to maintain reserves in the form of cash or deposits in its account at the Federal Reserve Bank of Richmond. The Bank’s average reserve requirements, before credit for vault cash, were $88.9, $87.7 and $87.8 million during the years ended September 30, 2007, 2006 and 2005, respectively.

Loans Held for Securitization and/or Sale:

At September 30, 2007, loans held for securitization and/or sale were comprised of single-family residential loans totaling $202.2 million and automobile loans totaling $108,000. At September 30, 2006, loans held for securitization and/or sale were composed of single-family residential loans of $467.6 million. These loans are originated or purchased for sale in the secondary market and are carried at the lower of aggregate cost or aggregate market value. The Bank periodically securitizes and sells certain pools of loan receivables in the public and private markets in transactions that are recorded as sales. Single-family residential loans held for sale will either be sold or will be exchanged for mortgage-backed securities and then sold.

Gains and losses on sales of loans held for securitization and/or sale are determined using the specific identification method.

89

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Investment and Mortgage-Backed Securities:

The Bank classifies its investment and mortgage-backed securities as either “held-to-maturity,” “available-for-sale” or “trading” at the time such securities are acquired. Investment and mortgage-backed securities classified as “held-to-maturity” are reported at amortized cost. Investment and mortgage-backed securities classified as “available-for-sale” are reported at fair value, with unrealized gains and losses, net of the related tax effect, reported as a separate component of stockholders’ equity. Investment and mortgage-backed securities classified as “trading” are reported at fair value, with unrealized gains and losses included in earnings. All investment securities and mortgage-backed securities are classified as held-to-maturity at September 30, 2007 and 2006. Premiums and discounts on investment securities and mortgage-backed securities are amortized or accreted using the level-yield method.

Trading Securities:

As part of its mortgage banking activities, the Bank exchanges certain loans held for sale for mortgage-backed securities and then sells the mortgage-backed securities, which are classified as trading securities, to third party investors in the month of issuance. Proceeds from sales of trading securities were $568.9, $224.5 and $192.1 million during the years ended September 30, 2007, 2006 and 2005, respectively. The Bank realized net gains of $1.0, $1.8 and $2.3 million on the sales of trading securities for the years ended September 30, 2007, 2006 and 2005, respectively. Gains and losses on sales of trading securities are determined using the specific identification method and are included in servicing, securitization and mortgage banking income in the Consolidated Statements of Operations. There were no mortgage-backed securities classified as trading securities at September 30, 2007 and 2006.

Loan Origination and Commitment Fees:

Nonrefundable loan fees, such as origination and commitment fees, and incremental loan origination costs relating to loans originated or purchased, are deferred. Net deferred fees (costs) related to loans held for investment are amortized over the life of the loan using the straight-line method for line of credit loans and the level-yield method for all other loan types. Net fees (costs) related to loans held for sale are deferred until such time as the loan is sold, at which time the net deferred fees (costs) become a component of the gain or loss on sale.

Impaired Loans:

A loan is considered impaired when, based on all current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the agreement, including all scheduled principal and interest payments. Loans reviewed by the Bank for impairment include real estate and commercial loans and loans modified in a troubled debt restructuring. Large groups of smaller-balance homogeneous loans that have not been modified in a troubled debt restructuring are collectively evaluated for impairment, which for the Bank include residential mortgage loans and other consumer loans. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate or, as a practical expedient, impairment may be measured based on the loan’s observable market price, or, if the loan is collateral-dependent, the fair value of the collateral. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance. Loans for which foreclosure is probable continue to be classified as loans.

Each impaired real estate or commercial loan is evaluated individually to determine the income recognition policy. Generally, payments received are applied as a reduction of principal. At September 30, 2007 and 2006, the Bank had no impaired loans. The Bank did not recognize any interest income on impaired loans during the years ended September 30, 2007, 2006 and 2005.

Allowance for Loan Losses:

The allowance for loan losses represents management’s estimate of credit losses inherent in the Bank’s loan portfolios as of the balance sheet date. The Bank’s methodology for assessing the appropriate level of the allowance consists of several key elements, which include the allocated allowance, specific allowances for identified problem loans and the unallocated allowance. Management reviews the adequacy of the allowance for loan losses using a variety of measures and tools including historical loss performance, delinquent status, current economic conditions, internal risk ratings and current underwriting policies and procedures.

The allocated allowance is assessed on both homogeneous and non-homogeneous loan portfolios. A range is calculated by applying loss and delinquency factors to the outstanding loan balances of these portfolios. Loss factors are based on analysis of the historical performance of each loan category and an assessment of portfolio trends and conditions, as well as specific risk factors impacting the loan portfolios. Each homogeneous portfolio is evaluated collectively. In addition, at September 30, 2007, the Bank performed an analysis of the underlying collateral on all single-family loans that are greater than two payments delinquent.

Non-homogeneous type loans, such as commercial banking loans and real estate banking loans, are analyzed and segregated by risk according to the Bank’s internal risk rating system. These loans are reviewed by the Bank’s credit and loan review groups on an individual loan basis to assign a risk rating. Industry loss factors are applied based on the risk rating assigned to the loan. A specific allowance may be assigned to individually identified non-homogeneous type loans that have been determined to be impaired. Any specific allowance considers all available evidence including, as appropriate, the present value of payments expected to be received, observable market price or, for loans that are solely dependent on collateral for repayment, the estimated fair value of the collateral.

90

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The unallocated allowance is based upon management’s evaluation and judgment of various conditions that are not directly measured in the determination of the allocated and specific allowances. The conditions evaluated in connection with the unallocated allowance include existing general economic and business conditions affecting the key lending areas of the Bank, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience in particular segments of the portfolio, regulatory examination results and findings of the Bank’s internal credit evaluations. At September 30, 2007 and 2006, most of the unallocated allowance relates to risks inherent in the mortgage loan portfolio, including, for example, geographic concentration and increased delinquent and non-accrual loans.

The allowance for losses is based on estimates and ultimate losses may vary from current estimates. As adjustments to the allowance become necessary, provisions for losses are reported in operations in the periods they are determined to be necessary.

Accrued Interest Receivable on Loans:

Loans are reviewed on a monthly basis and are placed on non-accrual status when, in the opinion of management, the full collection of principal or interest has become unlikely. Uncollectible accrued interest receivable on non-accrual loans is charged against current period interest income. Loans on non-accrual status totaled $87.1 and $31.4 million at September 30, 2007 and 2006, respectively.

Real Estate Held for Sale:

Real estate held for sale, included in other assets on the Consolidated Statements of Financial Condition, consists of real estate acquired in settlement of loans (“REO”) and is carried at the lower of cost or fair value (less estimated selling costs). Costs relating to the development and improvement of property, including interest, are capitalized, whereas costs relating to the holding of property are expensed. REO totaled $48.4 and $32.3 million at September 30, 2007 and 2006, respectively.

Property and Equipment:

Property and equipment is stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method, which allocates the cost of the applicable assets over their estimated useful lives as set forth in Note 18. Major improvements and alterations to office premises and leaseholds are capitalized. Leasehold and tenant improvements are amortized over the shorter of the terms of the respective leases (including renewal options that are expected to be exercised) or up to 40 years. Maintenance and repairs are charged to operating expenses as incurred.

Automobiles Subject to Lease:

The Bank owns automobiles, which are leased to third parties. The leases are accounted for as operating leases with lease payments recognized as rental income. Automobiles are stated at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method which allocates the cost of the automobile less estimated residual value over the term of the lease. The Bank periodically updates the estimated residual values of its automobile leases. If estimated residual values have declined from the prior estimate, the amount of the decline is recorded as additional depreciation expense over the remaining term of the lease.

Goodwill and Other Intangible Assets:

Goodwill is not amortized, but, instead, is periodically tested for impairment. An impairment loss on goodwill is recognized if the fair value is less than the carrying amount. At September 30, 2007 and 2006, the fair value of the goodwill recorded on the Bank’s balance sheet exceeded its carrying value. At September 30, 2007 and 2006, goodwill totaled $43.2 and $37.3 million, respectively.

In July 2005, a subsidiary of the Bank purchased an investment management company and recorded goodwill of $5.9 million and a separately identified intangible asset of $1.1 million. The separately identified intangible asset is being amortized over its expected life. The subsidiary was required to pay an additional $750,000 during each of fiscal year 2007 and 2006, which was capitalized as goodwill.

In October 2005, another subsidiary of the Bank purchased an investment management company and recorded goodwill of $6.9 million and a separately identified intangible asset of $1.9 million. The intangible asset is being amortized over its expected life. The subsidiary was required to pay an additional $5.2 million during the fiscal year 2007 and could be required to pay an additional $13.7 million over the next two years, if certain contingencies are satisfied.

The premium attributable to the value of home equity relationships related to certain home equity loans purchased in fiscal 1999, amounting to $131,000 and $165,000, net, at September 30, 2007 and 2006, respectively, is included in goodwill and other intangible assets in the Consolidated Statements of Financial Condition. This premium is being amortized over the estimated term of the underlying relationships. The Bank did not purchase any home equity loans during fiscal years 2007, 2006 and 2005.

Accumulated amortization of other intangible assets was $12.1 and $11.7 million at September 30, 2007 and 2006, respectively.

91

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Servicing Assets:

Servicing assets are recorded when purchased and in conjunction with loan sale and securitization transactions. Prior to October 1, 2006, servicing assets were stated net of accumulated amortization and were amortized in proportion to the remaining net servicing revenues estimated to be generated by the underlying loans. Effective October 1, 2006, servicing assets are carried at their fair value.

The fair value of servicing assets is estimated using projected cash flows, adjusted for the effect of anticipated prepayments, and a market discount rate. See Note 16.

Interest-Only Strips Receivable:

The Bank accounts for its interest-only certificates and/or interest-only strips receivable (collectively, “interest-only assets”) as trading securities and, accordingly, carries them at fair value. The Bank uses certain assumptions to calculate the carrying values of the interest-only assets, mainly estimates of prepayment speeds, credit losses and interest rates, which are beyond the control of the Bank. To the extent actual results differ from the assumptions, the carrying values are adjusted accordingly. The fair value adjustments for interest-only assets are included in servicing, securitization and mortgage banking income. Fair value write downs of $8.9, $88.3 and $121.0 million were recorded in the years ended September 30, 2007, 2006 and 2005, respectively.

Interest-only assets capitalized in the years ended September 30, 2007, 2006 and 2005 amounted to $100.3, $208.1 and $275.4 million, respectively, and were related to the securitization and sale of loan receivables. See Note 17.

Derivative Financial Instruments:

The Bank uses derivative financial instruments to reduce interest-rate risk with respect to its mortgage banking activities. At September 30, 2007 and 2006, all derivatives are recorded on the balance sheet at their fair market value. See Note 29.

Marketing:

Advertising costs are expensed as incurred. In August 2006, the Bank entered into a multi-year naming rights agreement with the University of Maryland. Under the agreement the Bank has certain marketing rights, including the right to name the playing surface at Byrd Stadium “Chevy Chase Bank Field.” The net present value of the payments to the university is being amortized to marketing expense over the life of the contract.

Recently Issued Accounting Standards:

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

In September 2006, the FASB ratified Emerging Issues Task Force (“EITF”) consensus 06-5, “Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4” (“EITF 06-5”). EITF 06-5 eliminates the diversity in policyholder calculations of the amount that would be realized under a life insurance contract if that contract were terminated. Under EITF 06-5, policyholders will be required to recognize contract-based values at their net present value. EITF 06-5 is effective for the Bank’s fiscal year beginning October 1, 2007. The adoption of EITF 06-5 did not have a material impact on the Bank’s financial condition or results of operations.

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

92

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets” (“SFAS 156”). SFAS 156 amends SFAS 140 to require an entity (i) to initially measure all separately recognized servicing assets and servicing liabilities at fair value, if practicable; (ii) to separately present servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position; and (iii) to provide additional disclosures for all separately recognized servicing assets and servicing liabilities. In addition, SFAS 156 permitted an entity to irrevocably choose either the amortization method or the fair value measurement method for the subsequent measurement of each class of separately recognized servicing assets and servicing liabilities. SFAS 156 was effective for the Bank on October 1, 2006. As a result of the adoption of SFAS 156 the Bank identified its mortgage servicing rights (“MSRs”) relating primarily to residential mortgage loans as a class of servicing rights and elected to apply fair value accounting to this class of MSRs. Presently, this class, which also includes servicing rights related to home equity and home improvement loans, represents all of the Bank’s MSRs.

The impact of the adoption, which represents the difference between the fair value and the carrying amount of the MSRs, net of any related valuation allowance, was $4.1 million, net of related income taxes, and was recorded as a cumulative-effect adjustment to retained earnings on October 1, 2006.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS 155”). SFAS 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”) by eliminating SFAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS 155 permits fair value measurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided that the whole instrument is accounted for on a fair value basis and eliminates a restriction on the passive derivative instruments that a qualifying special-purpose entity may hold. SFAS 155 applies to all financial instruments acquired or issued by the Bank on October 1, 2006 and upon adoption for existing bifurcated hybrid financial instruments not being used in hedging relationships. The adoption of this statement did not have a material effect on the Bank’s financial condition or results of operations.

4. LIQUIDITY AND CAPITAL RESOURCES—REAL ESTATE TRUST:

The Real Estate Trust’s cash flow from operating activities, excluding dividends and tax sharing payments from the Bank, has 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, 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. Although cash flows from operating activities have improved over the prior two fiscal years, 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 other than the sale of unsecured notes. 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. Dividend and tax sharing payments received by the Real Estate Trust are presented as cash flows from operating activities in the Consolidated Statements of Cash Flows.

During fiscal 2007, 2006 and 2005, the Bank made dividend payments totaling $16.0, $32.0 and $39.2 million to the Real Estate Trust. During fiscal 2007, 2006 and 2005, the Bank made net tax sharing payments totaling $4.0, $2.0 and $2.1 million to the Real Estate Trust.

Although operations have shown significant improvement in fiscal 2007 and 2006, in recent years the operations of the Real Estate Trust have generated net operating losses while the Bank has reported net income. The Trust’s consolidation of the Bank’s operations into the Trust’s federal income tax return has resulted in the use of the Real Estate Trust’s net operating losses to reduce the federal income taxes the Bank would otherwise have owed. If in any future year, the Bank has taxable losses or unused credits, the Real Estate Trust would be obligated to reimburse the Bank for the greater of (i) the tax benefit to the group using such tax losses or unused tax credits in the group’s consolidated federal income tax returns or (ii) the amount of the refund which the Bank would otherwise have been able to claim if it were not being included in the consolidated federal income tax return of the group.

5. INVESTMENT IN SAUL CENTERS, INC. AND SAUL HOLDINGS LIMITED PARTNERSHIP—REAL ESTATE TRUST:

During fiscal 2007 and 2006 the Real Estate Trust purchased, through dividend reinvestment and on the open market, approximately 628,000 and 254,000 shares of common stock of Saul Centers, Inc. (“Saul Centers”), respectively and as of September 30, 2007 and 2006 owned approximately 5,348,000 shares and 4,721,000 shares representing 30.2% and 27.5% of such company’s outstanding common stock, respectively. As of September 30, 2007 and 2006, the market value of the total shares was approximately $275.0 million and $212.0 million, respectively. The majority of these shares have been pledged as collateral with the Real Estate Trust’s credit line banks.

93

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

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 $196.0 million of mortgage debt and deferred interest associated with such properties, to a newly formed partnership, Saul Holdings Limited Partnership (“Saul Holdings Limited Partnership”), in which as of September 30, 2007, the Real Estate Trust owns (directly or through one of its wholly owned subsidiaries) a 18.9% interest, other entities affiliated with the Real Estate Trust own a 4.5% interest, and Saul Centers owns a 76.6% interest. As of September 30, 2006 the Real Estate Trust owned (directly or through one of its wholly owned subsidiaries) a 19.4% interest, other entities affiliated with the Real Estate Trust owned a 4.6% interest and Saul Centers owned a 76.0% interest. Certain officers and trustees of the Trust are also officers and/or directors of Saul Centers. Under the Saul Holdings Partnership Agreement, the units are generally convertible on a one-for-one basis into common stock of Saul Centers. However, most of the limited partnership units were not convertible as of September 30, 2007 because the conversion would cause the Real Estate Trust and certain affiliates of the Trust to exceed the ownership limitation under our articles of incorporation, which restricts the amount of our equity they may constructively or beneficially own, denoted by reference to provisions of the Code. 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 Limited Partnership provides for quarterly distributions to the partners out of net cash flow. During fiscal 2007, the Real Estate Trust received total cash distributions of $7.5 million from Saul Holdings Partnership which were all reinvested in common stock of Saul Centers. 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.

Pursuant to a reimbursement agreement among the partners of Saul Holdings Limited 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 September 30, 2007, the maximum potential obligations of the Real Estate Trust and its subsidiaries under this agreement totaled approximately $100.0 million. The Real Estate Trust believes that Saul Holdings will be able to make all payments due with respect to its debt obligations.

The fair market value of each of the properties contributed to the Partnerships by the Real Estate Trust at the date of transfer (the FMV of each such property) exceeded the tax basis of such property (with respect to each property, such excess is referred to as the FMV-Tax Difference). In the event Saul Centers, as general partner of the Partnerships, causes the Partnerships to dispose of one or more of such properties, a disproportionately large share of the total gain for federal income tax purposes would be allocated to the Real Estate Trust or its subsidiaries. In general, if the gain recognized by the Partnerships on a property disposition is less than or equal to the FMV-Tax Difference for such property (as previously reduced by the amounts of special tax allocations of depreciation deductions to the partners), a gain equal to the FMV-Tax Difference (as adjusted) will be allocated to the Real Estate Trust. To the extent the gain recognized by the Partnerships on the property disposition exceeds the FMV-Tax Difference (as adjusted), such excess generally will be allocated among all the partners in Saul Holdings based on their relative percentage interests. In general, the amount of gain allocated to the Real Estate Trust in the event of such a property disposition is likely to exceed, perhaps substantially, the amount of cash, if any, distributable to the Real Estate Trust as a result of the property disposition. In addition, future reductions in the level of the Partnerships’ debt, or any release of the guarantees of such debt by the Real Estate Trust, could cause the Real Estate Trust to have taxable constructive distributions without the receipt of any corresponding amounts of cash. Currently, management does not intend to seek a release of or a reduction in the guarantees or to convert its limited partner units in Saul Holdings into shares of Saul Centers common stock.

At the date of transfer of the Real Estate Trust properties to Saul Holdings, liabilities exceeded assets transferred by approximately $104.3 million on an historical cost basis. The assets and liabilities were recorded by Saul Holdings and Saul Centers at their historical cost rather than market value because of affiliated ownership and common management and because the assets and liabilities were the subject of the business combination between Saul Centers and Saul Holdings, newly formed entities with no prior operations.

The management of Saul Centers has adopted a strategy of maintaining a ratio of total debt to total asset value, as estimated by management, of fifty percent or less. The management of Saul Centers has concluded at September 30, 2007, that the total debt of Saul Centers remains below fifty percent of total asset value. The total asset value is determined by the management of Saul Centers as the aggregate fair value of the portfolio of properties by reference to the properties’ aggregate cash flow. As a result, the management of the Real Estate Trust has concluded that fundings under the reimbursement agreement are remote.

94

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

As of September 30, 2007 and 2006, the Real Estate Trust’s investment in the consolidated entities of Saul Centers, which is accounted for under the equity method, consisted of the following.

(In thousands)	September 30, 2007			September 30, 2006
Saul Holdings:
Investment in partnership units	$	19,112		$	19,112
Distributions in excess of allocated net income		(24,118	)		(23,631	)
Saul Centers:
Investment in common shares		151,438			110,521
Distributions in excess of allocated net income		(19,353	)		(16,200	)
Total	$	127,079		$	89,802

The Trust’s investments in Saul Centers exceeded the underlying book value of the investment at the time of the purchases. At September 30, 2007 and 2006, the cumulative excess totaled $132.1 and $101.0 million, respectively. This amount is being amortized over the estimated remaining useful life of the underlying real estate assets. At September 30, 2007 and 2006, the unamortized balance was $116.4 and $88.2 million, respectively.

The unaudited Condensed Consolidated Balance Sheets as of September 30, 2007 and 2006, and the unaudited Condensed Consolidated Statements of Operations for the twelve months ended September 30, 2007, 2006 and 2005 of Saul Centers follow.

95

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

SAUL CENTERS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

	September 30,
(In thousands)	2007			2006
Assets
Real estate investments	$	881,646		$	834,050
Accumulated depreciation		(229,055	)		(210,025	)
Other assets		72,432			65,714
Total assets	$	725,023		$	689,739
Liabilities and stockholders’ equity
Mortgage notes payable	$	528,604		$	490,897
Other liabilities		42,798			73,800
Total liabilities		571,402			564,697
Minority Interests		5,091			5,926
Total stockholders’ equity		148,530			119,116
Total liabilities and stockholders’ equity	$	725,023		$	689,739

SAUL CENTERS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the Twelve Months Ended September 30,
(In thousands)	2007			2006			2005
Revenue
Base rent	$	116,911		$	107,579		$	97,438
Other revenue		30,767			27,329			26,372
Total revenue		147,678			134,908			123,810
Expenses
Operating expenses		32,336			28,658			24,942
Interest expense and amortization of debt expense		33,414			31,894			29,663
Depreciation and amortization		25,885			25,128			24,137
General and administrative		11,013			10,015			9,527
Total expenses		102,648			95,695			88,269
Operating income before minority interests		45,030			39,213			35,541
Minority interests		(8,751	)		(7,507	)		(7,976	)
Net income		36,279			31,706			27,565
Preferred dividends		(8,000	)		(8,000	)		(8,000	)
Net income available to common shareholders	$	28,279		$	23,706		$	19,565

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

6. REAL ESTATE INVESTMENT PROPERTIES—REAL ESTATE TRUST:

The following table summarizes the cost basis of income-producing properties and land parcels together with their related debt.

(Dollars in thousands)	No.	Land		Buildings and Improvements		Total		Related Debt (1)
September 30, 2007
Income-producing properties
Hotels	18	$	36,758	$	351,001	$	387,759	$	302,555
Office and industrial	15		23,931		241,720		265,651	$	237,044
Other	2		1,128		—		1,128		—
	35	$	61,817	$	592,721	$	654,538	$	539,599
Land Parcels	11	$	43,354	$	—	$	43,354	$	—
Construction in Progress	4	$	3,429	$	80,327	$	83,756	$	40,406

(1) Amount includes $579.6 million of mortgage notes payable and approximately $366 of capital leases.

(Dollars in thousands)	No.	Land		Buildings and Improvements		Total		Related Debt (2)
September 30, 2006:
Income-producing properties
Hotels	17	$	36,215	$	323,590	$	359,805	$	285,132
Office and industrial	14		15,369		194,646		210,015		200,010
Other	2		1,128		—		1,128		—
	33	$	52,712	$	518,236	$	570,948	$	485,142
Land Parcels	11	$	44,582	$	—	$	44,582	$	—
Construction in Progress	4	$	3,972	$	30,974	$	34,946	$	4,011

(2) Amount includes $488.3 million of mortgage notes payable and approximately $815 of capital leases.

On March 29, 2007, the Real Estate Trust acquired an approximately 178,000 square foot office building located in Bethesda, Maryland from the Bank for a purchase price of $46.0 million.

On March 24, 2006, the Real Estate Trust acquired a 145 room historic hotel located in Washington, D. C. for $100.0 million.

On February 23, 2006, the sale of one of the Real Estate Trust’s other real estate assets located in Metairie, LA was finalized and the Real Estate Trust received proceeds of approximately $4.0 million resulting in a gain of approximately $2.9 million in fiscal 2006.

In February 2006, the Real Estate Trust was notified that a 3.71 acre parcel of land had been condemned by the Virginia Department of Transportation. Proceeds of approximately $708,000 were placed in escrow and received by the Real Estate Trust on August 8, 2006. An initial gain of $416,000 was recorded in fiscal 2006.

On January 19, 2006, the sale of a hotel property, which was the second of two hotel properties placed on the market during fiscal year 2005, was finalized and the Real Estate Trust received proceeds from the sale of approximately $5.5 million resulting in a gain of $2.2 million in fiscal 2006. The Real Estate Trust financed an additional $500,000 through the issuance of a note by the purchaser.

On December 16, 2005, the sale of a hotel property, which was one of two hotel properties placed on the market during fiscal year 2005, was finalized and the Real Estate Trust received proceeds from the sale of approximately $7.9 million resulting in a gain of $1.3 million in fiscal 2006.

On November 1, 2005, the Real Estate Trust acquired a 137 room hotel property located in Fairfax County, Virginia for a purchase price of approximately $12.7 million, which included the assumption of a mortgage note of $5.8 million.

On September 13, 2005, the Real Estate Trust closed on a $6.2 million purchase of a land parcel from the Bank located in Loudoun County, VA. The purchase was funded from cash on hand, see Note 12.

On July 25, 2005, the Real Estate Trust closed on a $1.9 million purchase of a land parcel from the Bank located in Loudoun County, VA. The purchase was funded from available cash on hand, see Note 12.

97

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

On July 11, 2005, approximately 22 acres of the Real Estate Trust’s 159 acre land parcel in Overland Park, Kansas was acquired by the Kansas Department of Transportation through a condemnation proceeding. The Real Estate Trust was awarded approximately $1.2 million which resulted in a gain of $263,000 in fiscal 2005.

During fiscal 2005, the Real Estate Trust placed two of its hotel properties on the market for sale, as these properties no longer meet its investment criteria. No adjustment to the carrying value of the properties was required. Sales of both properties closed in fiscal 2006.

On May 25, 2005, the Real Estate Trust acquired an approximately 12,000 square foot office building located in Montgomery County, Maryland for approximately $5.3 million, see Note 7.

On January 31, 2005, the Real Estate Trust sold one of its other real estate properties because the property no longer met the Real Estate Trust’s investment criteria. No adjustment to the carrying value of the property was required. The Real Estate Trust received proceeds from the sale of approximately $1.4 million, resulting in a gain of $900,000 in fiscal 2005.

On December 9, 2004, the sale of a hotel property, which was placed on the market for sale during fiscal 2004, was finalized and the Real Estate Trust received proceeds from the sale of approximately $2.2 million, resulting in a loss of $327,000, $310,000 recognized in fiscal 2004 and $17,000 recognized in fiscal 2005.

7. REAL ESTATE ACQUIRED – OPERATING PROPERTIES – REAL ESTATE TRUST:

On March 29, 2007, the Real Estate Trust acquired an approximately 178,000 square foot office building located in Bethesda, Maryland from the Bank for a purchase price of $46.0 million. The acquisition was funded by the Real Estate Trust’s revolving credit facilities and with cash on hand. A $37.0 million mortgage note was placed on this property on June 21, 2007. The purchase price for the acquisition was established using an independent appraisal. The Bank realized an after tax gain totaling $9.6 million on the sale. The gain was eliminated in consolidation and the Real Estate Trust has recorded this office building using the Bank’s basis. The results of operations of the office building were included in the Real Estate section of the consolidated statements of operations beginning April 1, 2007.

On March 24, 2006, the Real Estate Trust acquired a 145 room historic hotel located in Washington, D.C. for a purchase price of approximately $100.0 million. The Real Estate Trust accounted for the acquisition in accordance with SFAS No. 141, “Business Combinations.” The Real Estate Trust allocates the purchase price to various components, such as land, building, personal property and certain marketing related, customer related and franchise related intangibles, if applicable, as described in Note 2.Of the total cost $9.0 million has been allocated to intangible assets, included in Other Assets on the Consolidated Balance Sheets, $4.1 million has been allocated to personal property and the remainder allocated to land and building which are included in Hotel Real Estate on the consolidated balance sheet. The results of operations of the acquired hotel were included in the consolidated statements of operations as of the acquisition date.

On November 1, 2005, the Real Estate Trust acquired a 137 room hotel property located in Fairfax County, Virginia for a purchase price of approximately $12.7 million, which included the assumption of a mortgage note of $5.8 million, see Note 10. The Real Estate Trust accounted for the acquisition in accordance with SFAS No. 141, “Business Combinations.” A total of $317,000 of the total cost was allocated as personal property and is included in hotel real estate assets. The personal property assets are being amortized over their estimated remaining useful life, a weighted average term of 2.0 years. There were no above or below market lease intangibles or any value assigned to customer or franchise relationships. The results of operations of the acquired hotel were included in the consolidated statements of operations as of the acquisition date.

On May 25, 2005 the Real Estate Trust acquired an approximately 12,000 square foot office building located in Montgomery County, Maryland for approximately $5.3 million. The Real Estate Trust accounted for the acquisition in accordance with SFAS No. 141, “Business Combinations.” The $5.3 million total cost includes both the property’s purchase price and closing costs. A total of $150,000 of the total cost was allocated as lease intangible assets and included in other assets. The lease intangible assets are being amortized over the remaining periods of the leases acquired, a weighted average term of 2.6 years. The values of below market leases totaled $266,000 and are being amortized over a weighted average term of 2.1 years and included in other liabilities and accrued expenses. There were no above market lease intangibles. The results of operations of the acquired office building were included in the consolidated statements of operations as of the acquisition date.

As of September 30, 2007 and 2006 the gross carrying amount of the lease intangible assets included in lease acquisition costs was $150,000 in each period and accumulated amortization was $135,000 and $101,000, respectively. Total amortization of this asset was $34,000, $76,000 and $25,000 for the years ended September 30, 2007, 2006 and 2005, respectively. As of September 30, 2007 and 2006 the gross carrying amount of the below market lease intangibles included in other liabilities and accrued expenses was $266,000 in each period and accumulated amortization was $253,000 and $203,000, respectively. Total amortization of this liability was $50,000, $153,000 and $50,000 for the years ended September 30, 2007, 2006 and 2005, respectively.

98

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

8. REAL ESTATE SOLD/DISCONTINUED OPERATIONS – REAL ESTATE TRUST:

Land Parcels:

On June 22, 2007 the Real Estate Trust was notified that its appeal regarding additional proceeds from a February 2006 condemnation of a 3.71 acre parcel had been approved by the Loudoun County Circuit Court. Additional proceeds of $325,000 were received on July 10, 2007 and the remainder of the gain was recorded in fiscal 2007. The initial proceeds of approximately $708,000 were originally placed in escrow then received by the Real Estate Trust on August 8, 2006. An initial gain of $416,000 was recorded in fiscal 2006.

On November 22, 2006, the Real Estate Trust received additional proceeds of approximately $1.6 million as final settlement of the February 2004 condemnation of 7.93 acres of land by the Commonwealth of Virginia. The proceeds of $1.6 million include approximately $300,000 in interest income and $8,000 of cost reimbursements. The Real Estate Trust recorded the final gain of approximately $1.2 million, net of approximately $400,000 of related expenses during fiscal 2007. The initial gain on this condemnation of $2.7 million was recorded in fiscal 2004.

On July 11, 2005, approximately 22 acres of the Real Estate Trust’s 159 acre land parcel in Overland Park, Kansas was acquired by the Kansas Department of Transportation through a condemnation proceeding. The Real Estate Trust was awarded approximately $1.2 million which resulted in a gain of $263,000 in fiscal 2005 which was recorded as Gain on Sales of Property.

Operating Properties:

Included in income from operations of discontinued real estate assets for fiscal 2006 and 2005 are two hotel properties and two other real estate property assets. The sales of the hotel properties closed in December 2005 and January 2006, respectively. The sales of the other real estate assets closed in February 2006 and January 2005. There was no income from operations of discontinued real estate assets during fiscal 2007.

The Real Estate Trust makes the determination to sell a property when it no longer meets its investment criteria. The Real Estate Trust determines if the assets meet the held for sale criteria in accordance with FASB No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Accordingly, the Real Estate Trust compares the carrying value of these assets to their estimated fair value, less cost to sell, to determine if the assets were impaired. No impairment charges have been recorded. At September 30, 2006 the two hotel assets and one of the other real estate properties held for sale were classified as Real Estate Held for Sale on the Consolidated Balance Sheets and the corresponding mortgage notes secured by the two hotel assets were classified as Mortgage notes payable – real estate held for sale on the Consolidated Balance Sheets. There were no assets held for sale at September 30, 2007.

Income from operations of discontinued real estate assets totaled $4.2 million in fiscal 2006. Net operating results for the two hotel properties for fiscal 2006 produced income from operations of discontinued real estate assets of approximately $1.3 million, which includes a combined gain on sale of approximately $3.4 million, and a loss from operations of discontinued real estate assets of $2.1 million. Included in the loss from operations is $1.8 million of costs associated with the defeasance of a mortgage which secured one of the hotel properties. Also included in income from operations of discontinued real estate assets in fiscal 2006 is a gain on the sale of one of the Real Estate Trust’s other real estate assets of $2.9 million and income from operations of the other real estate asset of approximately $47,000. This asset was sold in February 2006.

Loss from operations of discontinued real estate assets totaled $1.5 million for fiscal 2005. Included, are operating losses of $920,000 for the two hotels which were sold in fiscal 2006 and an operating loss of $1.8 million for a hotel that was sold in December 2004. Included in the $1.8 million operating loss is $1.6 million of costs associated with the defeasance of the mortgage which the hotel property secured, including a $1.5 million prepayment premium and an additional loss of $17,000 which reflects the difference between the actual loss on the sale of the hotel property and the estimated loss recorded in fiscal 2004. Also included in the fiscal 2005 net loss is operating income of approximately $284,000 associated with the other real estate property sold in February 2006 and an approximately $900,000 gain on sale and $12,000 operating income from the other real estate asset sold in January 2005.

9. DEBT—REAL ESTATE TRUST:

Mortgage notes payable:

Mortgage notes payable are secured by various income-producing properties, land parcels, and properties under construction. Almost all mortgage notes are payable in monthly installments, have maturity dates ranging to 2021 and accrue interest at annual rates from 5.3% to 9.1%. Certain mortgages contain a number of restrictions, including cross default provisions.

On June 21, 2007, the Real Estate Trust placed a $37.0 million mortgage note on the office building located in Bethesda, Maryland which was purchased on March 29, 2007. The note, which is due on July 1, 2022, bears interest at 5.73% and requires monthly principal and interest payments of $232,322 with a balloon payment of $21.4 million due at maturity. The proceeds from the financing were used to pay down the Real Estate Trust’s revolving credit facilities.

99

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

On May 25, 2007, the Real Estate Trust closed on a $105.0 million construction/permanent loan for its Tysons Park Place II development. The loan is for a term of 14.5 years and will bear interest at 6.28%. Interest only will be payable for the initial three years, thereafter monthly interest and principal will be payable based on a 30 year amortization period. The loan will be used to fund the majority of the construction costs for the Tysons Park Place II development. The Real Estate Trust received loan draws of $26.7 million during fiscal 2007, which amounted to the balance outstanding under this loan at September 30, 2007.

On May 18, 2007, the Real Estate Trust placed a $21.4 million mortgage note on the newly constructed SpringHill Suites Hotel located in Loudoun County, Virginia. The note, which is due on June 1, 2017, bears interest at 5.77% and requires monthly principal and interest payments of $134,678 with a balloon payment of $16.5 million due at maturity. A portion of the proceeds from the financing were used to repay and retire the $14.9 million interest only construction loan on the property which was obtained on May 2006, the remainder of the proceeds were used to pay down the Real Estate Trust’s revolving credit facilities.

On March 29, 2007, the Real Estate Trust closed on a $21.2 million construction loan which will be used to finance the construction of the Hampton Inn Dulles located in Loudoun County, Virginia. The loan, which is due on March 29, 2009, with three one-year extension options, bears interest at 155 basis points over a floating rate index. Interest only is payable through maturity. The loan balance as of September 30, 2007 is $13.7 million, all of which was drawn during fiscal 2007.

On January 31, 2007, the Real Estate Trust placed an $8.5 million mortgage note on an industrial property located in Northern Virginia. The note, which is due on April 11, 2017, bears interest at 5.55% and requires monthly interest only payments for the initial five years. Beginning in year six, monthly principal and interest payments of $48,529 are required with a balloon payment of $7.9 million due at maturity. The majority of the proceeds from the refinancing were used to repay a $5.7 million variable rate construction loan which was secured by the subject property.

On October 19, 2006, amendments were executed for two of the Real Estate Trust’s mortgage notes, both of which were held by the same lender and both closed in fiscal 2006. The balance of the mortgage note secured by the 145 room historic hotel was increased by $10.0 million to $75.0 million with the interest rate remaining at 6.199%. A corresponding $10.0 million reduction to the mortgage note secured by a hotel property in Loudoun County, Virginia was made to reduce this note to $34.8 million. The rate on this loan was reduced by approximately 3 basis points from 6.1010% to 6.0714% which maintains the Real Estate Trust’s annual interest expense on the two loans.

On June 16, 2006, the Real Estate Trust placed a $31.2 million mortgage note on an office property located in Atlanta, Georgia. The note, which is due on July 1, 2021, bears interest at 6.353% and requires monthly interest only payments for the initial three years. Beginning in year four, monthly principal and interest payments of $194,000 are required with a balloon payment of $25.6 million due at maturity. The proceeds from the financing were used to fund development projects and general corporate purposes.

On May 26, 2006, the Real Estate Trust closed two mortgage financings, a $44.8 million mortgage note secured by a hotel property located in Loudoun County, Virginia and a $22.2 million mortgage note, also secured by a hotel property located in Gaithersburg, Maryland. The $44.8 million note, which is due on June 1, 2016, bears interest at 6.101% and requires monthly interest only payments for the initial three years. Beginning in year four, monthly principal and interest payments of $272,000 are required with a balloon payment of $40.8 million due at maturity. The $22.2 million note, which is due on June 1, 2018, bears interest at 6.258% and requires interest only payments for the initial three years. Beginning in year four, monthly principal and interest payments of $137,000 are required with a balloon payment of $19.5 million due at maturity. The proceeds from these financings were used to pay down the Real Estate Trust’s line of credit borrowing, fund development projects and for general corporate purposes.

On May 23, 2006, the Real Estate Trust placed a $40.0 million mortgage note on a hotel property located in McLean, Virginia. The note, which is due on May 1, 2021, bears interest at 6.1% and requires monthly principal and interest payments of $260,000 with a balloon payment of $23.7 million due at maturity. The proceeds from the financing were used to repay the bridge loan, which financed the purchase of the 145 room historic hotel, and pay down the Real Estate Trust’s line of credit borrowings.

On April 21, 2006, the Real Estate Trust closed on a $65.0 million mortgage note secured by the 145 room historic hotel located in Washington, D.C., which was purchased on March 24, 2006. The note, which is due on May 1, 2021, bears interest at 6.199% and requires interest only payments for the initial five years. Beginning in year six, monthly principal and interest payments of $398,000 are required with a balloon payment of $55.1 million due at maturity. $61.0 million of the proceeds from the financing were used to pay down a portion of the bridge loan.

On March 24, 2006, the Real Estate Trust financed the $100.0 million purchase of the 145 room historic hotel located in Washington, D. C. with an unsecured bridge loan of $86.2 million and cash on hand for the balance. The loan had a six month term with five six-month extension options. The loan was an interest only loan and bore interest at LIBOR plus 175 basis points. The loan was repaid in full from proceeds of permanent financings on May 24, 2006.

On December 29, 2005, the Real Estate Trust placed a $9.5 million mortgage note on the hotel property that was acquired on November 1, 2005. The note, which is due on January 1, 2016, bears interest at 5.92%. Monthly principal and interest payments, based on a 25 year amortization schedule, of $60,745 are required with a balloon payment of $7.4 million due at maturity.

100

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

On December 2, 2005, the Real Estate Trust refinanced one of six properties that were secured by an approximately $88.0 million portfolio mortgage note which was due on March 31, 2006. The property was refinanced with a new 10 year mortgage note of $76.0 million. The proceeds from this refinancing, along with available cash and line of credit borrowings were used to repay the portfolio loan. The loan, which is due on January 11, 2016, bears interest at 5.3% and requires interest only payments for the initial five years. Beginning in year six, monthly principal and interest payments of $422,000 are required with a balloon payment of $70.3 million due at maturity.

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 $200.0 million of Senior Secured Notes issued in 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. 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 used the net proceeds to fund renovation and construction activities as well as for general corporate purposes.

Notes payable – unsecured:

Notes payable—unsecured includes notes which have been sold by the Real Estate Trust directly to investors at varying interest rates with maturities of one to ten years. These notes do not contain any provisions for conversion, sinking fund or amortization, but are subject to a provision permitting the Real Estate Trust to call them prior to maturity as long as the notes have been outstanding for over one year. On June 19, 2006 the Real Estate Trust terminated its public offering of these notes and subsequently withdrew the registration of the un-issued notes. Consistent with the terms of the notes, during the year ended September 30, 2006, the Real Estate Trust called $29.6 million of the outstanding notes for prepayment, of which $19.1 million were outstanding at September 30, 2006 and were prepaid during the first quarter of fiscal 2007. The remaining $2.3 million of uncalled unsecured notes matured during the first quarter of fiscal 2007. As of the end of the first quarter of fiscal 2007 all of the unsecured notes outstanding as of September 30, 2006 were repaid. There were no unsecured notes outstanding as of September 30, 2007. The weighted average interest rate was 7.6% at September 30, 2006.

Credit facilities:

Effective July 2, 2007, the Real Estate Trust amended and restated its $60.0 million secured revolving credit line with an unrelated bank, expanding the facility to $75.0 million and extending the maturity date two years to January 31, 2010, with provisions for extending the term for an additional year. 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 with the current interest rate spread, effective June 29, 2007, at 150 basis points over the index. At September 30, 2007, the Real Estate Trust had $6.0 million in outstanding borrowings and unrestricted availability of $69.0 million.

Effective June 14, 2007, the Real Estate Trust amended and restated its additional $60.0 million revolving credit line with an unrelated bank, expanding the facility to $75.0 million and extending the maturity date two years to June 30, 2010, with provisions for extending the term for an additional year. 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 with the current interest rate spread, effective June 14, 2007, at 150 basis points over the index. At September 30, 2007, the Real Estate Trust had $8.0 million in outstanding borrowings and unrestricted availability of $61.5 million. The Real Estate Trust was issued a $6.0 million letter of credit, which was reduced to $5.5 million during fiscal 2007, for the benefit of a mortgage lender as part of one of the mortgage financings completed during fiscal 2006. The letter of credit will continue to be reduced annually based on the amount of capital expended at the subject property. The letter of credit reduces the availability under the revolving credit facility.

At September 30, 2007 and 2006 the Real Estate Trust was in compliance with its debt covenants.

101

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The maturity schedule for the Real Estate Trust’s outstanding debt, including mortgage notes payable for real estate held for sale, at September 30, 2007 for the fiscal years commencing October 1, 2007 is set forth in the following table:

Debt Maturity Schedule

(In thousands)

Fiscal Year	Mortgage Notes		Notes Payable—Secured		Total
2008	$	7,531	$	—	$	7,531
2009		17,667		—		17,667
2010		13,108		14,000		27,108
2011		23,790		—		23,790
2012		31,415		—		31,415
Thereafter (1)		486,128		250,000		736,128
Total	$	579,639	$	264,000	$	843,639

Of the $579.6 million of mortgage notes outstanding at September 30, 2007, $539.2 million was non-recourse to the Real Estate Trust.

(1) Includes 100%, $26.7 million, of the Tysons Park Place II construction/permanent loan balance drawn to date.

10. EXTINGUISHMENT OF LIABILITIES – REAL ESTATE TRUST:

On January 19, 2006, the Real Estate Trust deposited cash of approximately $7.6 million into an escrow fund with which United States government securities were purchased to complete a partial defeasance of a mortgage loan made to the Real Estate Trust. The defeased portion of the loan encumbered the hotel property which was sold January 19, 2006. The defeasance was funded by available cash and line of credit borrowings. The government securities became the replacement collateral for the loan securing the hotel, and became the sole source of payment for the $5.8 million loan. As a result of the transaction, the principal amount owed by the Real Estate Trust was reduced by $5.8 million, with corresponding reductions in the principal and interest payments to be made to maturity. The Real Estate Trust incurred defeasance charges of approximately $1.8 million, including a prepayment premium of $1.7 million. The escrow fund is maintained by Wells Fargo Bank, National Association, as Securities Intermediary and Custodian, and the Real Estate Trust is no longer the primary obligor with respect to the defeased loan.

In connection with the hotel asset acquired on November 1, 2005 (see Note 7) the Real Estate Trust, on December 21, 2005, defeased the loan that was assumed with the acquisition of the hotel property. The Real Estate Trust paid $6.6 million into an escrow fund with which United States government securities were purchased. The defeasance was funded by available cash and line of credit borrowings. The government securities became replacement collateral for the loan securing the hotel, and became the sole source of payment of the $5.8 million loan. As a result of the transaction the Real Estate Trust is no longer the primary obligor with respect to this loan. The escrow fund is maintained by Wells Fargo Bank, National Association, as Securities Intermediary and Custodian. The $5.8 million defeased loan was accounted for as if it were extinguished in December 2005. The Real Estate Trust incurred defeasance charges of approximately $900,000, including a prepayment premium of $829,000.

On December 9, 2004 the sale of a hotel property, which was placed on the market for sale during fiscal 2004, was finalized and the Real Estate Trust received proceeds from the sale of approximately $2.2 million. The proceeds from the sale, along with an additional $3.6 million from the Real Estate Trust, were paid into an escrow fund with which United States government securities were purchased. The government securities became replacement collateral for the loan securing the hotel, and became the sole source of payment for the $4.4 million loan (the “Defeased loan”). As a result of the transaction, the principal amount owed by the Real Estate Trust was reduced by $4.4 million, with corresponding reductions in the principal and interest payments to be made to maturity. The escrow fund is maintained by Wells Fargo Bank, National Association, as Securities Intermediary and Custodian, and the Real Estate Trust is no longer the primary obligor with respect to the Defeased loan and therefore the debt is considered extinguished. The Real Estate Trust incurred defeasance charges of approximately $1.6 million, including a $1.5 million prepayment premium.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

11. INCOME FROM COMMERCIAL PROPERTIES—REAL ESTATE TRUST:

Income from commercial properties includes minimum rent arising from non-cancelable commercial leases. Minimum rent for fiscal years 2007, 2006 and 2005 amounted to $37.4, $35.2 and $34.9 million, respectively. Future minimum rentals as of September 30, 2007 under non-cancelable leases are as follows:

Fiscal Year	(In thousands)
2008	$	38,999
2009		33,575
2010		25,941
2011		20,053
2012		13,427
Thereafter		29,925
Total	$	161,920

12. TRANSACTIONS WITH RELATED PARTIES—REAL ESTATE TRUST:

TRANSACTIONS WITH B. F. SAUL COMPANY AND ITS SUBSIDIARIES

In fiscal 2005, the Real Estate Trust was managed by B. F. Saul Advisory Company, L.L.C., (the “Advisor”), a wholly-owned subsidiary of B. F. Saul Company (“Saul Co.”). On October 1, 2005, the Advisor’s obligations under the advisory agreement were assigned to Saul Co. and thus, in fiscals 2006 and 2007, the Real Estate Trust was managed by Saul Co. pursuant to an advisory agreement that expires on December 31, 2007, except that it will continue year to year thereafter unless cancelled by either party at the end of any contract year. All of the Real Estate Trust officers and four Trustees of the Trust are also officers and/or directors of Saul Co. The Advisor was and Saul Co. is paid a fixed monthly fee which is subject to annual review by the Trustees. The average monthly fee was $602,000 during fiscal 2007, $560,000 during fiscal 2006, and $487,000 during fiscal 2005.

Saul Co. and B.F. Saul Property Company (“Saul Property Co.”), a wholly-owned subsidiary of Saul Co., provide services to the Real Estate Trust through commercial property management and leasing, hotel management, development and construction management, and acquisitions, sales and financings of real property agreements. Fees paid to Saul Co. and Saul Property Co. amounted to $14.7, $13.0 and $9.1 million in fiscal 2007, 2006 and 2005, respectively, related to these services.

The Real Estate Trust reimburses Saul Co. and Saul Property Co. for costs and expenses incurred on behalf of the Real Estate Trust, in-house legal expenses, and for all travel expenses incurred in connection with the affairs of the Real Estate Trust.

In fiscal 2005, the Real Estate Trust paid the Advisor fees equal to 2% of the principal amount of the unsecured notes as they are issued to offset its costs of administering the program. On October 1, 2005, in conjunction with the Real Estate Trust’s decision to discontinue the public sale of unsecured notes, the fee agreement was modified whereas the fee to Saul Co. for any calendar month that the Real Estate Trust did not issue notes under the program was to be $7,500 for such month. These payments amounted to $90,000, $111,000 and $267,000 in fiscal 2007, 2006 and 2005, respectively. No unsecured notes were sold in fiscals 2006 and 2007, and all notes were repaid as of September 30, 2007.

A subsidiary of Saul Co. is a general insurance agency which receives commissions and countersignature fees in connection with the Real Estate Trust’s insurance program. Such commissions and fees amounted to approximately $391,000, $311,000 and $316,000 in fiscal 2007, 2006 and 2005, respectively.

Under an existing unsecured note receivable from Saul Co., which was modified and amended on October 1, 2005, not to exceed $30.0 million, the Real Estate Trust received net repayments of $4.9 million during fiscal 2007. During fiscal 2006 net repayments totaled $2.8 million. At September 30, 2007 and September 30, 2006, the note balance totaled $5.4 million and $10.3 million, respectively. Interest is computed on the note at 200 basis points over a floating rate index. Interest earned on the note amounted to $532,000, $959,000 and $616,000 during fiscal 2007, 2006 and 2005, respectively. The note is due and payable on September 30, 2015.

TRANSACTIONS WITH CHEVY CHASE BANK AND ITS SUBSIDIARIES

On March 29, 2007, the Real Estate Trust closed on a $46.0 million purchase of an office building from the Bank located in Bethesda, MD. The purchase price of the acquisition was established using an independent appraisal. The Bank realized a gain totaling $9.6 million on the sale. The gain is eliminated in consolidation and the Real Estate Trust has recorded this office building using the Bank’s carryover basis.

On September 13, 2005, the Real Estate Trust closed on a $6.2 million purchase of a land parcel from the Bank located in Loudoun County, VA.

103

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

On July 25, 2005 the Real Estate Trust closed on a $1.9 million purchase of a land parcel from the Bank located in Loudoun County, VA.

The purchase price for the two land parcel acquisitions was established using independent appraisals. The Bank realized gains totaling $2.3 million on the two sales. The gains are eliminated in consolidation and the Real Estate Trust has recorded these land parcels using the Bank’s carryover basis.

REMUNERATION OF TRUSTEES AND OFFICERS

For fiscal years 2007, 2006, and 2005, the Real Estate Trust paid the Trustees approximately $95,000, $94,000 and $104,000, respectively, for their services. Two of the Trustees have historically elected to defer the receipt of their fees. Interest is accrued on these deferred fees at the two year treasury rate, adjusted quarterly. Deferred fees totaled $30,000 per year in fiscal 2007, 2006 and 2005. Interest accrued on the deferred balances totaled $21,000, $20,000 and $16,000 for fiscal 2007, 2006 and 2005, respectively. At September 30, 2007 and 2006, the payable due to the Trustees, included in Other liabilities and accrued expenses on the Balance Sheet, totaled $483,000 and $432,000, respectively. These funds are available to the Trustees upon their request. No compensation was paid to the officers of the Real Estate Trust for acting as such; however, one Trustee was paid by the Bank for his services as Chairman of the Board and Chief Executive Officer of the Bank, and four others received payments for their services as directors of the Bank. Four of the Trustees and all of the officers of the Real Estate Trust receive compensation from Saul Co. as directors and/or officers.

SAUL HOLDINGS LIMITED PARTNERSHIP AND SAUL CENTERS, INC.

The Real Estate Trust accounts for these investments under the equity method. The Real Estate Trust’s share of earnings for fiscal 2007, 2006 and 2005 was $12.5, $10.6 and $8.8 million, respectively, see Note 5.

OTHER TRANSACTIONS

The Real Estate Trust leases space to the Bank and Saul Property Co. at several of its income-producing properties. Minimum rents and expense recoveries paid by these affiliates amounted to approximately $6.2, $5.8 and $5.4 million in fiscal 2007, 2006 and 2005, respectively.

104

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

13. INVESTMENT AND MORTGAGE-BACKED SECURITIES – THE BANK:

At September 30, 2007 and 2006, investment securities are comprised of U.S. Government and agency debt securities and are classified as held-to-maturity. At September 30, 2007 and 2006, all mortgage-backed securities are also classified as held-to-maturity. Gross unrealized holding gains and losses on the Bank’s U.S. Government and mortgage-backed securities are as follows:

(In thousands)	Amortized Cost		Gross Unrealized Holding Gains		Gross Unrealized Holding Losses		Aggregate Fair Value
September 30, 2007
Investment securities:
Original maturity after one year, but within five years	$	210,363	$	1,382	$	—	$	211,745
Mortgage-backed securities:
FNMA		162,491		230		1,083		161,638
FHLMC		708,667		115		7,185		701,597
Non-agency, AAA rated		163,990		—		3,608		160,382
Non-agency, other investment grade		18,285		—		1,478		16,807
Total	$	1,263,796	$	1,727	$	13,354	$	1,252,169
(In thousands)	Amortized Cost		Gross Unrealized Holding Gains		Gross Unrealized Holding Losses		Aggregate Fair Value
September 30, 2006
Investment securities:
Original maturity after one year, but within five years	$	201,455	$	—	$	1,303	$	200,152
Mortgage-backed securities:
FNMA		233,016		347		2,644		230,719
FHLMC		911,004		1,107		21,558		890,553
Non-agency, AAA rated		137,458		—		—		137,458
Non-agency, other investment grade		8,240		—		—		8,240
Total	$	1,491,173	$	1,454	$	25,505	$	1,467,122

During the years ended September 30, 2007 and 2005, the Bank sold mortgage-backed securities totaling $70.1 and $19.2 million, respectively. There were no sales of investment securities or mortgage-backed securities during the year ended September 30, 2006.

105

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The tables above show that some of the securities in the held-to-maturity investment portfolio have unrealized losses, or were temporarily impaired, as of September 30, 2007 and 2006. This temporary impairment represents the amount of loss that would be realized if the securities were sold at the valuation date, and occurs as a result of changes in overall bond yields between the date the bond was acquired and the valuation date. The unrealized losses associated with the U.S. Government, agency debt and mortgage-backed securities are not considered to be other than temporary because they relate to changes in interest rates and do not affect the expected cash flows of the securities. Securities which were temporarily impaired at September 30, 2007 and 2006 are shown below, along with the length of the impairment period.

	September 30, 2007
	Less than 12 months				12 months or longer				Total
(In thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. government securities	$	—	$	—	$	—	$	—	$	—	$	—
Agency debt securities		—		—		—		—		—		—
Municipal bonds		—		—		—		—		—		—
Mortgage-backed securities		465,404		3,575		330,884		4,692		796,288		8,268
Total temporarily impaired securities	$	465,404	$	3,575	$	330,884	$	4,692	$	796,288	$	8,268
	September 30, 2006
	Less than 12 months				12 months or longer				Total
(In thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. government securities	$	—	$	—	$	99,339	$	363	$	99,339	$	363
Agency debt securities		—		—		58,922		940		58,922		940
Mortgage-backed securities		476,714		10,191		550,954		14,011		1,027,668		24,202
Total temporarily impaired securities	$	476,714	$	10,191	$	709,215	$	15,314	$	1,185,929	$	25,505

Estimated maturities of the Bank’s mortgage-backed securities at September 30, 2007 are as follows:

(In thousands)

Due within one year	$	19,199
Due after one year, but within five years		73,744
Due after five years, but within ten years		99,184
Due after ten years		861,306
Total	$	1,053,433

Accrued interest receivable on investment and mortgage-backed securities totaled $3.8 and $6.1 million at September 30, 2007, respectively, and $2.1 and $7.7 million at September 30, 2006, respectively, and is included in other assets in the Consolidated Statements of Financial Condition.

106

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

14. LOANS RECEIVABLE – THE BANK:

Loans receivable is composed of the following:

	September 30,
(In thousands)	2007			2006
Single-family residential	$	8,044,052		$	6,648,885
Home equity		1,583,170			1,690,421
Other real estate		814,711			607,451
Commercial		935,999			987,850
Automobile		128,823			60,756
Other consumer		43,818			46,755
		11,550,573			10,042,118
Unearned discounts and net deferred origination costs deferred loan origination costs		116,216			103,703
Allowance for losses on loans		(29,000	)		(25,000	)
		87,216			78,703
Total	$	11,637,789		$	10,120,821

The Bank serviced loans owned by others amounting to $13,131.3 and $13,671.4 million at September 30, 2007 and 2006, respectively.

Cumulative deferred interest totaled $93.3 and $32.8 million at September 30, 2007 and 2006, respectively.

The following table summarizes deferred interest activity:

(In thousands)	Year Ended September 30, 2007
Balance at beginning of year	$	32,797
Additions		93,405
Sales		(11,528	)
Repayments		(2,054	)
Payoffs		(19,300	)
Balance at end of year	$	93,320

Accrued interest receivable on loans totaled $63.6 and $51.9 million at September 30, 2007 and 2006, respectively, and is included in other assets in the Consolidated Statements of Financial Condition.

15. ALLOWANCE FOR LOSSES – THE BANK:

Activity in the allowance for losses on loans receivable is summarized as follows:

	Year Ended September 30,
(In thousands)	2007			2006			2005
Beginning Balance	$	25,000		$	28,640		$	37,750
Provision (credit) for losses		3,383			(9,004	)		(11,569	)
Charge-offs		(7,587	)		(6,549	)		(14,522	)
Recoveries		8,204			11,913			16,981
Ending Balance	$	29,000		$	25,000		$	28,640

107

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

16. LOAN SERVICING RIGHTS – THE BANK:

Servicing assets are recorded when purchased and in conjunction with loan sales and securitization transactions when servicing rights are retained by the Bank. Activity in servicing assets is summarized as follows:

	Year Ended September 30,
(In thousands)	2007			2006			2005
Beginning Balance	$	168,059	(1)	$	201,156		$	164,764
Additions		57,874			89,527			99,551
Amortization		—			(83,428	)		(62,916	)
Accretion		16,297			—			—
Cash collected		(86,915	)		—			—
Charge-offs		—			—			(243	)
Net fair value adjustment		365			—			—
Ending Balance		155,680			207,255			201,156
Valuation Allowance		—			(39,196	)		(36,564	)
Carrying Value	$	155,680		$	168,059		$	164,592

⁽¹⁾ Includes the elimination of valuation allowances amounting to $39.2 million as a result of the adoption of SFAS 156 on October 1, 2006.

The aggregate fair value of servicing assets at September 30, 2007 and 2006 was $155.7 and $174.8 million respectively. Accumulated amortization was $356.3 million at September 30, 2006.

Activity in the valuation allowance for servicing assets is summarized as follows:

	Year Ended September 30,
(In thousands)	2007			2006		2005
Balance at beginning of year	$	39,196		$	36,564	$	16,909
Additions (reductions) charged to loan expenses		—			2,632		19,898
Charge-offs		—			—		(243	)
Elimination of valuation allowance per adoption of SFAS 156		(39,196	)		—		—
Balance at end of year	$	—		$	39,196	$	36,564

There were no sales of rights to service mortgage loans during fiscal years 2007, 2006 and 2005. Servicing fees are included in servicing, securitization and mortgage banking income in the Consolidated Statements of Operations.

108

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

At September 30, 2007 and 2006, key assumptions and the sensitivity of the current value of originated servicing assets to an immediate 10 percent and 20 percent adverse change in those assumptions are as follows:

	September 30, 2007
(Dollars in thousands)	Single-Family Residential			Home Equity/ Home Improvement
Carrying value	$	155,648		$	32
Weighted average life (in years)		3.6			3.3
Prepayment speed assumption (annual rate):(1)
First twelve months		18.7	%		30.5	%
Next twelve months		21.7	%		30.5	%
Thereafter		19.7	%		30.5	%
Impact on fair value at 10% adverse change	$	(5,816	)	$	(2	)
Impact on fair value at 20% adverse change	$	(11,579	)	$	(4	)
Discount rate (annual)		11.0	%		13.0	%
Impact on fair value at 10% adverse change	$	(4,600	)	$	—
Impact on fair value at 20% adverse change	$	(7,928	)	$	(1	)
	September 30, 2006
(Dollars in thousands)	Single-Family Residential			Home Equity/ Home Improvement
Carrying value	$	168,004		$	55
Weighted average life (in years)		3.3			2.7
Prepayment speed assumption (annual rate):(1)
First twelve months		28.7	%		36.5	%
Next twelve months		22.0	%		36.5	%
Thereafter		18.1	%		36.5	%
Impact on fair value at 10% adverse change	$	(9,950	)	$	(6	)
Impact on fair value at 20% adverse change	$	(18,203	)	$	(11	)
Discount rate (annual)		9.6	%		8.12	%
Impact on fair value at 10% adverse change	$	(4,190	)	$	(2	)
Impact on fair value at 20% adverse change	$	(7,497	)	$	(3	)

(1) Represents Constant Prepayment Rate.

The following table sets forth information regarding the Bank’s servicing fees collected during the periods indicated.

	Year Ended September 30,
(In thousands)	2007		2006		2005
Loan servicing fees(1)	$	44,977	$	45,473	$	43,493
Late charges(2)		2,199		1,873		1,506
Other servicing fees(1)		22,321		25,447		11,637
Total	$	69,497	$	72,793	$	56,636

⁽¹⁾ Included in servicing, securitization and mortgage banking income on the Condensed Consolidated Statements of Operation.

⁽²⁾ Included in other income on the Condensed Consolidated Statements of Operation.

109

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

17. LOAN SECURITIZATION TRANSACTIONS – THE BANK:

The Bank periodically sells various loan receivables through asset-backed securitizations, in which receivables are transferred to trusts, and certificates are sold to investors. The following chart summarizes the Bank’s securitization activities:

	As of or for the year ended September 30,
(In thousands)	2007		2006		2005
Single-Family Residential
Loans sold into new trusts during the year	$	1,949,709	$	4,210,911	$	5,320,133
Outstanding trust certificate balance at year end		6,879,430		8,710,468		9,446,395
Gains recognized during the year		48,625		112,591		178,580
Automobile
Loans sold into new trusts during the year	$	—	$	—	$	—
Outstanding trust certificate balance at year end		—		—		27,494
Gains recognized during the year		—		—		—

The Bank continues to service, and receive servicing fees on, the outstanding balance of securitized receivables. The Bank also retains rights, which may be subordinated, to future cash flows arising from the receivables. The Bank generally estimates the fair value of these retained interests based on the estimated present value of expected future cash flows from securitized and sold receivables, using management’s best estimates of the key assumptions – credit losses, prepayment speeds and discount rates commensurate with the risks involved.

The following table summarizes certain cash flows received from securitization trusts:

	Year Ended September 30,
(In thousands)	2007		2006		2005
Proceeds from new securitizations	$	1,913,260	$	4,135,697	$	5,221,409
Servicing fees received		30,081		33,108		31,576
Other cash flows received on retained interests		148,085		157,078		145,074

Servicing, securitization and mortgage banking income includes the initial gains on current securitization and sale transactions and income from interest-only strips receivable recognized in connection with current and prior period securitization and sale transactions. Activity in interest-only assets is summarized as follows:

	Year Ended September 30,
(In thousands)	2007			2006			2005
Beginning balance	$	344,317		$	348,227		$	287,840
Additions		100,266			208,133			275,405
Accretion		30,143			27,644			29,333
Cash received		(151,743	)		(151,403	)		(123,342	)
Fair value adjustments		(8,872	)		(88,284	)		(121,009	)
Ending balance/Carrying value	$	314,111		$	344,317		$	348,227

110

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

At September 30, 2007 and 2006, key assumptions and the sensitivity of the current fair value of the retained interests to an immediate 10 percent and 20 percent adverse change in those assumptions are as follows:

	Single–Family Residential
(Dollars in thousands)	September 30,
	2007			2006
Carrying value (fair value) (1)	$	317,093		$	364,817
Weighted average life (in years) (2)		2.8			2.4
Prepayment speed assumption(2)(3):
First twelve months		20.5	%		35.9	%
Next twelve months		25.7	%		27.0	%
Thereafter		23.3	%		21.3	%
Impact on fair value at 10% adverse change	$	(26,131	)	$	(35,701	)
Impact on fair value at 20% adverse change	$	(48,394	)	$	(66,796	)
Residual cash flow discount rate (annual)		12	%		9.5	%
Impact on fair value at 10% adverse change	$	(7,748	)	$	(7,804	)
Impact on fair value at 20% adverse change	$	(13,476	)	$	(15,324	)

⁽¹⁾ Fiscal year 2007 includes interest-only assets of $314.1 million and reserve accounts of $3.0 million. Fiscal year 2006 includes interest-only assets of $344.3 million and reserve accounts of $20.5 million.

⁽²⁾ Expected weighted average life and prepayment speed assumptions are based on life of securitization.

⁽³⁾ Represents Constant Prepayment Rate for single-family residential loans, and Absolute Pre-payment Speed or ABS for automobile loans. Certain loans may require the payment of a fee if the borrower prepays the loan during the period up to three years after origination. The Bank uses a lower prepayment assumption during these periods.

Key assumptions used in measuring retained interests at the date of single-family securitizations completed during fiscal year 2007 and 2006 are as follows:

	Year Ended September 30,
	2007		2006
Prepayment speed assumption(1) (average annual rate):
First twelve months	22.4	%	28.5	%
Next twelve months	28.0	%	27.9	%
Thereafter	28.5	%	25.5	%
Expected credit losses (annual rate)	—		—
Discount rate (annual rate)	10.0	%	8.9	%

⁽¹⁾ Expected weighted average life and prepayment speed assumptions are based on life of securitization.

These sensitivities are hypothetical and should be used with caution. Changes in fair value based on variations in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. The effects shown in the above tables of a variation in a particular assumption on the fair value of interest-only strips receivable is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another factor, which might magnify or counteract the sensitivities.

111

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Principal balances, delinquent amounts and net credit losses for securitized loans were as follows:

(In thousands)	As of or for the year ended September 30, 2007
	Total Principal Amount of Loans		Principal Amount of Loans Past Due 90 Days or More or Non-Performing		Net Credit Losses (Recoveries)
Single-family residential	$	6,901,187	$	177,853	$	762
(In thousands)	As of or for the year ended September 30, 2006
	Total Principal Amount of Loans		Principal Amount of Loans Past Due 90 Days or More or Non-Performing		Net Credit Losses (Recoveries)
Single-family residential	$	8,511,739	$	44,950	$	137

18. PROPERTY AND EQUIPMENT – THE BANK:

Property and equipment is composed of the following:

(Dollars in thousands)	Estimated Useful Lives	September 30,
		2007		2006
Land	—	$	151,153	$	130,838
Projects in progress	—		19,087		10,991
Buildings and improvements	10-65 years		285,019		309,555
Leasehold and tenant improvements	7-40 years		234,306		202,572
Furniture and equipment	5-10 years		293,700		274,221
Automobiles	3-5 years		6,955		6,222
			990,220		934,399
Less:
Accumulated depreciation and amortization			344,699		332,807
Total		$	645,521	$	601,592

Depreciation and amortization expense related to property and equipment amounted to $46.2, $45.7 and $42.5 million for the years ended September 30, 2007, 2006 and 2005, respectively.

112

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

19. AUTOMOBILES SUBJECT TO LEASE – THE BANK:

Automobiles subject to lease is composed of the following:

(Dollars in thousands)	Estimated Useful Lives	September 30,
		2007		2006
Automobiles	3-5 years	$	16,842	$	110,703
Less:
Accumulated depreciation			9,869		55,255
Total		$	6,973	$	55,448

Depreciation expense related to automobile leases amounted to $5.6, $23.3 million and $60.7 million for the years ended September 30, 2007, 2006, and 2005, respectively. Automobile rental income amounted to $8.3, $35.2 and $82.0 million for the years ended September 30, 2007, 2006 and 2005, respectively.

The Bank expects to earn future minimum automobile rental income of $1.2 million during fiscal year 2008.

20. LEASES – THE BANK:

The Bank has noncancelable, long-term leases for office premises and retail space which have a variety of terms expiring from fiscal year 2008 to fiscal year 2033 and ground leases which have terms expiring from fiscal year 2029 to fiscal year 2081. These leases are accounted for as operating leases. Some of the leases are subject to rent adjustments in the future based upon changes in the Consumer Price Index and some also contain renewal options.

The following is a schedule by years of future minimum lease payments required at September 30, 2007:

(In thousands)

Year Ending September 30,
2008	$	36,248
2009		34,121
2010		28,754
2011		27,464
2012		26,210
Thereafter		285,464
Total	$	438,261

Rent expense totaled $41.2, $33.4 and $27.4 million for the years ended September 30, 2007, 2006 and 2005, respectively. For operating leases with fixed escalation amounts, rent expense is recognized on a straight-line basis over the term of the lease.

113

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

21. DEPOSIT ACCOUNTS – THE BANK:

The Bank’s deposits are insured by the FDIC up to at least $100,000 for each insured depositor. An analysis of deposit accounts and the related weighted average effective interest rates at year end are as follows:

	September 30,
	2007				2006
(Dollars in thousands)	Amount		Weighted Average Rate		Amount		Weighted Average Rate
Non-interest bearing checking accounts	$	1,273,687	—		$	1,316,980	—
Interest bearing checking accounts		2,303,615	0.30	%		2,313,152	0.28	%
Money market deposit accounts		2,166,489	2.46	%		2,403,060	2.69	%
Savings accounts		1,063,780	1.15	%		953,663	0.47	%
Certificate accounts, less than $100,000		2,479,391	4.65	%		2,088,368	4.37	%
Certificate accounts, $100,000 or more		1,662,615	5.11	%		1,370,541	4.71	%
Total	$	10,949,577	2.49	%	$	10,445,764	2.21	%

Interest expense on deposit accounts is composed of the following:

	Year Ended September 30,
(In thousands)	2007		2006		2005
Checking accounts	$	6,741	$	6,021	$	5,012
Money market deposit accounts		63,794		55,035		34,765
Savings accounts		6,417		4,450		3,435
Certificate accounts		179,961		114,057		52,419
Total	$	256,913	$	179,563	$	95,631

Outstanding certificate accounts at September 30, 2007 mature in the years indicated as follows:

(In thousands)

Year Ending September 30,
2008	$	3,791,990
2009		295,109
2010		37,653
2011		9,075
2012		8,179
Total	$	4,142,006

At September 30, 2007, certificate accounts of $100,000 or more have contractual maturities as indicated below:

(In thousands)

Three months or less	$	941,539
Over three months through six months		396,625
Over six months through 12 months		201,434
Over 12 months		123,017
Total	$	1,662,615

114

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

22. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS – THE BANK:

Short-term borrowings are summarized as follows:

(Dollars in thousands)	September 30,
	2007			2006			2005
Securities sold under repurchase agreements:
Balance at year end	$	120,507		$	458,307		$	191,034
Average amount outstanding during the year		151,466			232,824			119,791
Maximum amount outstanding at any month end		213,124			458,307			191,109
Amount maturing within 30 days		120,507			458,307			191,034
Weighted average interest rate during the year		4.65	%		4.32	%		2.61	%
Weighted average interest rate on year end balances		3.87	%		5.18	%		3.59	%
Other short-term borrowings:
Balance at year end	$	443,391		$	364,332		$	307,880
Average amount outstanding during the year		434,639			335,874			221,691
Maximum amount outstanding at any month end		509,233			377,418			307,880
Amount maturing within 30 days		443,391			364,332			307,880
Weighted average interest rate during the year		4.53	%		4.00	%		1.79	%
Weighted average interest rate on year end balances		3.68	%		4.41	%		2.88	%

The investment and mortgage-backed securities underlying the dealer repurchase agreements were delivered to the dealers who arranged the transactions. The dealers may have loaned such securities to other parties in the normal course of their operations and agreed to resell to the Bank the identical securities upon the maturities of the agreements.

At September 30, 2007, the Bank had pledged mortgage-backed securities and investment securities with a combined book value of $134.5 and $486.2 million to secure securities sold under repurchase agreements and certain other short-term borrowings, respectively. Also at September 30, 2007, the Bank had pledged, but did not borrow against, other loans with a total principal balance of $1,098.7 million.

23. FEDERAL HOME LOAN BANK ADVANCES – THE BANK:

At September 30, 2007 and 2006, advances from the Federal Home Loan Bank of Atlanta (“FHLB”) totaled $2,007.3 and $1,343.3 million, respectively. The interest rate on each FHLB advance is fixed for the term of the advance and the weighted average interest rate for all advances was 4.92% at September 30, 2007. The advances mature over varying periods as follows:

(In thousands)
Six months or less	$	1,683,282
More than six months through one year		111,661
More than one year through three years		120,265
More than three years through five years		12,525
More than five years		79,541
Total	$	2,007,274

Under a Specific Collateral Agreement with the FHLB, advances are secured by the FHLB stock owned by the Bank and qualifying first mortgage loans and certain second mortgage loans and/or lines with a total principal balance of $6,109.2 million. The FHLB requires that members maintain qualifying collateral at least equal to 100% of the member’s outstanding advances at all times. The collateral held by the FHLB in excess of the amount of the September 30, 2007 advances is available to secure additional advances from the FHLB, subject to its collateralization guidelines.

115

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

24. CAPITAL NOTES - SUBORDINATED – THE BANK:

On December 2, 2003, the Bank issued $175.0 million aggregate principal amount of 6-7/8% subordinated debentures due 2013 (the “2003 Debentures”), which are subordinated to the interest of deposit account holders and other senior debt. The Bank may redeem some or all of the 2003 Debentures at any time on and after December 1, 2008 at the following redemption prices plus accrued and unpaid interest:

If redeemed during the 12-month period beginning December 1,	Redemption Price
2008	103.4375	%
2009	102.2917	%
2010	101.1458	%
2011 and thereafter	100.0000	%

The Bank received OTS approval to include the principal amount of the 2003 Debentures in the Bank’s supplementary capital for regulatory capital purposes.

The indenture pursuant to which the 2003 Debentures were sold (the “Indenture”) provides that the Bank may not pay dividends on its capital stock unless, after giving effect to the dividend, no event of default shall have occurred and be continuing and the Bank is in compliance with its regulatory capital requirements. In addition, the amount of the proposed dividend may not exceed the sum of (i) $50.0 million, (ii) 66 2/3% of the Bank’s consolidated net income (as defined in the Indenture) accrued on a cumulative basis commencing on October 1, 2002 and (iii) the aggregate net cash proceeds received by the Bank after October 1, 2002 from the sale of qualified capital stock or certain debt securities, minus the aggregate amount of any restricted payments made by the Bank. Notwithstanding the above restrictions on dividends, provided no event of default has occurred or is continuing, the Indenture does not restrict the payment of dividends on the Series C Preferred Stock (as defined below).

Deferred debt issuance costs, net of accumulated amortization, amounted to $2.6 and $2.9 million at September 30, 2007 and 2006, respectively, and are included in other assets in the Consolidated Statements of Financial Condition.

25. PREFERRED STOCK – THE BANK:

In October 2003, the Bank sold $125.0 million of its 8% Noncumulative Perpetual Preferred Stock, Series C (the “Series C Preferred Stock”). The Series C Preferred Stock trades on the New York Stock Exchange under the symbol “CCX PrC.” Dividends are payable quarterly 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. 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.

26. COMPENSATION PLANS – THE BANK:

The Bank participates in a defined contribution profit sharing retirement plan (the “Plan”), which can be modified or discontinued at any time, and which covers those full-time employees who meet the requirements as specified in the Plan.

Corporate contributions, at the discretionary amount of up to six percent of the employee’s cash compensation, subject to certain limits, were $12.1, $11.1 and $10.2 million for the years ended September 30, 2007, 2006 and 2005, respectively. There are no past service costs associated with the Plan and the Bank has no liability under the Plan other than its current contributions. The Plan owns 4.0% of the Bank’s common stock.

The Bank provides a supplemental defined contribution profit sharing retirement plan (the “SERP”), which covers certain highly-compensated full-time employees who meet the requirements as specified in the SERP. The SERP, which can be modified or discontinued at any time, requires participating employees to contribute 2.0% of their compensation in excess of a specified amount. Corporate contributions, equal to three times the employee’s contribution, were $1.6, $1.4 and $1.5 million for the years ended September 30, 2007, 2006 and 2005, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

There are no past service costs associated with the SERP. The Bank’s liability under the SERP, which includes contributions from employees and is not funded, was $22.6 and $19.2 million at September 30, 2007 and 2006, respectively, and is included in other liabilities on the Consolidated Statements of Financial Condition.

The Bank has granted awards under a deferred compensation plan to certain qualified employees. The deferred compensation plan provides that, as of the end of each fiscal year in the ten-year period prior to vesting, the Bank will add to or deduct from the account of each employee who has received an award, a contribution or deduction, which represents hypothetical interest (which may be positive or negative) earned on the principal contribution, based on the Bank’s rate of return on average assets as defined in the deferred compensation plan for the fiscal year then ended. The deferred compensation plan is unfunded. At September 30, 2007, the Bank had recorded a liability totaling $32.4 million reflecting the Bank’s obligations under the plan, which is included in other liabilities on the Consolidated Statements of Financial Condition. The Bank’s expense under the deferred compensation plan totaled $4.8, $6.7 and $7.2 million during the years ended September 30, 2007, 2006 and 2005, respectively.

Certain officers have entered into agreements with the Bank regarding confidentiality, nonsolicitation, ownership of certain works and termination upon change of control. Each of those officers has agreed not to compete with, solicit customers of or solicit the employees of the Bank for stated periods following any termination of employment with the Bank. In addition, the Bank has agreed to pay each such officer a specified amount if the officer is terminated without cause in the three-year period following a change of control of the Bank. The amount payable varies depending upon the officer’s base compensation and most recent bonus, the length of the officer’s employment with the Bank and the per share price at which the triggering change of control has occurred.

Certain executive officers have also entered into “Special Retirement Compensation Agreements” under which the executive could receive an amount up to three times his base compensation if he retires from the Bank after reaching age 63. These agreements are unfunded. As of September 30, 2007 and 2006, the Bank had recorded a liability totaling $4.0 and $3.3 million, respectively, which is included in other liabilities on the Consolidated Statements of Financial Condition. The Bank’s expense under the special retirement agreements totaled $691,000, $617,000 and $527,000 during the years ended September 30, 2007, 2006 and 2005, respectively.

117

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

27. REGULATORY MATTERS – THE BANK:

The Bank’s regulatory capital requirements at September 30, 2007 and 2006 were a 1.5% tangible capital requirement, a 4.0% core capital requirement and an 8.0% total risk-based capital requirement. Under the OTS “prompt corrective action” regulations, the Bank must maintain minimum leverage, tier 1 risk-based and total risk-based capital ratios of 4.0%, 4.0% and 8.0%, respectively, to meet the ratios established for “adequately capitalized” institutions. At September 30, 2007 and 2006, the Bank was in compliance with its regulatory capital requirements and exceeded the capital standards established for “well capitalized” institutions under the “prompt corrective action” regulations. The information below is based upon the Bank’s understanding of the applicable regulations and related interpretations. The table contains information of the Bank only does not include consolidation or elimination entries required for the Trust’s financial presentation.

	September 30, 2007
	Actual					Minimum Capital Requirement				Excess Capital
(Dollars in thousands)	Amount			As a % of Assets		Amount		As a % of Assets		Amount		As a % of Assets
Stockholders’ equity per financial statements	$	829,729
Minority interest in REIT Subsidiary(1)		144,000
Adjusted capital		973,729
Adjustments for tangible and core capital:
Intangible assets		(63,762	)
Non-includable subsidiaries		(2,965	)
Non-qualifying purchased/ originated loan servicing		(9,411	)
Total tangible capital		897,591		5.97	%	$	225,487	1.50	%	$	672,104	4.47	%
Total core capital(2)		897,591		5.97	%	$	601,298	4.00	%	$	296,293	1.97	%
Tier 1 risk-based capital(2)		897,591		8.85	%	$	404,178	4.00	%	$	493,413	4.85	%
Adjustments for total risk-based capital:
Subordinated capital debentures		175,000
Allowance for general loan losses		29,000
Total supplementary capital		204,000
Total available capital		1,101,591
Equity investments(3)		(2,456	)
Total risk-based capital(2)	$	1,099,135		10.85	%	$	808,357	8.00	%	$	290,778	2.85	%

⁽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⁾ 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%.

⁽³⁾ Includes one property classified as real estate held for sale which is treated as an equity investment for regulatory capital purposes.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in thousands)	September 30, 2006
	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	$	790,235
Minority interest in REIT Subsidiary(1)		144,000
Adjusted capital		934,235
Adjustments for tangible and core capital:
Intangible assets		(58,307	)
Non-includable subsidiaries		(3,097	)
Non-qualifying purchased / originated loan servicing		(5,582	)
Total tangible capital		867,249		6.15	%	$	211,396	1.50	%	$	655,853	4.65	%
Total core capital(2)		867,249		6.15	%	$	563,722	4.00	%	$	303,527	2.15	%
Tier 1 risk-based capital(2)		867,249		9.12	%	$	380,911	4.00	%	$	486,338	5.12	%
Adjustments for total risk-based capital:
Subordinated capital debentures		175,000
Allowance for general loan losses		25,000
Total supplementary capital		200,000
Total available capital		1,067,249
Equity investments(3)		(2,094	)
Total risk-based capital(2)	$	1,065,155		11.21	%	$	761,821	8.00	%	$	303,334	3.21	%

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

⁽²⁾ 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%.

⁽³⁾ Includes one property classified as real estate held for sale which is treated as an equity investment for regulatory capital purposes.

OTS capital regulations provide a five-year holding period (or such longer period as may be approved by the OTS) for REO to qualify for an exception from treatment as an equity investment. If an REO property is considered an equity investment, its then current book value is deducted from total risk-based capital. Accordingly, if the Bank is unable to dispose of any REO property prior to the end of its applicable five-year holding period and is unable to obtain an extension of such five-year holding period from the OTS, the Bank could be required to deduct the then-current book value of such REO property from total risk-based capital. In August 2007, the Bank received from the OTS an extension of the holding periods for certain of its REO properties through August 13, 2008.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The following table sets forth the Bank’s REO at September 30, 2007, by the fiscal year in which the property was acquired through foreclosure.

(In thousands)

Fiscal Year
1990	$	2,456	(1)
1991		7,618	(2)
1995		23,577	(2)
2007		14,792
Total REO	$	48,443

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

⁽²⁾ The Bank received an extension of the holding periods for these properties through August 13, 2008.

OTS regulations limit the ability of the Bank to make “capital distributions.” “Capital distributions” include payment of dividends, stock repurchases, cash-out mergers, repurchases of subordinated debt and other distributions charged against the capital accounts of an institution. The regulations do not apply to interest or principal payments on debt, including interest or principal payments on the Bank’s outstanding subordinated debentures.

The Bank must notify the OTS before making any capital distribution. In addition, the Bank must apply to the OTS to make any capital distribution if the Bank does not qualify for expedited treatment under OTS regulations. If the Bank qualifies for expedited treatment, an application is required only if the total amount of all of the Bank’s capital distributions for the year exceeds the sum of the Bank’s net income for the year and its retained net income for the previous two years.

In considering a notice or application, the OTS will not permit a capital distribution if:

• the Bank would be undercapitalized following the distribution;

• the capital distribution raises safety and soundness concerns; or

• the capital distribution violates any statute, regulation, agreement with the OTS, or condition imposed by the OTS.

The OTS has conditioned the Bank’s recent payments of common stock dividends on the Bank’s maintaining its well-capitalized status and there can be no assurance that the OTS will not impose a similar condition on payment of dividends on the 8% Preferred Stock.

28. TRANSACTIONS WITH RELATED PARTIES – THE BANK:

Loans Receivable:

From time to time, in the normal course of business, the Bank may make loans to executive officers and directors, their immediate family members or companies with which they are affiliated. These loans are on substantially the same terms as similar loans with unrelated parties. An analysis of activity with respect to these loans is as follows:

(In thousands)	Year Ended September 30,
	2007			2006			2005
Beginning balance	$	11,441		$	14,320		$	17,604
Additions		7,909			3,826			5,335
Reductions		(2,103	)		(6,705	)		(8,619	)
Ending balance	$	17,247		$	11,441		$	14,320

Services:

B.F. Saul Company, which is a shareholder of the Trust, and its subsidiaries provide certain services to the Bank. These services include property management, insurance brokerage and leasing. Fees for these services were $2.0, $1.6 and $1.4 million for the years ended September 30, 2007, 2006 and 2005, respectively.

For each of the years ended September 30, 2007, 2006 and 2005, a director of the Bank was paid $100,000 for consulting services rendered to the Bank and $6,000 for service on the Boards of Directors for two of the Bank’s subsidiaries. Another director of the Bank

120

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

was paid $100,000 for services as Chairman of the Bank’s Audit Committee. A third director of the Bank was paid total fees of $100,000 for consulting services rendered to two subsidiaries of the Bank and $6,000 for services as Chairman of the Board of Directors of those subsidiaries.

Tax Sharing Agreement:

The Bank and the other companies in the Trust’s affiliated group are parties to a tax sharing agreement (the “Tax Sharing Agreement”). The Tax Sharing Agreement provides for payments to be made by members of the Trust’s affiliated group to the Trust based on their separate company tax liabilities. The Tax Sharing Agreement also provides that, to the extent net operating losses or tax credits of a particular member are used to reduce the overall tax liability of the Trust’s affiliated group, such member will be reimbursed by the other members of the affiliated group that have taxable income in an amount equal to such tax reduction. The Bank made net payments of $4.0, $2.0 and $2.1 million to the Trust during fiscal 2007, 2006 and 2005, respectively, under the Tax Sharing Agreement. At September 30, 2007 and 2006, the estimated net tax sharing payment payable to the Trust by the Bank was $1.8 and $4.7 million, respectively.

Other:

During the year ended September 30, 2007, the Bank sold an office building located in Bethesda, MD to its parent company, the B.F. Saul Real Estate Investment Trust. The proceeds from the sale exceeded the Bank’s carrying value, net of related income taxes, by $9.6 million, which was accounted for as a capital contribution because the transfer was between entities under common control.

During the year ended September 30, 2005, two subsidiaries of the Bank each sold a property to the Trust. A gain of $1.4 million, net of taxes, was recorded as a capital contribution because these transfers were between entities under common control.

The Bank paid $11.0, $10.0 and $8.9 million for office space leased from or managed by companies affiliated with the Bank or its directors during the years ended September 30, 2007, 2006 and 2005, respectively.

The Trust, the B.F. Saul Company, Chevy Chase Lake Corporation and Van Ness Square Corporation, affiliates of the Bank, from time to time maintain interest-bearing deposit accounts with the Bank. Those accounts had aggregate balances of $45.7 and $91.0 million at September 30, 2007 and 2006, respectively. The Bank paid interest on the accounts amounting to $2.3, $1.9 and $1.0 million during fiscal years ended 2007, 2006 and 2005, respectively.

29. FINANCIAL INSTRUMENTS – THE BANK:

The Bank, in the normal course of business, is a party to financial instruments with off-balance-sheet risk and other derivative financial instruments to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit at both fixed and variable rates, letters of credit, interest-rate swap and cap agreements, forward purchase and sale commitments and assets sold with limited recourse. All such financial instruments are held or issued for purposes other than trading.

These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the Consolidated Statements of Financial Condition.

The contractual or notional amount of these instruments reflects the extent of involvement the Bank has in particular classes of financial instruments. For interest-rate swap and cap agreements, assets sold with limited recourse and forward purchase and sale commitments, the contractual or notional amounts do not represent exposure to credit loss in the event of nonperformance by the other party. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to Extend Credit:

The Bank had $3,781.7 million of commitments to extend credit at September 30, 2007. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These commitments are subject to the Bank’s normal underwriting and credit evaluation policies and procedures.

Standby Letters of Credit:

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. At September 30, 2007, the Bank had issued standby letters of credit in the amount of $109.5 million to guarantee the performance of and irrevocably assure payment by customers under construction projects. In accordance with FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” the Bank recorded a liability for the fair value of its guarantee equal to $333,000.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Of the total, $63.2 million will expire in fiscal 2008 and the remainder will expire over time through fiscal 2012. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan commitments to customers.

Recourse Arrangements:

The Bank is obligated under various recourse provisions (primarily related to credit losses) related to the securitization and sale of receivables. As a result of these securitization and sale activities, the Bank maintained restricted cash accounts amounting to $3.0 and $20.5 million at September 30, 2007 and 2006, respectively, which are included in other assets in the Consolidated Statements of Financial Condition. Of these amounts $0 and $2.5 million represented recourse to the Bank at September 30, 2007 and 2006, respectively.

The Bank is also obligated under recourse provisions related to the servicing of certain of its residential mortgage loans. Recourse to the Bank under these agreements was $3.0 and $2.9 million at September 30, 2007 and 2006, respectively.

Derivative Financial Instruments:

In accordance with SFAS 133, the Bank assigns derivatives to one of these categories at the purchase date: fair value hedge, cash flow hedge or non-designated hedge. SFAS 133 requires an assessment of the expected and ongoing effectiveness of any derivative assigned to a fair value hedge or cash flow hedge relationship.

Fair Value Hedges —For derivatives designated as fair value hedges, the derivative instrument and related hedged item are marked to market through earnings. Derivatives are included in other assets in the Consolidated Statements of Financial Condition. At September 30, 2007 and 2006, the Bank did not have any derivatives designated as fair value hedges.

Cash Flow Hedges —For derivatives designated as cash flow hedges, mark to market adjustments are recorded as a component of equity. At September 30, 2007 and 2006, the Bank did not have any derivatives designated as cash flow hedges.

Non-Designated Hedges —Certain economic hedges are not designated as cash flow hedges or as fair value hedges for accounting purposes. As a result, changes in their fair value are recorded in other income in the consolidated Statements of Operations. The fair value of these derivatives is included in other assets in the Consolidated Statements of Condition.

At September 30, 2007, the Bank had $83.4 million in forward sale commitments relating to fixed rate loans. The net unrealized loss in value of these commitments was $556,000 at September 30, 2007. The notional amount of the related Fixed Rate Loans was $83.4 million. The net unrealized loss in the value of these loans was $170,000. The net unrealized gains and losses are included in other income in the Consolidated Statement of Operations.

At September 30, 2007, the Bank had $2.7 million in forward sale commitments relating to hybrid loans. The net unrealized gain in value of these commitments was $3,000 at September 30, 2007. The notional amount of the related Hybrid Libor ARMs was $108.0 million. The net unrealized loss in the value of these loans was $1.3 million. The net unrealized gains and losses are included in other income in the Consolidated Statement of Operations.

As September 30, 2006, the Bank had $75.0 million in forward sale commitments. The net unrealized loss in value of these commitments was $406,000 at September 30, 2006. The notional amount of the related Fixed Rate loans was $83.7 million. The net unrealized gain in the value of these loans was $596,000. The net unrealized gains and losses are included in other income in the Consolidated Statement of Operations.

At September 30, 2007, the Bank had $139.0 million in forward sale commitments related to fixed rate loan interest rate locks (“IRLS”). The net unrealized loss in the value of these commitments was $210,000 at September 30, 2007. At September 30, 2007, the Bank had fixed rate IRLs with a notional amount of $242.5 million. The net unrealized loss in the value of the IRLs was $105,000.

At September 30, 2007, the Bank had no forward sale commitments related to hybrid LIBOR arm IRLs. At September 30, 2007, the Bank had hybrid libor arm IRLs with a notional amount of $14.5 million. The net unrealized gain in the value of the IRLs was $299,000.

At September 30, 2006, the Bank had $73.0 million in forward sale commitments. The net unrealized loss in the value of these commitments was $293,000 at September 30, 2006. At September 30, 2006, the Bank had IRLs with a notional amount of $89.1 million. The net unrealized gain in the value of the IRLs was $175,000.

Liquidity Facility:

In connection with the securitization and sale of certain payment option residential mortgage loans, the Bank is obligated to fund a portion of any “negative amortization” resulting from the borrowers electing their option to make monthly payments that are not sufficient to

122

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

cover the interest accrued for the payment period. For each dollar of negative amortization funded by the Bank, the balances of certain highly-rated mortgage-backed securities received by the Bank as part of the securitization transaction increase accordingly. When the borrowers ultimately make the principal payments, the Bank receives its pro rata portion of those payments in cash, and the balances of those securities held by the Bank are reduced accordingly. During the year ended September 30, 2007, the Bank funded $141.6 million of negative amortization under these obligations, and received $105.0 million in principal payments representing previously funded negative amortization.

Concentrations of Credit:

The Bank’s principal market is the metropolitan Washington, DC area. In addition, a significant portion of the Bank’s residential mortgage loans are secured by properties in California. Service industries and federal, state and local governments employ a significant portion of the Washington, DC area labor force. Adverse changes in economic conditions in these areas could have a direct impact on the timing and amount of payments by borrowers.

30. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS – THE BANK:

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

The estimated fair values of the Bank’s financial instruments are as follows:

(In thousands)	September 30,
	2007					2006
	Carrying Amount			Fair Value		Carrying Amount			Fair Value
Financial assets:
Cash, due from banks and interest-bearing deposits	$	380,099		$	380,099	$	410,188		$	410,188
Loans held for securitization and/or sale		202,268			204,048		467,574			476,801
U.S. Government securities		210,363			211,745		201,455			200,152
Mortgage-backed securities		1,053,433			1,040,424		1,289,718			1,266,970
Loans receivable, net		11,637,789			11,557,258		10,120,821			10,063,355
Interest-only strips receivable		314,111			314,111		344,317			344,317
Servicing assets, net		155,680			155,680		168,059			174,781
Other financial assets		157,550			157,550		144,479			144,479
Financial liabilities:
Deposit accounts with no stated maturities		6,807,571			6,807,571		6,986,855			6,986,855
Deposit accounts with stated maturities		4,142,006			4,170,652		3,458,909			3,469,791
Securities sold under repurchase agreements and other short-term borrowings and Federal Home Loan Bank advances		2,571,172			2,573,602		2,165,951			2,166,114
Capital notes-subordinated		172,396	(1)		169,771		172,072	(1)		172,947
Other financial liabilities		247,418			247,418		247,879			247,879

⁽¹⁾ Net of deferred debt issuance costs which are included in other assets in the Consolidated Statements of Financial Condition.

The following methods and assumptions were used to estimate the fair value amounts at September 30, 2007 and 2006:

Cash, due from banks and, interest-bearing deposits: Carrying amount approximates fair value.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Loans held for securitization and/or sale:The fair value of loans held for securitization and/or sale is determined using discounted cash flow analysis, using quoted prices for loans or securities backed by loans with similar characteristics, or outstanding commitment prices from investors.

U.S. Government securities:Fair value is based on quoted market prices.

Mortgage-backed securities: Fair value is based on quoted market prices, dealer quotes or estimates using dealer quoted market prices for similar securities.

Loans receivable, net: Fair value of certain homogeneous groups of loans (e.g., single-family residential, automobile loans, home improvement loans and fixed-rate commercial and multifamily loans) is estimated using discounted cash flow analyses based on contractual repayment schedules and management’s estimate of future prepayment rates. The discount rates used in these analyses are based on either the interest rates paid on U.S.

Treasury securities of comparable maturities adjusted for credit risk and non-interest operating costs, or the interest rates currently offered by the Bank for loans with similar terms to borrowers of similar credit quality. For loans, which reprice frequently at market rates (e.g., home equity, variable-rate commercial and multifamily, real estate construction and ground loans), the carrying amount approximates fair value. The fair value of the Bank’s loan portfolio as presented above does not include the value of established credit line customer relationships, or the value relating to estimated cash flows from future receivables and the associated fees generated from existing customers.

Interest-only strips receivable:Interest-only strips receivable are carried at fair value.

Servicing assets, net:Fair value of servicing assets is estimated using discounted cash flow analyses based on contractual repayment schedules and management’s estimate of future prepayment rates.

Other financial assets: The carrying amount of Federal Home Loan Bank stock, accrued interest receivable, interest-bearing deposits maintained pursuant to various asset securitizations and other short-term receivables approximate fair value. Derivative financial instruments are carried at fair value.

Deposit accounts with no stated maturities: Deposit liabilities payable on demand, consisting of NOW accounts, money market deposits, statement savings and other deposit accounts, are assumed to have an estimated fair value equal to carrying value. The indicated fair value does not consider the value of the Bank’s established deposit customer relationships.

Deposit accounts with stated maturities:Fair value of fixed-rate certificates of deposit is estimated based on the remaining maturity of the underlying accounts and interest rates currently offered on certificates of deposits with similar maturities.

Securities sold under repurchase agreements and other short-term borrowings and Federal Home Loan Bank advances:For these borrowings, which either reprice frequently to market interest rates or are short-term in duration, the carrying amount approximates fair value. Fair value of the remaining amounts borrowed is estimated based on discounted cash flow analyses using interest rates currently charged by the lender for comparable borrowings with similar remaining maturities.

Capital notes-subordinated: Fair value of the Bank’s subordinated debentures is based on quoted market prices.

Other financial liabilities: The carrying amount of custodial accounts, amounts due to banks, accrued interest payable and other short-term payables approximates fair value.

124

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

31. BUSINESS SEGMENTS – THE BANK:

The Bank has three operating segments: retail banking, commercial banking, and asset management 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. Asset management services include asset management and similar services offered by subsidiaries of the Bank.

Selected segment information is as follows:

	Retail Banking			Commercial Banking			Asset Management			Total
Year Ended September 30, 2007
Core operating income	$	720,422		$	52,703		$	39,010		$	812,135
Core operating expense		635,494			29,500			35,914			700,908
Core earnings		84,928			23,203			3,096			111,227
Non-core items		(4,443	)		4,432			(412	)		(423	)
Operating income	$	80,485		$	27,635		$	2,684		$	110,804
Average assets	$	13,297,204		$	1,354,860		$	57,495		$	14,709,559
Year Ended September 30, 2006
Core operating income	$	735,637		$	49,471		$	33,342		$	818,450
Core operating expense		614,763			25,977			33,531			674,271
Core earnings (loss)		120,874			23,494			(189	)		144,179
Non-core items		(4,093	)		(344	)		(939	)		(5,376	)
Operating income (loss)	$	116,781		$	23,150		$	(1,128	)	$	138,803
Average assets	$	13,101,110		$	1,389,027		$	53,073		$	14,543,210
Year Ended September 30, 2005
Core operating income	$	739,600		$	42,213		$	18,827		$	800,640
Core operating expense		591,382			24,380			24,739			640,501
Core earnings (loss)		148,218			17,833			(5,912	)		160,139
Non-core items		28,620			968			(32	)		29,556
Operating income (loss)	$	176,838		$	18,801		$	(5,944	)	$	189,695
Average assets	$	12,723,216		$	1,262,957		$	37,783		$	14,023,956

The financial information for each segment is reported on the basis used internally by the Bank’s management to evaluate performance. Pre-tax core earnings excludes certain items such as gains and losses related to certain securitization transactions, adjustments to loan loss reserves in excess of net chargeoffs, amortization of intangible assets, and certain other nonrecurring items. Items excluded from pre-tax 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.

At September 30, 2007, goodwill of $18.3 million related to the retail banking segment and $43.2 million related to two reporting units within the asset management segment and is included in the non-banking segment.

32. LITIGATION – THE BANK:

During the normal course of business, the Bank is involved in litigation, which may include litigation arising out of its lending activities, the enforcement or defense of the priority of its security interests, the continued development and marketing of certain of its real estate properties and certain employment claims. Although the amounts claimed in some of these suits in which the Bank is a defendant may be material, the Bank denies liability and, in the opinion of management, litigation which is currently pending will not have a material impact on the financial condition or future operations of the Bank.

125

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

On January 16, 2007, in the case of Andrews v. Chevy Chase Bank in the U.S. District Court for the Eastern District of Wisconsin, the court ruled that the Bank’s disclosures relating to certain residential mortgage loans violated the federal Truth-in-Lending (“TIL”) Act. The mortgage loans in question have a feature which permits a borrower to elect monthly, for up to five years, to make either (i) a minimum payment based on a payment rate less than the variable interest rate; (ii) a payment equal to all accrued interest; (iii) a fully amortizing payment based on a 15-year term; or (iv) a fully amortizing payment based on the original term of the loan (“five year option ARMs”).

All of the mandated TIL disclosures (APR, Finance Charges and Payment Amounts) were accurate. However, the TIL document provided to Andrews and certain other borrowers (the number of which is unknown at this time) had optional loan tracking nomenclature which inadvertently had been truncated when printed on the form. (The Bank stopped using the optional language at issue in 2005.) The court found that the inadvertently truncated language rendered the correct TIL disclosures capable of misinterpretation and therefore helped create three separate TIL disclosure violations. The court also found that the Bank failed to clearly disclose that “monthly” payments were required, despite language in the disclosures indicating that payment options must be chosen “each month.”

The case was brought by the named plaintiff as a class action on behalf of borrowers of five-year option ARMs for the period April 20, 2004 to the date of class certification who had received the same disclosure documents as the named plaintiff. The court granted class status to those plaintiffs. With respect to a remedy, no actual damages were alleged and the court concluded that the violations did not give rise to statutory damages. However, the court said that the affected borrowers were entitled to be given the option under the TIL Act to rescind their loans.

The rescission remedy is available only for certain loans that are secured by a principal residence but were not used to purchase the residence, principally refinancings. The court further excluded borrowers who had received a different version of the TIL disclosure document than had been received by the Andrews. The precise parameters and members of the class will depend upon further court proceedings.

The Bank has appealed the availability of a class-wide rescission remedy to the U.S. Court of Appeals for the Seventh Circuit, which held oral argument on the matter on September 26, 2007. Several major bank trade associations have filed a brief supporting the Bank’s position. The only two federal courts of appeal that have considered the question have ruled unanimously that a class wide rescission remedy is not available. The question has not yet been addressed by the Seventh Circuit.

The District Court has suspended further proceedings in the case pending a ruling on the Bank’s appeal. However, subsequent to that action, the District Court issued an opinion finding that the filing of the class action lawsuit tolled the running of the three-year rescission period under the Truth in Lending Act. The Bank plans to appeal that ruling, as well as the ruling that the Bank’s disclosures violated the Truth in Lending Act, at the proper time.

Management believes that the resolution of this litigation will not have a material adverse effect on the operations or financial condition of the Bank. However, management recognizes the inherent uncertainties in litigation. If all appeals eventually were resolved adversely to the Bank and the size of the class were ultimately determined to be significant and if a material percentage of the borrowers to whom rescission was offered elected to rescind, the outcome would adversely affect the income of the Bank.

126

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

33. QUARTERLY FINANCIAL DATA – THE TRUST (Unaudited):

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

	December 2006			March 2007				June 2007			September 2007
OPERATING DATA:
REAL ESTATE:
Real estate income	$	44,339		$	49,546			$	57,457		$	48,203
Real estate expense		48,882			53,181				57,296			56,758
Equity earnings		3,051			2,988				3,117			3,384
Gain on sale of property		1,209			—				325			—
Real estate operating income (loss)		(283	)		(647	)			3,603			(5,171	)
BANKING:
Interest income		198,973			205,104				207,782			214,960
Interest expense		93,357			94,783		��		96,327			103,824
Net interest income		105,616			110,321				111,455			111,136
Provision (credit) for loan losses		(382	)		(625	)			(786	)		5,176
Net interest income after provision (credit) for loan losses		105,998			110,946				112,241			105,960
Other income
Deposit servicing fees		37,836			36,080				39,581			40,077
Servicing, securitization and mortgage banking income		41,001			7,794				46,561			50,401
Automobile rental income, net		3,602			2,221				1,343			1,143
Asset management fees		8,612			9,819				9,876			10,620
Other		6,412			5,240				6,163			6,397
Total other income		97,463			61,154				103,524			108,638
Operating expenses
Salaries and employee benefits		83,718			88,254				87,141			90,934
Servicing assets adjustments and other loan expenses		24,517			26,212				21,615			20,795
Property and equipment		14,902			16,297				17,788			18,003
Marketing		5,116			3,966				6,630			4,871
Data processing		10,284			11,005				10,557			11,937
Depreciation and amortization		14,551			13,713				11,389			12,620
Other		16,613			17,759				17,520			16,413
Total operating expenses		169,701			177,206				172,640			175,573
Bank operating income (loss)		33,760			(5,106	)			43,125			39,025
Income from continuing operations before taxes and minority int.		33,477			(5,753	)			46,728			33,854
Provision (credit) for income taxes		10,872			(4,197	)			15,524			13,236
Income from continuing operations before minority interest		22,605			(1,556	)			31,204			20,618
Minority interest		10,395			5,620				11,617			10,622
NET INCOME (LOSS)		12,210			(7,176	)			19,587			9,996
Preferred stock dividends		1,354			1,355				1,355			1,354
NET INCOME (LOSS) AVAILABLE TO COMMONSTOCKHOLDERS		10,856			(8,531	)			18,232			8,642
NET INCOME (LOSS) PER COMMON SHARE	$	2.26		$	(1.78	)		$	3.78		$	1.81

127

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

	December 2005			March 2006			June 2006			September 2006
OPERATING DATA:
REAL ESTATE:
Real estate income	$	35,622		$	39,071		$	51,131		$	43,813
Real estate expense		40,603			40,939			49,995			50,597
Equity earnings		2,451			2,463			2,417			2,720
Gain on sale of property		—			416			—			—
Real estate operating income (loss)		(2,530	)		1,011			3,553			(4,064	)
BANKING:
Interest income		169,971			185,494			188,266			193,615
Interest expense		69,221			78,029			82,133			88,788
Net interest income		100,750			107,465			106,133			104,827
Credit for loan losses		(557	)		(1,222	)		(5,836	)		(1,389	)
Net interest income after credit for loan losses		101,307			108,687			111,969			106,216
Other income
Deposit servicing fees		35,519			33,610			37,308			38,111
Servicing, securitization and mortgage banking income		51,097			8,985			56,717			39,639
Automobile rental income, net		12,526			10,051			7,410			5,209
Asset management fees		6,680			10,472			7,826			8,313
Other		6,161			6,237			5,476			5,229
Total other income		111,983			69,355			114,737			96,501
Operating expenses
Salaries and employee benefits		71,888			79,746			79,409			78,322
Servicing assets amortization and other loan expenses		22,178			25,576			25,379			30,563
Property and equipment		13,258			13,551			14,293			14,730
Marketing		5,677			4,037			7,778			4,669
Data processing		9,997			9,672			9,486			9,558
Depreciation and amortization		19,895			18,539			15,934			15,097
Other		14,813			18,951		��	32,348			16,608
Total operating expenses		157,706			170,072			184,627			169,547
Bank operating income (loss)		55,584			7,970			42,079			33,170
Income from continuing operations before taxes and minority int.		53,054			8,981			45,632			29,106
Provision for income taxes		18,584			960			13,520			6,599
Income from continuing operations before minority interest		34,470			8,021			32,112			22,507
Minority interest		13,046			7,200			11,704			10,788
Income from continuing operations		21,424			821			20,408			11,719
Discontinued operations, net of tax		892			1,698			—			—
NET INCOME		22,316			2,519			20,408			11,719
Preferred stock dividends		1,354			1,355			1,355			1,354
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS		20,962			1,164			19,053			10,365
NET INCOME (LOSS) PER COMMON SHARE	$	4.36		$	0.24		$	3.95		$	2.16

128

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

34. MINORITY INTEREST—THE TRUST:

At September 30, 2007 and 2006, minority interest held by affiliates of $138.3 and $130.5 million represent the 20% minority interest in the Bank’s common shares.

Minority interest — other consists of the following:

	September 30,
(In thousands)	2007		2006
Preferred Stock of Chevy Chase’s REIT subsidiary	$	144,000	$	144,000
Chevy Chase’s Preferred Stock (See Note 25)		120,622		120,622
Chevy Chase’s ground lease (See below)		31,391		31,391
Total minority interest—other	$	296,013	$	296,013

At September 30, 2007, the Bank is the primary beneficiary of one variable interest entity which holds the ground lease under the Bank’s executive offices. In April 1998, the Bank entered into a ground lease agreement with a single purpose LLC. The LLC’s only significant asset is the land on which the Bank’s executive office building was constructed. Lease payments made to the LLC are presented as minority interest in the Consolidated Statements of Operations. The following is a schedule by years of the future lease payments under the agreement as of September 30, 2007:

Year Ending September 30,	(In thousands)
2008	$	3,723
2009		3,798
2010		3,874
2011		3,951
2012		4,030
Thereafter		262,327
Total	$	281,703

The lease, which expires in year 2062, is subject to fixed rent adjustments. At the end of the lease term, the Bank has the option to purchase the land for $84.1 million from the LLC. The lease also allows the owners of the LLC to put their equity interests in the LLC to the Bank, subject to certain limitations.

The Bank consolidates the assets and liabilities of the LLC. As a result, property and equipment and minority interest on the Consolidated Balance Sheets each include $31.4 million at September 30, 2007 and 2006 related to the Bank’s involvement with the LLC.

Minority interest also includes the net cash proceeds received by a subsidiary of the Bank (the “REIT Subsidiary”) from the November 1996 sale of $150.0 million of its Noncumulative Exchangeable Preferred Stock, Series A, par value $5 per share (the “REIT Preferred Stock”). Cash dividends on the REIT Preferred Stock are payable quarterly in arrears at an annual rate of 10- ³/8%. The liquidation value of each share of REIT Preferred Stock is $50 plus accrued and unpaid dividends. Except under certain limited circumstances, the holders of the REIT Preferred Stockholders have no voting rights. The REIT Preferred Stock is automatically exchangeable for a new series of Preferred Stock of the Bank upon the occurrence of certain events.

The REIT Preferred Stock is redeemable at the option of the REIT subsidiary at any time on or after January 15, 2007, in whole or in part, at the following per share redemption prices plus accrued and unpaid dividends:

If redeemed during the 12-month period beginning January 15	Redemption Price
2007	$	52.594
2008	$	52.075
2009	$	51.556
2010	$	51.038
2011	$	50.519
2012 and thereafter	$	50.000

The Bank received OTS approval to include the net proceeds from the sale of the REIT Preferred Stock in the core capital of the Bank for regulatory capital purposes in an amount up to 25% of the Bank’s core capital. Dividends on the REIT Preferred Stock are presented as minority interest in the Consolidated Statements of Operations.

129

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

35. INCOME TAXES—THE TRUST:

The Trust voluntarily terminated its qualification as a real estate investment trust under the Internal Revenue Code during fiscal 1978.

The provisions for income taxes for the years ended September 30, 2007, 2006 and 2005, consist of the following:

	Year Ended September 30,
(In thousands)	2007			2006			2005
Current provision (benefit):
Federal	$	48,666		$	43,224		$	88,146
State		8,120			2,869			5,513
		56,786			46,093			93,659
Deferred provision (benefit):
Federal		(20,778	)		(5,277	)		(37,567	)
State		(573	)		482			2,513
		(21,351	)		(4,795	)		(35,054	)
Total	$	35,435		$	41,298		$	58,605
Tax effect of other equity transactions	$	2,913		$	1,210		$	1,309

The Trust’s effective income tax rate varies from the statutory Federal income tax rate as a result of the following factors:

	Year Ended September 30,
(In thousands)	2007			2006			2005
Computed tax at statutory Federal income tax rate	$	37,907		$	49,325		$	63,276
Increase (reduction) in taxes resulting from:
Minority interest		(6,724	)		(6,675	)		(6,675	)
Change in valuation allowance for deferred tax asset allocated to income tax expense		166			(1,317	)		(1,414	)
State income taxes		5,404			3,086			7,241
Tax credits		(1,602	)		(1,097	)		(2,374	)
Other		284			(2,024	)		(1,449	)
Total	$	35,435		$	41,298		$	58,605

The components of the net deferred tax asset (liability) were as follows:

	September 30,
(In thousands)	2007			2006
Deferred tax assets:
State net operating loss carry forwards		16,731			15,930
Asset securitizations, net		22,292			25,221
Provision for loan and lease losses		18,642			16,891
Deferred compensation		23,238			20,982
Other		16,796			8,677
Gross deferred tax assets		97,699			87,701
Deferred tax liabilities:
Automobile leasing		—			11,704
Saul Holdings and Saul Centers		49,606			47,472
Mortgage servicing rights		46,948			47,017
Property and depreciation		6,771			15,321
Deferred expenses and other		43,571			43,764
Gross deferred tax liabilities		146,896			165,278
		(49,197	)		(77,577	)
Valuation allowance		(7,663	)		(8,149	)
Net deferred tax liability	$	(56,860	)	$	(85,726	)

At September 30, 2007, the Real Estate Trust and the Bank had state net operating loss carryovers totaling approximately $190.2 and $82.5 million, respectively. The state net operating loss carryovers will expire in the years 2008 through 2027.

130

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The Trust establishes a valuation allowance against the gross deferred tax asset to the extent the Trust cannot determine that it is more likely than not such assets will be realized through taxes available in carryback years, future reversals of existing taxable temporary differences or projected future taxable income. Such a valuation allowance has been established to reduce the gross deferred asset for state net operating loss carryforwards to an amount that is considered more likely than not to be realized. In fiscal years 2007 and 2006, the Real Estate Trust determined it will be able to utilize currently some of its state net operating loss carryforwards and, as a result, decreased the valuation allowance by $740,000 and $1.3 million, respectively. In addition, at the Real Estate Trust, state net operating loss carryforwards in excess of state deferred tax liabilities are fully reserved due to expected future state tax losses.

Management believes the existing net deductible temporary differences will reverse during periods in which the Bank generates taxable income in excess of Real Estate Trust taxable losses. Management believes that the positive consolidated earnings will continue as a result of the Bank’s earnings.

TAX SHARING AGREEMENT

The Trust’s affiliated group, including the Bank, entered into a tax sharing agreement dated June 28, 1990, as amended. This agreement provides that payments be made by members of the affiliated group to the Trust based on their respective allocable shares of the overall federal income tax liability of the affiliated group for taxable years and partial taxable years beginning on or after that date. In addition, the agreement also applies if some or all of the members file a consolidated return in any state.

Allocable shares of the overall tax liability are prorated among the members with taxable income calculated on a separate return basis. The agreement also provides that, to the extent net operating losses or tax credits of a particular member are used to reduce overall tax liability of the Trust’s affiliated group, such member will be reimbursed on a dollar-for-dollar basis by the other members of the affiliated group that have taxable income in an amount equal to such tax reduction. Under the tax sharing agreement, the Bank paid $4.0, $2.0 and $2.1 million, to the Real Estate Trust during fiscal 2007, 2006 and 2005. At September 30, 2007, the Real Estate Trust was due $1.8 million from the Bank under the tax sharing agreement.

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 Trust would be obligated to reimburse the Bank for the greater of (i) the tax benefit to the group using such tax losses or unused tax credits in the group’s consolidated Federal and state income tax returns or (ii) the amount of tax refund which the Bank would otherwise have been able to claim if it were not being included in the consolidated Federal and state income tax returns of the group.

36. SHAREHOLDERS’ EQUITY—THE TRUST:

In June 1990, the Trust acquired from affiliated companies an additional equity interest in the Bank, which raised the Trust’s ownership share of the Bank to 80%. In exchange for the interest acquired, the Trust issued 450,000 shares of a new class of $10.50 cumulative preferred shares of beneficial interest with a par value of $1 (the “preferred shares”). The transaction has been accounted for at historical cost in a manner similar to the pooling of interests method because the entities are considered to be under common control. In addition, the Trust acquired two real estate properties from an affiliate in exchange for 66,000 preferred shares.

The Trust paid preferred dividends of $5.4 million per year in fiscal 2007, 2006 and 2005, respectively. At September 30, 2007 and 2006, there were no dividends in arrears on the preferred shares.

131

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

37. 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.

	Year Ended September 30
(In thousands)	2007			2006			2005
INCOME (from continuing operations)
Hotels	$	144,665		$	127,238		$	98,621
Office and industrial properties		43,475			39,984			39,466
Residential		9,820			—			—
Other		1,585			2,415			1,417
	$	199,545		$	169,637		$	139,504
OPERATING PROFIT (LOSS) (from continuing operations) (1)
Hotels	$	38,621		$	37,137		$	27,316
Office and industrial properties		18,229			18,303			19,857
Residential		1,553			—			—
Other		226			1,215			322
		58,629			56,655			47,495
Equity earnings of unconsolidated entities		12,540			10,051			8,246
Gain on sales of property		1,534			416			263
Interest and amortization of debt expense		(54,043	)		(50,516	)		(46,503	)
Advisory fee, management and leasing fees—related parties		(16,696	)		(15,480	)		(13,448	)
General and administrative		(4,462	)		(3,156	)		(3,421	)
Operating loss from continuing operations	$	(2,498	)	$	(2,030	)	$	(7,368	)
IDENTIFIABLE ASSETS (AT YEAR END)
Hotels	$	326,479		$	296,174		$	169,848
Office and industrial properties		202,857			142,514			130,268
Residential		25,605			16,401			—
Other		196,945			207,723			165,714
	$	751,886		$	662,812		$	465,830
INTEREST AND AMORTIZATION OF DEBT EXPENSE (from continuing operations)
Hotels	$	19,833		$	14,262		$	10,538
Office and industrial properties		14,562			12,456			11,616
Other		19,648			23,798			24,349
	$	54,043		$	50,516		$	46,503
DEPRECIATION (from continuing operations)
Hotels	$	13,545		$	12,060		$	11,303
Office and industrial properties		9,190			8,307			7,552
Other		23			23			23
	$	22,758		$	20,390		$	18,878
CAPITAL EXPENDITURES AND PROPERTY ACQUISITIONS
Hotels	$	38,158		$	130,468		$	8,896
Office and industrial properties		74,140			17,268			11,070
Residential, net of $7,580 allocated to cost of sales in 2007		11,174			11,719			—
Other		1,665			1,382			9,980
	$	125,137		$	160,837		$	29,946

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

132

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

38. CONDENSED FINANCIAL STATEMENTS – THE TRUST:

These condensed financial statements reflect the Real Estate Trust and all its consolidated subsidiaries except for the Bank which has been reflected on the equity method.

CONDENSED BALANCE SHEETS

	September 30
(In thousands)	2007			2006
ASSETS
Income-producing properties	$	654,538		$	570,948
Accumulated depreciation		(236,685	)		(197,855	)
		417,853			373,093
Land parcels		43,354			44,582
Construction in progress		83,756			34,946
Equity investment in bank		553,384			522,283
Equity investment in Saul Holdings and Saul Centers		127,079			89,802
Cash and cash equivalents		8,889			46,391
Note receivable and accrued interest—related party		5,400			10,300
Other assets		65,392			63,535
TOTAL ASSETS	$	1,305,107		$	1,184,932
LIABILITIES
Mortgage notes payable	$	579,639		$	488,339
Notes payable – secured		250,000			250,000
Revolving credit facility outstanding		14,000			—
Notes payable – unsecured		—			21,398
Other liabilities and accrued expenses		79,533			72,642
Total liabilities		923,172			832,379
TOTAL SHAREHOLDERS’ EQUITY		381,935			352,553
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,305,107		$	1,184,932

* See Consolidated Statements of Shareholders’ Equity

CONDENSED STATEMENTS OF OPERATIONS

	For the Year Ended September 30
(In thousands)	2007			2006			2005
Total income	$	199,545		$	169,637		$	139,504
Total expenses		(216,117	)		(182,134	)		(155,381	)
Equity in earnings of unconsolidated entities, net		12,540			10,051			8,246
Gain on sales of property		1,534			416			263
Real estate operating loss from continuing operations		(2,498	)		(2,030	)		(7,368	)
Equity in earnings of Bank		36,165			54,388			78,063
Total company operating income		33,667			52,358			70,695
Income tax benefit		950			2,014			3,904
Discontinued operations-net of income tax benefit		—			2,590			(1,001	)
TOTAL COMPANY NET INCOME	$	34,617		$	56,962		$	73,598

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED STATEMENTS OF CASH FLOWS

	For the Year Ended September 30
(In thousands)	2007			2006			2005
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	34,617		$	56,962		$	73,598
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		22,758			20,390			19,857
Amortization of debt expense		2,346			2,672			2,197
Equity in earnings of Bank, net of distributions		(20,165	)		(22,388	)		(38,863	)
Equity in earnings of unconsolidated entities, net of distributions		(12,540	)		(4,415	)		(3,336	)
Gain on sale of property		(1,534	)		(6,702	)		(1,146	)
Deferred tax benefit (expense)		72			4,121			(922	)
Increase (decrease) in accounts receivable and accrued income		3,018			(5,020	)		(2,318	)
Decrease (increase) in accounts payable and accrued expenses		1,368			2,318			(493	)
Other		(2,383	)		(5,137	)		489
Net cash provided by operating activities		27,557			42,801 4			49,063
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures and acquisitions – properties		(125,137	)		(160,837	)		(29,946	)
Property sales		1,810			17,146			4,715
Note receivable and accrued interest – (advances)/repayments, net		4,900			2,800			(5,423	)
Equity investment in Saul Holdings and Saul Centers		(16,413	)		(6,104	)		(5,901	)
Other investments		110			(431	)		(776	)
Net cash used in investing activities		(134,730	)		(147,426	)		(37,331	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from mortgage financing		118,142			294,882			—
Principal curtailments and repayments of mortgages		(26,842	)		(12,678	)		(15,793	)
Net secured note financings (repayments)		—			(93,430	)		—
Proceeds from sales of unsecured notes		—			935			5,674
Repayments of unsecured notes		(21,398	)		(37,297	)		(4,342	)
Costs of obtaining financings		(2,231	)		(3,316	)		(3,193	)
Net proceeds from revolving credit facility		14,000			—			—
Dividends paid—common and preferred shares of beneficial interest		(12,000	)		(12,000	)		(12,000	)
Net cash provided by (used in) financing activities		69,671			137,096			(29,654	)
Net (decrease) increase in cash and cash equivalents		(37,502	)		32,471			(17,922	)
Cash and cash equivalents at beginning of year		46,391			13,920			31,842
Cash and cash equivalents at end of year	$	8,889		$	46,391		$	13,920

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

The Trust maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Trust’s reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Trust’s management, including its Chairman and its Vice President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures based closely on the definition of “disclosure controls and procedures” in Rule 13a-15(e) promulgated under the Exchange Act. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

The Trust carried out an evaluation, under the supervision and with the participation of the Trust’s management, including its Chairman and its Vice President and Chief Financial Officer of the effectiveness of the design and operation of the Trust’s disclosure controls and procedures as of September 30, 2007. Based on the foregoing, the Company’s Chairman and its Vice President and Chief Financial Officer concluded that the Trust’s disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2007.

During the three months ended September 30, 2007, there were no changes in the Trust’s internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Trust’s internal control over financial reporting.

ITEM 9B. OTHER ITEMS

The Trust has applied to the OTS for approval of a new bank holding company. If approved by the OTS and if the Trust elected to proceed, the Trust’s ownership of 80% of the common stock of Chevy Chase Bank, subject to the $250 million of Senior Secured Notes, would be transferred to the new bank holding company, as permitted under the Indenture governing the Senior Secured Notes. The decision of when and even whether to proceed with the formation of the new bank holding company has not yet been made by the Trust.

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PART III

ITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The Declaration of Trust provides that there shall be no fewer than three nor more than twelve trustees, as determined from time to time by the trustees in office. The Board of Trustees has fixed its permanent membership at six trustees divided into three classes with overlapping three-year terms. The term of each class expires at the Annual Meeting of Shareholders, which is usually held on the last Friday of January.

The following list sets forth the name, age, position with the Trust, present principal occupation or employment and material occupations, positions, offices or employments during the past five years of each trustee and executive officer of the Trust. Unless otherwise indicated, each individual has held an office with the Trust for at least the past five years.

Class Three Trustees—Terms End at the 2008 Annual Meeting

B. Francis Saul II, age 75 has served as Chairman and Chief Executive Officer of the Trust since 1969 and as a Trustee since 1964. Mr. Saul also serves as Chief Executive Officer and Chairman of the Board of Directors of B.F. Saul Company, Chevy Chase and Saul Centers, as President and Chairman of the Board of Directors of CCPC, Westminster Investing Company, and Chevy Chase Lake Corporation, and as a Trustee of the National Geographic and the John Hopkins Medicine Board. Mr. Saul is the father of B. Francis Saul III.

John R. Whitmore, age 74 has served as a Trustee since 1984. He is a Financial Advisor who served as Senior Advisor to The Bessemer Group, Incorporated (a financial management and banking firm) and its Bessemer Trust Company subsidiaries from 1999 to 2003. Mr. Whitmore is a director of Chevy Chase, CCPC, Saul Company and Saul Centers. During the period 1975-1998, Mr. Whitmore was President and Chief Executive Officer of Bessemer Group, Incorporated and its Bessemer Trust Company subsidiaries and a director of Bessemer Securities Corporation.

Class One Trustees—Terms End at the 2009 Annual Meeting

Philip D. Caraci, age 69 was elected a Trustee in 2003. For the previous six years he served as Senior Vice President and Secretary of the Trust, Executive Vice President of Saul Company, Senior Vice President of the Advisor, Chairman of the Board of Saul Property Co., and a Director and President of Saul Centers. Mr.Caraci is also a member of the ASB Real Estate Advisory Committee, a subsidiary of Chevy Chase.

Gilbert M. Grosvenor, age 76 has served as a Trustee since 1971. Mr. Grosvenor also serves as Chairman of the Board of the National Geographic Society and as a Director of Chevy Chase Bank and Saul Centers.

Class Two Trustees—Terms End at the 2010 Annual Meeting

George M. Rogers, Jr., age 74 has served as a Trustee since 1969. Mr. Rogers is a Senior Counsel in the law firm of Pillsbury Winthrop Shaw Pittman LLP, Washington, DC, which serves as counsel to the Trust and Chevy Chase. Mr. Rogers serves as a Director of Chevy Chase, Saul Company, CCPC, Westminster Investing Corporation, and Chevy Chase Lake Corporation.

B. Francis Saul III, age 45 is Senior Vice President of the Trust and has served as a Trustee since 1997. Mr. Saul also serves as a Director and Vice Chairman of Chevy Chase and as a Director and/or Officer of Saul Company, Saul Property Co., CCPC and Westminster Investing Corporation. He is President and Director of Saul Centers. He is also Chairman Emeritus of the Boys & Girls Clubs of Greater Washington, Vice Chairman of Children’s National Medical Center, and a Director of The Conservation Fund and The Economic Club of Washington. Mr. Saul is the son of B. Francis Saul II.

Executive Officers of the Trust Who Are Not Directors

Stephen R. Halpin, Jr., age 52 serves as Vice President and Chief Financial Officer of the Trust, and Senior Vice President and Chief Financial Officer of Saul Company. He also serves as Executive Vice President and Chief Financial Officer of Chevy Chase.

Thomas H. McCormick, age 57 joined the Trust in February 2005 and serves as General Counsel of the Trust, Executive Vice President and General Counsel of Chevy Chase, Senior Vice President and General Counsel and a Director of B.F. Saul Company and Senior Vice President and General Counsel of Saul Centers. Prior to joining the Trust, Mr. McCormick was a senior partner with the law firm Shaw Pittman LLP, now know as Pillsbury Winthrop Shaw Pittman LLP. He also served as the Chair of Shaw Pittman’s Board of Directors and its Corporate and Securities group.

Patrick T. Connors, age 45 has served as a Vice President of the Trust and Senior Vice President of Saul Company since January 2000. For the previous four years, he was an attorney with the law firm of Shaw Pittman LLP, Washington, DC.

Kenneth D. Shoop,age 48 joined the Trust in September 2003 and serves as Vice President, Chief Accounting Officer and Treasurer, of the Trust, Treasurer and Vice President of Saul Company, the Advisor, Saul Property Company and Chief Accounting Officer and Vice President of Saul Centers. Prior to joining the Trust, Mr. Shoop was Vice President and Controller of Federal Realty Investment Trust.

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Ross E. Heasley, age 68 serves as Vice President of the Trust, Saul Company, the Advisor, Saul Property Co. and Saul Centers.

John A. Spain, age 44 serves as Vice President of the Trust and Saul Company.

Committees of the Board of Trustees

The Board of Trustees met four times during fiscal 2007. Each member of the Board attended at least 75% of the aggregate number of meetings of the Board and of the committees of the Board on which he served.

The Board of Trustees has two standing committees: the Audit Committee and the Executive Committee.

The Audit Committee is composed of Messrs. Caraci and Grosvenor. The Audit Committee’s duties include nominating the Trust’s independent registered public accounting firm, discussing with them the scope of their examination of the Trust, reviewing with them the Trust’s financial statements and accompanying report, and reviewing their recommendations regarding internal controls and related matters. This committee met five times during fiscal 2007.

None of the members of the Audit Committee qualify as an “audit committee financial expert” as such term is defined in the Exchange Act and the rules and regulations thereunder. A substantial portion of the Trust’s consolidated assets are held, and operations are performed, at the Bank level. As of September 30, 2007, the Bank accounted for 95% of the Trust’s assets on a consolidated basis and, for the year ended September 30, 2007, the Bank accounted for 86% of the Trust’s revenue on a consolidated basis. Because the Bank operates in a highly regulated industry and has audited financial statements that are reviewed and approved by its own audit committee, which includes two persons who are deemed audit committee financial experts, the Board of Trustees has determined that it is not necessary for the Audit Committee of the Trust to include an audit committee financial expert at this time. In addition, the Board of Trustees has noted that Mr. Caraci, in his previous position as President of Saul Centers, gained substantial experience regarding accounting issues of the breadth and complexity that typically arise in connection with the Real Estate Trust’s business.

The Executive Committee is composed of Messrs. Rogers, Saul II and Whitmore. It is empowered to oversee day-to-day actions of Saul Company and Saul Property Co. in connection with the operations of the Trust, including the acquisition, administration, sale or disposition of investments. No meetings of this committee were held during fiscal 2007.

Trustees of the Trust are currently paid an annual retainer of $12,500 and a fee of $600 for each board or committee meeting attended. Trustees from outside the Washington, D.C. area are also reimbursed for out-of-pocket expenses in connection with their attendance at meetings. Mr. Saul II is not paid for attending Executive Committee meetings. For the fiscal year ended September 30, 2007, the Real Estate Trust paid total fees of $95,000 to the Trustees, including $15,000 to Mr. Saul II. Two of the Trustees have historically elected to defer the receipt of their fees. Interest is accrued on these fees at the two year treasury rate, adjusted quarterly. Deferred fees totaled $30,000 in fiscal 2007. Interest accrued on the deferred balances totaled $21,000 in fiscal 2007. At September 30, 2007, the payable due to the Trustees totaled $483,000. These funds are available to the Trustees upon their request.

Code of Ethics

The Trust’s officers and trustees are governed by a code of ethics. The code of ethics will be made available free of charge to any person upon request. Requests shall be made in writing to Mr. Kenneth Shoop, Vice President and Chief Accounting Officer, B.F. Saul Real Estate Investment Trust, 7501 Wisconsin Avenue, Bethesda, Maryland 20814.

ITEM 11. EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

The Real Estate Trust pays no compensation to its executive officers for their services in such capacity. Messrs. Saul II, Halpin, Saul III and McCormick receive compensation from Chevy Chase for their services as officers of Chevy Chase. No other executive officers of the Real Estate Trust received any compensation from the Real Estate Trust or its subsidiaries with respect to any of the fiscal years ended September 30, 2007, 2006 and 2005.

The Bank’s executive compensation philosophy, policies, plans and programs are generally established by the Chairman and Chief Executive Officer of the Bank, subject to review and approval by the Compensation Committee (for purposes of this discussion and analysis, the “Committee”) of the Bank’s Board of Directors. While the Committee is ultimately responsible for approving the compensation elements and amounts paid to named executive officers, the Committee asks for and customarily accepts the recommendations of the Chairman and Chief Executive Officer. This arrangement reflects the fact that the Chairman and Chief Executive Officer is, indirectly, a significant shareholder who, together with his immediate and extended family, owns indirectly approximately 96% of the Bank. Thus, the Chairman and Chief Executive Officer is uniquely positioned to act in the best interests of the shareholders. The Chairman and Chief Executive Officer does not participate in the Committee’s discussion of his own compensation and similarly abstains from voting on his own compensation. In reviewing the compensation of the Chairman and Chief Executive Officer, the Committee informally informs itself of the general compensation levels of chief executive officers of comparable financial institutions. In reviewing the compensation of other executive officers, the Committee relies on the information provided by the Chairman and Chief Executive Officer.

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In this Annual Report on Form 10-K, the individuals who served as the Bank’s Chairman and Chief Executive Officer and as the Bank’s Chief Financial Officer during fiscal 2007, as well as two other individuals included in the Summary Compensation Table on page 141, are referred to as the “named executive officers.” The Bank has not adopted any specific policies concerning the relationship of corporate performance to executive compensation. Instead, the Bank follows a more flexible approach which it believes to be better suited to the specific circumstances of the Bank.

Generally, decisions with respect to the Bank’s executive compensation are designed to achieve the following objectives:

• focus executive officers on both annual and long-term business results; and

• provide executive compensation packages that attract, retain and motivate individuals of the highest qualifications, experience and ability.

Elements of Compensation

Consistent with the Bank’s compensation objectives described above, our executive compensation program is designed to be competitive with those of other banks that are similar in size and scope of operations to the Bank.

The total compensation program for the named executive officers includes base salary, a bonus based on the executive’s performance, a long-term incentive award under the Bank’s Deferred Compensation Plan, retirement plans and perquisites. Because the Bank’s common stock is privately held, the Bank does not offer stock options as part of its compensation program.

As part of the review of compensation, the Chairman and Chief Executive Officer, as well as the Committee, has access to a variety of information, including each individual’s tenure, level of responsibility and performance, as well as factors relating to the overall financial performance of the Bank, the value of the Bank’s franchise, the results of regulatory examinations, and the Bank’s overall compliance status. Executive level compensation of banks of comparable size to the Bank is also taken into account. Neither the Bank nor the Committee uses an outside compensation consultant and there are no plans to engage one for the foreseeable future. In determining compensation of its senior officers, the Bank seeks to maintain a competitive position in the marketplace, taking into account that it does not offer equity-based compensation programs.

There is no pre-established policy or target for the allocation between either cash and non-cash, or short and long-term incentive compensation.

Base Salary

The Bank provides a base salary to attract and retain executive officers and compensate them for their services during the year. Salary levels typically are reviewed on an annual basis. Increases to salaries of named executive officers are based on an assessment of the individual’s job performance with consideration given to the Bank’s overall performance. Based on a review of these factors, increases were approved for each of the named executive officers’ base salaries in 2007. The base salary percentage increase for the named executive officers’ as a group totaled 6.9% as compared to the approximately 4.2% increase for other officers at that time in 2007. Mr. Saul II received a $100,000 (or 5.13%) increase. Messrs. Halpin (7.7%) and McCormick (8.3%) each received a $50,000 increase. Mr. Saul III (13.3%) received a $40,000 increase.

Short-Term Incentive Compensation- Cash Bonuses

The Bank pays bonuses to its named executive officers in order to reward the named executive officers for achieving short-term business objectives. As with the other components of the officers’ compensation, specific benchmarks are not used to determine the amount of the awards, but rather a more flexible approach is employed. Accordingly, a variety of factors are considered, including the Bank’s overall performance in light of market conditions. In 2007, in general, the cash bonuses awarded the named executive officers’ were based on a percentage of the base salary. Mr. McCormick received a 15% ($90,000) bonus. Mr. Halpin received a 15% bonus ($97,500), plus an additional cash award of $100,000. Mr. Saul III received a 15% ($45,000) bonus. Mr. Saul II received a cash bonus of $2,750,000, a 10% increase over his bonus in fiscal 2006.

Long-Term Incentive Program

The Bank maintains a Deferred Compensation Plan to provide long-term incentives for the named executive officers. Because the Bank is privately held and does not issue stock grants or stock options, the Deferred Compensation Plan is intended, in part, to provide incentives similar to those provided under other companies’ stock plans. The Deferred Compensation Plan is designed to reward the prior year’s performance because the amount granted to each named executive officer’s account varies based on an assessment of individual and business performance in the prior fiscal year. Second, the Deferred Compensation Plan functions as a long-term incentive; over time, the value of the grant should increase as the performance of the business improves. Third, the vesting schedule for the Deferred Compensation Plan provides a retention benefit to the Bank. Deferred Compensation Awards were granted in 2007 for fiscal year 2006 to Mr. Saul II ($950,000), Mr. Halpin ($200,000), Mr. Saul III ($45,000), and Mr. McCormick ($200,000). The Deferred Compensation Awards granted in 2007 reflect the contributions made by the named executive officers.

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Retirement Plans

The retirement plans available to the Bank’s named executive officers are the B.F. Saul Company Employees Profit Sharing Retirement Plan, a defined contribution plan, and the Bank’s Supplemental Executive Retirement Plan (the “SERP”). In addition, certain of the named executive officers have entered into “Special Retirement Compensation Agreements,” discussed below under Note 26 – Compensation Plans.

Perquisites

The Bank provides named executive officers with perquisites and other personal benefits that the Bank believes to be reasonable and consistent with its overall compensation program to better enable the Bank to attract and retain superior employees for key positions. The Bank’s executive officers participate in the health and dental coverage, life insurance, paid vacation and holiday, company-owned automobiles and other programs that are generally available to all of the Company’s employees. The Bank periodically reviews the levels of perquisites and other personal benefits provided to named executive officers.

Potential Payments Upon Termination or Change In Control

Changes in employment status such as termination, death or disability, change in control or retirement can trigger a benefit or accelerate a benefit for our salaried employees, including the named executive officers. These payments are set forth below.

Payments Made Upon Termination

In general, when a named executive officer terminates employment with the Bank, other than a termination for cause, the named executive officer is entitled to receive the amounts they have earned during the term of their employment and any benefits allowed as part of our compensation plans. These amounts that they will receive include the following:

• amounts contributed under the defined contribution plan;

• unused vacation pay; and

• amounts accrued and vested under the Plan and the SERP for those named executive officers who have reached the eligible retirement age.

Payments Made Upon Death or Disability

In the event of the death or disability of a named executive officer, in addition to the items identified above, all named executive officers will receive benefits under the disability plan or payments under the life insurance plan, as appropriate.

Payments Made Upon a Change In Control

Messrs. Halpin and McCormick have entered into agreements with the Bank entitled “Agreement For Executive Level Officers Governing Confidentiality, Nonsolicitation, Ownership of Certain Works and Termination Upon Change of Control” under which the executive officer has agreed not to compete with, solicit customers of or solicit the employees of the Bank for stated periods following any termination of employment with the Bank. In addition, the Bank agrees to pay the executive a specified amount if the executive is terminated without cause in the three-year period following a change of control of the Bank. The amount payable varies, and the estimated potential minimum and maximum payouts for the named executive officers are 100% and 600% of base salary and bonus, respectively, depending on their tenure with the Bank at the time of the event and the per share price at which the triggering event has occurred.

Tax Impact on Compensation Decisions

The Bank has considered the provisions of Section 162(m) of the Internal Revenue Code of 1986, as amended, which generally limits the annual tax deductibility of compensation paid to each named executive officer to $1 million. To the extent possible, the Bank intends to preserve the federal income tax deductibility, but may choose to provide compensation that may not be deductible if it believes that such payments are appropriate to ensure that our named executive officers receive total compensation that is competitive with other banks, or reflects superior performance.

Recovery of Compensation

The Bank has no policies for recovery of compensation in the event of financial adjustments or restatements.

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Report of the Compensation Committee

The Bank’s Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis contained in this Annual Report on Form 10-K with Bank management and, based on such review and discussion, the Compensation Committee recommended to the Bank’s Board of Directors that the Compensation Discussion and Analysis be included in the Bank’s Annual Report on Form 10-K.

Members of the Bank’s Compensation Committee

Garland P. Moore, Jr.

George M. Rogers, Jr.

B. Francis Saul II

The report of the Compensation Committee does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent the Bank specifically requests that the information be treated as soliciting material or incorporates this item therein by reference.

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Summary of Cash and Certain Other Compensation

General. The following table sets forth information for fiscal 2007 regarding the compensation earned by the Chief Executive Officer and the Chief Financial Officer of the Bank and Messrs. Saul III and McCormick, for all capacities in which they served the Bank.

Summary Compensation Table

Name and Principal Position	Year	Salary ($)		Bonus ($)		Non-Equity Incentive Plan Compensation ($)		Change in Pension Value and Nonqualified Deferred Compensation Earnings($)(1)		All Other Compensation ($)(2)		Total ($)
(a)	(b)	(c)		(d)		(g)		(h)		(i)		(j)
B. Francis Saul, II Chairman and Chief Executive Officer	2007	$	1,988,462	$	2,750,000	$	950,000	$	634,332	$	344,055	$	6,666,849
Stephen R. Halpin, Jr. Executive Vice President and Chief Financial Officer	2007	$	669,231	$	197,500	$	200,000	$	71,554	$	135,125	$	1,273,410
B. Francis Saul, III Vice Chairman	2007	$	315,385	$	45,000	$	45,000	$	17,117	$	23,168	$	445,670
Thomas H. McCormick Executive Vice President	2007	$	619,231	$	90,000	$	200,000	$	3,225	$	57,757	$	970,213

(1) The amounts shown in the “Change in Pension Value and Nonqualified Deferred Compensation Earnings” include the aggregate earnings for fiscal year 2007 for each named executive officer under the Bank’s Supplemental Employee Retirement Plan, discussed below in the “Nonqualified Deferred Compensation” table and the accompanying text.

(2) The total amounts shown in the “All Other Compensation” column for fiscal year 2007 consist of the following:

• contributions made by the Bank to the Bank’s Supplemental Executive Retirement Plan on behalf of Mr. Saul II ($328,343), Mr. Halpin ($48,289), Mr. Saul III ($21,623), and Mr. McCormick ($29,169);

• the taxable benefit of premiums paid by the Bank for group term life insurance on behalf of Mr. Saul II ($11,112), Mr. Halpin ($2,610), Mr. Saul III ($1,545), and Mr. McCormick ($4,890);

• contributions to the B. F. Saul Company Employees Profit Sharing Retirement Plan (the “Retirement Plan”), a defined contribution plan, on behalf of Mr. Halpin ($13,500), and Mr. McCormick ($13,500);

• accrued compensation on behalf of Mr. Halpin ($67,188) for the “Special Retirement Compensation Agreements” under which the executive could receive an amount up to three times his base compensation if he retires from the Bank after reaching age 63.

• the taxable benefit of the personal use of a bank-owned automobile on behalf of Mr. Saul II ($4,600), Mr. Halpin ($3,538), and Mr. McCormick ($10,198).

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Grants of Plan-Based Awards

Name		Estimated Future Payouts Under Non-Equity Incentive Plan Awards (1)(3)
	Grant Date	Threshold ($)		Target ($)(2)		Maximum ($)
(a)	(b)	(c)		(d)		(e)
B. Francis Saul, II Chairman and Chief Executive Officer	03/01/2007	$	950,000	$	2,050,979	$	5,882,150
Stephen R. Halpin, Jr. Executive Vice President and Chief Financial Officer	03/01/2007	$	200,000	$	431,785	$	1,238,347
B. Francis Saul, III Vice Chairman	03/01/2007	$	70,000	$	151,125	$	433,422
Thomas H. McCormick Executive Vice President	03/01/2007	$	200,000	$	431,785	$	1,238,347

(1) The estimated future payouts shown in the table are based on assumed performance rates for the Bank during each year in the ten-year performance period. The actual payouts under the Deferred Compensation Plan (the “Plan”) may vary substantially from the payouts shown in the table, depending upon the Bank’s actual rate of return on average assets for each fiscal year in the ten-year performance period ending September 30, 2016.

(2) The Plan does not establish any target performance levels. The target payout amounts shown in this column have been calculated assuming that the Bank generates a 0.50% rate of return on average assets during each of the years in the performance period, which equates to hypothetical interest of 8% being credited to the account for each year.

(3) The payout amounts shown for all participants are the estimated amounts that would be payable to such participants if their employment continued with the Bank for the entire ten-year performance period of the Plan. Mr. Saul attained the age of 72 in 2004, at which time he became fully vested in the Account maintained for his benefit under the Plan. As of September 30, 2007, the vested account balance maintained for Mr. Saul’s benefit under the Plan was $9,890,700. Under the Plan, if Mr. Saul were to retire after that date, he could elect to have the Bank pay out the Net Contribution (defined below) in his Account prior to the year 2016.

At September 30, 2007, the following individuals have vested amounts that are payable within 120 days after September 30, 2007: Mr. Saul II ($769,306) and Mr. Halpin ($169,247).

The Plan provides that, as of the end of each fiscal year in the ten-year period ending September 30, 2016 (or the executive officer’s earlier termination of employment with the Bank), the Bank will add to or deduct from each executive officer’s Account a contribution or deduction, as the case may be, which represents the hypothetical interest (which may be positive or negative) earned on the Principal Contribution, based on the Bank’s rate of return on average assets (as computed under the Plan) for the fiscal year then ended. (The Principal Contribution, plus or minus any interest credited or deducted, is referred to as the “Net Contribution.”)

Executive officers are entitled to receive the Net Contribution in their respective Account only upon full or partial vesting. Plan participants become fully vested in their Account under the Plan, provided that they remain continuously employed by the Bank during the vesting period, upon the earliest to occur of any of the following:

• September 30, 2016;

• attainment of age 65;

• death;

• total and permanent disability; or

• a change in control of the Bank (as defined in the Plan).

Plan participants become partially vested, to the extent of 50% of the Net Contribution in the Account, upon the termination of their employment by the Bank without cause (as defined in the Plan) after September 30, 2011.

Payouts are made under the Plan within 120 days after September 30, 2016, or the earlier termination of the executive officer’s employment with the Bank, provided that vesting or partial vesting has occurred under the Plan.

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Other Compensation Agreements

In addition to the change in control agreements discussed in “Compensation Discussion and Analysis— Potential Payments Upon Termination or Change In Control,” Mr. Halpin also has entered into “Special Retirement Compensation Agreements” under which the executive could receive an amount up to three times his base compensation if he retires from the Bank after reaching age 63. As of September 30, 2007, accrued compensation on behalf of Mr. Halpin totaled $401,216.

Nonqualified Deferred Compensation

Name	Executive Contributions in Last FY ($)		Registrant Contributions in Last FY ($)		Aggregate Earnings in Last FY ($)		Aggregate Withdrawals/ Distributions ($)		Aggregate Balance at Last FYE ($)
(a)	(b)		(c)		(d)		(e)		(f)
B. Francis Saul, II Chairman and Chief Executive Officer	$	109,448	$	1,278,343	$	634,332	$	733,918	$	18,333,403
Stephen R. Halpin, Jr. Executive Vice President and Chief Financial Officer	$	16,096	$	203,839	$	71,554	$	163,093	$	2,302,060
B. Francis Saul, III Vice Chairman	$	7,208	$	51,623	$	17,117	$	—	$	425,065
Thomas H. McCormick Executive Vice President	$	9,723	$	68,169	$	3,225	$	—	$	149,244

Nonqualified Deferred Compensation

Deferred Compensation Plan

The Bank maintains a Deferred Compensation Plan (the “Deferred Compensation Plan”) to provide long-term incentives for the named executive officers. The awards granted in 2007 reflect the overall performance of the Bank and the contributions made by the named executive officers.

Under the Deferred Compensation Plan, the named executive officers do not contribute to their respective accounts. The following amounts were contributed by the Bank for the named executives during fiscal year 2007: Mr. Saul II ($950,000), Mr. Halpin ($155,000), Mr. Saul III ($30,000), and Mr. McCormick ($39,000).

The Deferred Compensation Plan provides that the Bank will add to or deduct from each executive officer’s Account a contribution or deduction, as the case may be, which represents the hypothetical interest (which may be positive or negative) earned on the Principal Contribution, based on the Bank’s rate of return on average assets (as computed under the Deferred Compensation Plan) for the most recently completed fiscal year. (The Principal Contribution, plus or minus any interest credited or deducted, is referred to as the “Net Contribution.”) For the fiscal year ended September 30, 2007, the Bank’s rate of return on average assets totaled 0.38% which resulted in no interest being credited to the named executive officers’ deferred compensation accounts.

On January 5, 2007, the following individuals received payouts as stipulated under the plan for deferred compensation awards granted for fiscal year 1996: Mr. Saul II ($733,918) and Mr. Halpin; ($163,093).

The aggregate deferred compensation balances for fiscal year 2007 were: Mr. Saul II ($9,890,700), Mr. Halpin ($1,337,310), Mr. Saul III ($187,952), and Mr. McCormick ($89,200).

Supplemental Employee Retirement Plan

The Bank provides a supplemental defined contribution profit sharing retirement plan (the “SERP”), which covers certain highly-compensated full-time employees who meet the requirements as specified in the SERP. The SERP, which can be modified or discontinued at any time, requires participating employees to contribute 2.0% of their compensation in excess of a specified amount. The Lehman U.S. Corporate High Yield – Yield to Worst rates are used to compute the earnings calculation for the SERP.

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The named executive officers made the following contributions to the SERP for fiscal year 2007: Mr. Saul II ($109,448), Mr. Halpin ($16,096), Mr. Saul III ($7,208), and Mr. McCormick ($9,723).

The named executive officers received the following corporate contributions equal to three times the employee’s contribution for fiscal year 2007: Mr. Saul II ($328,343), Mr. Halpin ($48,289), Mr. Saul III ($21,623), and Mr. McCormick ($29,169).

The named executive officers earned interest in the following amounts on their aggregate SERP account balances for fiscal year 2007: Mr. Saul II ($634,332), Mr. Halpin ($71,554), Mr. Saul III ($17,117), and Mr. McCormick ($3,225).

There were no withdrawals by, or distributions to, the named executive officers in fiscal year 2007. The aggregate balances for each named executive officer as of September 30, 2007 were: Mr. Saul II ($8,442,703), Mr. Halpin ($964,750), Mr. Saul III ($237,113), and Mr. McCormick ($60,044).

Trustee Compensation

Name	Fees Earned or Paid in Cash ($)
(a)	(b)
B. Francis Saul, II (1)	$	14,900
B. Francis Saul, III	$	14,900
Philip D. Caraci (2)	$	17,900
Gilbert M. Grosvenor (2)	$	17,900
George M. Rogers, Jr. (1)	$	14,900
John R. Whitmore (1)	$	14,900

(1) Member of the Executive Committee.

(2) Member of the Audit Committee.

Trustee Compensation

During fiscal year 2007, all trustees of the Real Estate Trust received an annual base fee of $12,500 and $600 for each meeting of the Board of Trustees and the Audit Committee attended.

Compensation Committee Interlocks and Insider Participation. Mr. B. Francis Saul II, Mr. Garland P. Moore, Jr. and Mr. George M. Rogers, Jr. are the current members of the Compensation Committee of the Board of Directors of the Bank. All of the current members also served as members of the Compensation Committee during fiscal year 2007 and fiscal year 2006. Mr. Saul is the Chairman of the Board and Chief Executive Officer of the Bank.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table sets forth certain information, as of December 14, 2007, concerning beneficial ownership of Common Shares and preferred shares of beneficial interest, referred to in this report as the “Preferred Shares,” by (a) each person known by the Trust to be the beneficial owner of more than 5% of the Common Shares and the Preferred Shares, (b) each member of the Board of Trustees, (c) each executive officer of the Trust named in the Summary Compensation Table under “Item 11. Executive Compensation” and (d) all trustees and executive officers of the Trust as a group.

Name of Beneficial Owner	Aggregate Number of Shares Beneficially Owned (1)		Percent of Class (1)
B. Francis Saul II	Preferred: 516,000	(2)	100.00	%
	Common: 4,807,510	(3)	100.00	%
All Trustees and executive officers as a group (9 persons)	Preferred: 516,000	(2)	100.00	%
	Common: 4,807,510	(3)	100.00	%

(1) Beneficial owner and percent of class are calculated pursuant to rule 13d-3 under the Securities Exchange Act of 1934.

(2) Consists of Preferred Shares owned of record by Saul Company and other companies of which Mr. Saul is an officer, director and/or more than 10% shareholder, comprising 270,000 Preferred Shares owned by Saul Company, 90,000 Preferred Shares owned by Franklin Development Company, Inc., 90,000 Preferred Shares owned by The Klingle Corporation, and 66,000 Preferred Shares owned by Westminster Investing Corporation. The address of each person listed in this footnote is 7501 Wisconsin Avenue, Bethesda, Maryland 20814. Pursuant to Rule 13d-3, the Preferred Shares described above are considered to be beneficially owned by Mr. Saul because he has or may be deemed to have sole or shared voting and/or investment power in respect thereof.

(3) Consists of Common Shares owned of record by Saul Company and other companies of which Mr. Saul is an officer and director and/or more than 10% shareholder, comprising 1,125,739 Common Shares owned by Westminster Investing Corporation, 43,673 Common Shares owned by Derwood Investment Corporation, a subsidiary of Westminster Investing Corporation, 34,400 Common Shares owned by Somerset Investment Company, Inc., a subsidiary of Westminster Investing Corporation, 2,751,662 Common Shares owned by Saul Company, 283,400 Common Shares owned by Columbia Securities Company of Washington, D.C., 172,918 Common Shares owned by Franklin Development Company, Inc., and 395,718 Common Shares owned by The Klingle Corporation. The address of each person listed in this footnote is 7501 Wisconsin Avenue, Bethesda, Maryland 20814. Pursuant to Rule 13d-3, the Common Shares described above are considered to be beneficially owned by Mr. Saul because he has or may be deemed to have sole or shared voting and/or investment power in respect thereof.

The Preferred Shares were issued in June 1990 in connection with the transaction in which the Trust increased its equity interest in Chevy Chase from 60% to 80%. The dividend rate on the Preferred Shares is $10.50 per share per annum. Dividends are cumulative and are payable annually or at such other times as the Trustees may determine, as and when declared by the Trustees out of any assets legally available therefore. The Preferred Shares have a liquidation preference of $100 per share. Subject to limits in certain of the Trust’s loan agreements, the Preferred Shares are subject to redemption at the option of the Trust at a redemption price equal to their liquidation preference. Except as otherwise required by applicable law, the holders of Preferred Shares are entitled to vote only in certain limited situations, such as the merger of the Trust or a sale of all or substantially all of the assets of the Trust.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Management Personnel

All of the officers of the Trust and Messrs. Saul II, Saul III, Rogers and Whitmore, each of whom is a trustee of the Trust, are also officers and/or directors of Saul Company and/or its subsidiaries. In addition, Messrs. Saul II, Saul III, Whitmore, Grosvenor, Caraci, McCormick, Heasley and Shoop are also officers and/or directors of Saul Centers and/or its subsidiaries.

Transactions with Saul Company and its Subsidiaries

Prior to October 1, 2005, the Real Estate Trust was managed by B. F. Saul Advisory Company, L.L.C., (the “Former Advisor”), a wholly-owned subsidiary of B. F. Saul Company (“Saul Company”). Effective October 1, 2005, the Former Advisor’s obligations under the advisory contract were assigned to Saul Company. All of the Real Estate Trust officers and four Trustees of the Trust are also officers and/or directors of Saul Company. Saul Company is paid a fixed monthly fee which is subject to annual review by the Trustees. The average monthly fee was $602,000 during fiscal 2007, $560,000 during fiscal 2006, and $487,000 during fiscal 2005. The advisory agreement continues year to year unless canceled by either party at the end of any contract year. Certain loan agreements prohibit termination of this contract.

Saul Company and Saul Property Co., a wholly owned subsidiary of Saul Company, provide services to the Real Estate Trust in the areas of commercial property management and leasing, hotel management, development and construction management, and acquisitions, sales and financings of real property. Fees to the two companies amounted to $14.7 million in fiscal 2007.

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The Real Estate Trust reimburses Saul Company and Saul Property Co. for costs and expenses incurred in connection with the acquisition and development of real property on behalf of the Real Estate Trust, in-house legal expenses, and all travel expenses incurred in connection with the affairs of the Real Estate Trust.

While the Real Estate Trust made public offerings of unsecured notes it paid the Former Advisor fees equal to 2% of the principal amount of publicly offered unsecured notes as they were issued to offset the Former Advisor’s costs of administering the program. In October 2006, in conjunction with the Real Estate Trust’s decision to discontinue the public sale of unsecured notes, the fee agreement was modified whereas the fee for any calendar month that the Real Estate Trust did not issue notes under the programs was to be $7,500 for such month. The Saul Company received $90,000 in such fees in fiscal 2007.

B. F. Saul Insurance Agency of Maryland, Inc., a subsidiary of Saul Company, is a general insurance agency that receives commissions and counter-signature fees in connection with the Real Estate Trust’s insurance program. Such commissions and fees amounted to approximately $391,000 in fiscal 2007.

Under an existing unsecured note receivable from Saul Company, which was modified and amended on October 1, 2005, not to exceed $30.0 million, the Real Estate Trust received net repayments of $4.9 million during fiscal 2007. During fiscal 2006 net repayments totaled $2.8 million. At September 30, 2007 and September 30, 2006, the note balance totaled $5.4 million and $10.3 million, respectively. Interest is computed on the note at 200 basis points over a floating rate index. Interest earned on the note amounted to $532,000, $959,000 and $616,000 during fiscal 2007, 2006 and 2005, respectively. The note is due and payable on September 30, 2015.

The Trust has retained the law firm of Pillsbury Winthrop Shaw Pittman LLP, at which Mr. Rogers is senior counsel, to perform legal services for the Trust in fiscal 2007 and 2006.

The Board of Trustees of the Trust, including the independent trustees, reviews the fees and compensation arrangements between the Real Estate Trust and Saul Company and its related entities and affiliates and believes that such fees and compensation arrangements are as favorable to the Real Estate Trust as would be obtainable from unaffiliated sources. Except as otherwise noted, the Real Estate Trust does not have any written policies or procedures for the review, approval or ratification or transactions with related persons.

Transactions with Saul Centers

Shared Services. The Trust shares with Saul Centers certain personnel and ancillary functions at cost, such as computer hardware, software and support services, payroll services, benefits administration, in-house legal services and other direct and indirect administrative payroll. In addition the Trust shares insurance expense with Saul Centers on a pro rata basis. Depending on the service, the method of determining the cost of the shared services is based upon head count, estimates of usage or estimates of time incurred, as applicable. Although the Trust believes that the amounts allocated to it for such shared services represent a fair allocation between the Trust and Saul Centers, the Trust has not obtained a third party appraisal of the value of these services.

Exclusivity Agreement and Right of First Refusal. The Real Estate Trust has entered into an Exclusivity Agreement with, and has granted a right of first refusal to, Saul Centers and Saul Holdings Limited Partnership. The purpose of these agreements is to minimize potential conflicts of interest between the Real Estate Trust, Saul Centers and Saul Holdings Limited Partnership.

Saul Holdings Limited Partnership. The exclusivity agreement and right of first refusal generally require the Real Estate Trust to conduct its shopping center business exclusively through Saul Centers and Saul Holdings Limited Partnership and to grant these entities a right of first refusal to purchase commercial properties and development sites that become available to the Real Estate Trust in the District of Columbia or adjacent suburban Maryland. Subject to the exclusivity agreement and right of first refusal, the Real Estate Trust will continue to develop, acquire, own and manage commercial properties and own land suitable for development as, among other things, shopping centers and other commercial properties.

Reimbursement Agreement. Pursuant to a reimbursement agreement among the partners of the Saul Holdings Limited Partnership and certain of their affiliates, the Real Estate Trust and two of its subsidiaries have agreed to reimburse Saul Centers and the other partners in the event the Saul Holdings Limited Partnership fails to make payments with respect to certain portions of its debt obligations and Saul Centers or any such other partners personally make payments with respect to such debt obligations. As of September 30, 2007, the maximum potential obligation of the Real Estate Trust and its subsidiaries under the agreement was approximately $100 million. See Note 5 to the Consolidated Financial Statements in this report. The Real Estate Trust believes that Saul Holdings Limited Partnership will be able to make all payments due with respect to its debt obligations.

Tax Conflicts. The fair market value of each of the properties contributed to Saul Holdings Limited Partnership and its subsidiaries by the Real Estate Trust and its subsidiaries in connection with the formation of Saul Centers and Saul Holdings Limited Partnership in 1993 exceeded the tax basis of such properties. In the event Saul Centers or its wholly owned subsidiary, Saul QRS, Inc., acting as general partner, causes Saul Holdings Limited Partnership to dispose of, or there is an involuntary disposition of, one or more of such properties, a disproportionately large share of the total gain for federal income tax purposes would be allocated to the Real Estate Trust and its subsidiaries as a result of the property disposition. See Note 5 to the Consolidated Financial Statements in this report.

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Other related party transactions

Remuneration of Trustees and Officers. For fiscal 2007, the Trust paid the trustees $95,000 in fees for their services. See “Item 10. Trustees and Executive Officers of the Trust.” No compensation was paid to the officers of the Trust for acting as such; however, Messrs. Saul II, Halpin, Saul III and McCormick were paid by Chevy Chase for services as Officers of Chevy Chase. See “Item 11. Executive Compensation.” Messrs. Grosvenor, Rogers, Saul II and Saul III receive compensation for their services as directors of Chevy Chase and Messrs. Rogers, Saul II, Saul III and Whitmore and all of the officers of the Real Estate Trust receive compensation from Saul Company and/or its affiliated corporations as directors or officers thereof.

Related Party Rents. The Real Estate Trust leases space to Chevy Chase and the Saul Property Co. at four of its income-producing properties. Minimum rents and expense recoveries paid under these leases amounted to approximately $6.2 million in fiscal 2007. Chevy Chase leases space in several of the shopping centers owned by Saul Centers. The total rental payments made to Saul Centers by Chevy Chase in fiscal 2007 was $2.8 million. On September 24, 2001 Chevy Chase entered into an agreement to lease to Saul Company approximately 46,000 square feet of office space at its new corporate headquarters at 7501 Wisconsin Avenue, Bethesda, Maryland. Total payments under the lease for fiscal 2007 were $2.3 million. In addition, Chevy Chase has retained Saul Company as its leasing agent to secure tenants for additional space that will be available in the new corporate headquarters. The Trust believes that these leases have comparable terms to leases that would have been entered into with unaffiliated parties.

Independence of Trustees

The Real Estate Trust does not have securities listed on any national securities market or in any inter-dealer quotation system. Accordingly, the Real Estate Trust’s Board of Trustees is not required to, and does not, make regular determinations relating to the independence of trustees. For this reason, none of the trustees would qualify as an “independent” trustee under the listing rules of the New York Stock Exchange (“NYSE”), as such rules mandate that no trustee qualifies as “independent” without an affirmative determination by the Board of Trustees that such trustee has no material relationship with the listed company. However, if NYSE listing standards were applied to the Real Estate Trust, the Board of Trustees would not be prohibited from determining that Messrs. Caraci, Grosvenor, Rogers and Whitmore are “independent directors,” as defined in NYSE listing standards. Furthermore, the Board of Trustees would not be prohibited from determining that Messrs. Caraci and Grosvenor meet the additional independence standards applicable under NYSE listing standards to members of audit committees. The Real Estate Trust’s Board of Trustees does not have a separately designated nominating or compensation committee, as a result of which the functions that would otherwise be performed by such committees are performed by the entire Board of Trustees. The NYSE listing standards require that each member of the nominating and compensation committee of a listed company be independent. For purposes of NYSE listing standards, Messrs. Saul II and Saul III would not be considered independent, while the Board of Trustees would not be prohibited from determining that Messrs. Caraci, Grosvenor, Rogers and Whitmore are independent.

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ITEM 14. PRINCIPAL INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FEES AND SERVICES

Fees Paid to Independent Registered Public Accounting Firm

During fiscal years 2007 and 2006, The Trust retained Ernst & Young LLP to provide services in the following categories and amounts:

	Fiscal Year 2007		Fiscal Year 2006
Audit Fees (1)	$	1,549,700	$	1,401,625
Audit Related Fees (2)		164,800		62,500
Subtotaled		1,714,500		1,464,125
Tax Fees (3)		83,750		80,000
All Other Fees		83,100		105,800
Total Fees	$	1,881,350	$	1,649,925

(1) Audit fees include the audit fee and fees for comfort letters, attest services, consents and assistance with and review of documents filed with the SEC and OTS.

(2) Audit related fees consist of fees incurred for consultation concerning financial accounting and reporting standards, performance of agreed-upon procedures, and other audit or attest services not required by statute or regulation.

(3) Tax fees consist of fees for tax consultation and tax compliance services.

Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Registered Public Accounting Firm.

The Audit Committee has responsibility for appointing, setting compensation and overseeing the work of the independent registered public accounting firm. In recognition of this responsibility, the Audit Committee has established a policy to pre-approve all audit and permissible non-audit services provided by the independent registered public accounting firm.

Prior to engagement of the independent registered public accounting firm for the next year’s audit, management will submit to the Audit Committee for approval an aggregate of services expected to be rendered during that year for the services listed above.

Prior to engagement, the Audit Committee pre-approves these services by types of service. The fees are budgeted and the Audit Committee requires the independent registered public accounting firm and management to report actual fees versus the budget periodically throughout the year by category of service. During the year, circumstances may arise when it may become necessary to engage the independent registered public accounting firm for additional services not contemplated in the original pre-approval. In those instances, the Audit Committee requires specific pre-approval before engaging them.

Pursuant to the Trust’s Audit Committee Charter, the Audit Committee may delegate pre-approval authority to the chairman of the Audit Committee, who shall promptly advise the remaining members of the Audit Committee of such approval at the next regularly scheduled meeting.

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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) The following documents are filed as part of this report:

1. Financial Statements

The following consolidated financial statements of the Trust are incorporated by reference in Part II, Item 8.

(a)	Report of Independent Auditors.
(b)	Consolidated Balance Sheets—As of September 30, 2007 and 2006.
(c)	Consolidated Statements of Operations—For the years ended September 30, 2007, 2006 and 2005.
(d)	Consolidated Statements of Comprehensive Income and Changes in Shareholders’ Equity—For the years ended September 30, 2007, 2006 and 2005.
(e)	Consolidated Statements of Cash Flows—For the years ended September 30, 2007, 2006 and 2005.
(f)	Notes to Consolidated Financial Statements.

2. Financial Statement Schedules and Supplementary Data

(a) Schedules of the Real Estate Trust:

Schedule I—Condensed Financial Information—For the years ended September 30, 2007, 2006 and 2005.

Schedule III—Consolidated Schedule of Investment Properties As of September 30, 2007.

(b) Exhibits

EXHIBITS	DESCRIPTION
3. ORGANIZATIONAL DOCUMENTS
(a)	Second Amended and Restated Declaration of Trust filed with the Maryland State Department of Assessments and Taxation on May 23, 2002 as Exhibit 3(a) to Registration Statement 333-70753 is hereby incorporated by reference.
(b)	Second Amended and Restated By-Laws of the Trust dated as of May 23, 2002 as Exhibit 3(b) to Registration Statement 333-70753 is hereby incorporated by reference.
4. INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES
(a)	Indenture, dated as of February 25, 2004, by and between the Trust and Wells Fargo Bank, National Association, as Trustee, with respect to the Trust’s 7 1/2% Senior Secured Notes due 2014 and 7 1/2% Series B Senior Secured Notes due 2014, including Form of Note, as filed as Exhibit 4 (a) to Registration Statement 333-113640 is hereby incorporated by reference.
(b)	Indenture, dated as of April 14, 2003, between the Trust and U.S. Bank National Association, as Trustee, with respect to the Trust’s Unsecured Notes Due for One Year to Ten Years from Date of Issue, as filed as Exhibit 4 (a) to Registration Statement 333-104068 is hereby incorporated by reference.
(c)	Indenture dated as of September 1, 1992 with respect to the Trust’s Notes due from One to Ten Years form Date of Issue filed as Exhibit 4(a) to Registration Statement No. 33-34930 is hereby incorporated by reference.
(d)	First Supplemental Indenture dated as of January 16, 1997 with respect to the Trust’s Notes due from One to Ten Years from Date of Issue filed as Exhibit 4(b) to Registration Statement No. 33-34930 is hereby incorporated by reference.
(e)	Second Supplemental Indenture dated as of January 13, 1999 with respect to the Trust’s Notes due from One to Ten Years from Date of Issuance as filed as Exhibit 4(l) to Registration Statement No. 333-70753 is hereby incorporated by reference.

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EXHIBITS	DESCRIPTION
10. MATERIAL CONTRACTS
(a)	Amended and Restated Advisory Contract dated as of October 1, 2005 by and among the Trust, B.F. Saul Company and B.F. Saul Advisory Company, LLC, filed as Exhibit 10(a) to Trust’s September 30 2005 Form 8-K is hereby incorporated by reference
(b)	Form of Commercial Asset Management and Leasing Agreement between the Trust and B.F. Saul Property Company filed as Exhibit 10(c) to the Trust’s September 30, 2005 Form 8-K is hereby incorporated by reference.
(c)	Tax Sharing Agreement dated June 28, 1990 among the Trust, Chevy Chase Bank F.S.B. and certain of their subsidiaries filed as Exhibit 10(c) to Registration Statement No. 33-34930 is hereby incorporated by reference.
(d)	First Amendment to Tax Sharing Agreement effective May 16, 1995 among the Trust, Chevy Chase Bank F.S.B. and certain of their subsidiaries, as filed as Exhibit 10(f) to the Trust’s Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 2001 is hereby incorporated by reference.
(e)	Agreement dated June 28, 1990 among the Trust, B.F. Saul Company, Franklin Development Co., Inc., The Klingle Corporation and Westminster Investing Corporation relating to the transfer of certain shares of Chevy Chase Bank, F.S.B. and certain real property to the Trust in exchange for Preferred Shares of the Trust filed as Exhibit 10(d) to Registration Statement No. 33-34930 is hereby incorporated by reference.
(f)	Regulatory Capital Maintenance/Dividend Agreement dated May 17, 1988 among B.F. Saul Company, the Trust and the Federal Savings and Loan Insurance Corporation filed as Exhibit 10(e) to the Trust’s Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 1991 is hereby incorporated by reference.
(g)	Registration Rights and Lock-Up Agreement dated August 26, 1993 by and among Saul Centers, Inc. and the Trust, Westminster Investing Corporation, Van Ness Square Corporation, Dearborn, L.L.C., B.F. Saul Property Company and Avenel Executive Park Phase II, Inc. as filed as Exhibit 10.6 to Registration Statement No. 33-64562 is hereby incorporated by reference.
(h)	First Amendment to Registration Rights and Lock-Up Agreement dated September 29, 1999 by and among Saul Centers, Inc., the Trust, Westminster Investing Corporation, Van Ness Square Corporation, Dearborn Corporation, Franklin Property Company and Avenel Executive Park Phase II, Inc., as filed as Exhibit 10(b) to the Trust’s Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 2001 is hereby incorporated by reference.
(i)	Exclusivity and Right of First Refusal Agreement dated August 26, 1993 among Saul Centers, Inc., the Trust, B.F. Saul Company, Westminster Investing Corporation, B.F. Saul Property Company, Van Ness Square Corporation, and Chevy Chase Savings Bank, F.S.B. as filed as Exhibit 10.7 to Registration Statement No. 33-64562 hereby incorporated by reference.
(j)	Fourth Amended and Restated Reimbursement Agreement dated as of April 25, 2000 by and among Saul Centers, Inc., Saul Holdings Limited Partnership, Saul Subsidiary I Limited Partnership, Saul Subsidiary II Limited Partnership, Saul QRS, Inc., B.F. Saul Property Company, Westminster Investing Corporation, Van Ness Square Corporation, Dearborn, L.L.C., Avenel Executive Park Phase II, L.L.C., and the Trust, as filed as Exhibit 10(k) to the Trust’s Quarterly Report on Form 10-Q (File No. 1-7184) for the fiscal quarter ended March 31, 2000 is hereby incorporated by reference.
(k)	Bank Stock Registration Rights Agreement dated as of March 25, 1998 between the Trust and Norwest Bank Minnesota, National Association, as Trustee, as filed as Exhibit 4(d) to Registration Statement No. 333-49937 is hereby incorporated by reference.
(l)	Amended and Restated Note Administration Fee Agreement dated as of October 1, 2005, between the Trust, B.F. Saul Company and B.F. Saul Advisory Company L.L.C., as filed as Exhibit 10(n) to the Trust’s September 30, 2005 Form 8-K is hereby incorporated by reference.
(m)	Development Agreement dated as of October 1, 2005 between the Trust and B.F. Saul Property Company, as filed as Exhibit 10(o) to the Trust’s September 30, 2005 Form 8-K is hereby incorporated by reference.
(n)	Amendment No.1 to Amended and Restated Advisory Contract, made as of April 3, 2006 by and among the Trust and B. F. Saul Company, as filed as Exhibit 10(a) to the Trust’s April 3, 2006 Form 8-K is hereby incorporated by reference.
(o)	Amendment No. 2 to Amended and Restated Advisory Contract, made as of January 18, 2007 by and among the Trust and B. F. Saul Company, as filed as Exhibit 10(o) to the Trust’s December 31, 2006 Form 10-Q is hereby incorporated by reference.
(p)	A current report on Form 8-K, dated April 18, 2007 was filed by the Trust with the SEC reporting the misclassification of certain cash flows from the sales of loans which were originated for investment and subsequently transferred to loans held for securitization and/or sale. (Item repeated: Item 4.02(a))
12.	Ratio of Earnings to Fixed Charges (filed herewith).
12.1	Ratio of Consolidated Earnings to Fixed Charges (filed herewith).

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EXHIBITS	DESCRIPTION
21.	List of Subsidiaries of the Trust (filed herewith).
31.	Rule 13a – 14(a)/15d – 14(a) Certifications of Chief Executive Officer and Chief Financial Officer (filed herewith).
32.	Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer (filed herewith).

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SCHEDULE I

B.F. SAUL REAL ESTATE INVESTMENT TRUST

CONDENSED FINANCIAL INFORMATION

(a) Required condensed financial information on the Trust is disclosed in the audited consolidated financial statements included herewith.

(b) Amounts of cash dividends paid to the Trust by consolidated subsidiaries were as follows:

Year Ended September 30
2007		2006		2005
$	16,000,000	$	32,000,000	$	39,200,000

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SCHEDULE III

CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIES—REAL ESTATE TRUST

September 30, 2007

(Dollars in Thousands)

Hotels	Initial Basis to Trust		Costs Capitalized Subsequent to Acquisitions		Land		Basis at Close of Period Buildings and Improvements		Total
Best Western—Dulles Airport, Sterling VA	$	—	$	8,253	$	290	$	7,963	$	8,253
Courtyard—Tyson’s Corner, McLean VA		31,077		560		843		30,794		31,637
Crowne Plaza—Auburn Hills MI		10,450		3,966		1,031		13,385		14,416
Crowne Plaza—National Airport, Arlington VA		26,979		9,923		4,229		32,673		36,902
Crowne Plaza—Tysons Corner, McLean VA		6,976		20,722		2,265		25,433		27,698
Hampton Inn—Dulles South, Sterling, VA		12,909		1,894		3,164		11,639		14,803
Hampton Inn—Dulles Town Center, Sterling VA		11,379		486		795		11,070		11,865
Holiday Inn—Dulles Airport, Sterling VA		6,950		25,213		862		31,301		32,163
Holiday Inn—Gaithersburg MD		3,849		19,102		1,781		21,170		22,951
Holiday Inn—National Airport, Arlington VA		10,187		11,461		1,183		20,465		21,648
Holiday Inn Express—Herndon VA		5,259		1,808		1,178		5,889		7,067
SpringHill Suites—Dulles Airport, Sterling VA		—		20,158		543		19,615		20,158
SpringHill Suites—Boca Raton FL		10,942		1,512		1,220		11,234		12,454
TownePlace Suites—Boca Raton FL		7,527		908		869		7,566		8,435
TownePlace Suites—Dulles Airport, Sterling VA		5,849		1,082		219		6,712		6,931
TownePlace Suites—Ft. Lauderdale FL		7,059		857		420		7,496		7,916
TownePlace Suites—Gaithersburg MD		6,382		977		107		7,252		7,359
The Hay Adams—Washington DC		91,981		3,122		15,759		79,344		95,103
Subtotal—Hotels	$	255,755	$	132,004	$	36,758	$	351,001	$	387,759

153

	SCHEDULE III
CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIES—REAL ESTATE TRUST September 30, 2007 (Dollars in Thousands)	(continued)

Office and Industrial	Initial Basis to Trust		Costs Capitalized Subsequent to Acquisitions			Land		Basis at Close of Period Buildings and Improvements		Total
900 Circle 75 Parkway—Atlanta GA	$	33,434	$	5,820		$	563	$	38,691	$	39,254
1000 Circle 75 Parkway—Atlanta GA		2,820		2,417			248		4,989		5,237
1100 Circle 75 Parkway—Atlanta GA		22,746		6,353			419		28,680		29,099
8001 Wisconsin Avenue—Bethesda MD		5,408		171			1,895		3,684		5,579
Garden Plaza—Bethesda, MD		51,473		62			8,563		42,972		51,535
8201 Greensboro Drive—Tysons Corner VA		28,890		7,302			1,633		34,559		36,192
Commerce Center—Ft. Lauderdale FL		4,266		908			782		4,392		5,174
Dulles North—Loudoun County VA		5,882		630			507		6,005		6,512
Dulles North Two—Loudoun County VA		7,729		91			404		7,416		7,820
Dulles North Four—Loudoun County VA		11,093		178			2,208		9,063		11,271
Dulles North Five—Loudoun County VA		5,078		(76	)		535		4,467		5,002
Dulles North Six—Loudoun County VA		2,667		1,883			257		4,293		4,550
Loudoun Tech Center I—Loudoun County VA		5,334		4,248			1,075		8,507		9,582
Sweitzer Lane—Laurel MD		13,703		—			3,701		10,002		13,703
Tysons Park Place—Tysons Corner VA		21,811		13,330			1,142		33,999		35,141
Subtotal—Office and Industrial	$	222,334	$	43,317		$	23,932	$	241,719	$	265,651

154

	SCHEDULE III
CONSOLIDATED SCHEDULE OF INVESTMENTS PROPERTIES—REAL ESTATE TRUST September 30, 2007 (Dollars in Thousands)	(continued)

Purchase Leasebacks	Initial Basis to Trust		Costs Capitalized Subsequent to Acquisitions			Land		Basis at Close of Period Buildings and Improvements		Total
Country Club—Knoxville TN	$	500	$	(22	)	$	478	$	—	$	478
Houston Mall—Warner Robbins GA		650		—			650		��		650
Subtotal—Purchase Leasebacks	$	1,150	$	(22	)	$	1,128	$	—	$	1,128
Total Income—Producing Properties	$	479,239	$	175,299		$	61,818	$	592,720	$	654,538
Land Parcels	Initial Basis to Trust		Costs Capitalized Subsequent to Acquisitions			Land		Basis at Close of Period Buildings and Improvements		Total
Arvida Park of Commerce—Boca Raton FL	$	7,378	$	(1,706	)	$	5,433	$	239	$	5,672
Ashburn Village—Loudoun Co VA		4,919		478			4,919		478		5,397
Cedar Green—Loudoun Co VA		3,314		125			2,832		607		3,439
Church Road—Loudoun Co VA		2,586		1,282			3,834		34		3,868
Circle 75—Atlanta GA		12,927		3,103			14,680		1,350		16,030
Crowne Plaza—Auburn Hills MI		218		—			218		—		218
Loudoun Tech II—Sterling VA		939		114			946		107		1,053
Overland Park—Overland Park KA		2,842		786			3,568		60		3,628
Prospect Industrial Park—Fort Lauderdale FL		2,203		(1,943	)		260		—		260
Sterling Boulevard—Loudoun Co VA		505		3,284			1,070		2,719		3,789
Subtotal—Land Parcels	$	37,831	$	5,523		$	37,760	$	5,594	$	43,354

155

	SCHEDULE III
CONSOLIDATED SCHEDULE OF INVESTMENTS PROPERTIES—REAL ESTATE TRUST September 30, 2007 (Dollars in Thousands)	(continued)

Construction in Progress	Initial Basis to Trust		Costs Capitalized Subsequent to Acquisitions		Land		Basis at Close of Period Buildings and Improvements		Total
Circle 75—Atlanta GA	$	1,369	$	24,223	$	1,369	$	24,223	$	25,592
Hampton Inn—Dulles North, Sterling VA		748		23,069		748		23,069		23,817
Tysons Park Place II—Fairfax VA		1,312		33,035		1,312		33,035		34,347
Subtotal—Construction in Progress	$	3,429	$	80,327	$	3,429	$	80,327	$	83,756
Total Investment Properties (1)	$	520,499	$	261,149	$	103,007	$	678,641	$	781,648

156

	SCHEDULE III
CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIES—REAL ESTATE TRUST September 30, 2007 (Dollars in Thousands)	(continued)

Hotels	Accumulated Depreciation		(1) Related Debt		Date of Construction	Date Acquired/ Transferred	Buildings and Improvements Depreciable Lives (Years)
Best Western—Dulles Airport, Sterling VA	$	4,130	$	5,362	1987	4/87	31.5
Courtyard—Tyson’s Corner, McLean VA		10,776		24,323	2000	12/00	40
Crowne Plaza—Auburn Hills MI		5,614		9,965	1989	11/94	31.5
Crowne Plaza—National Airport, Arlington VA		11,639		13,995	1959	12/97	39
Crowne Plaza—Tysons Corner, McLean VA		12,574		39,179	1971	6/75	47
Hampton Inn—Dulles South, Sterling, VA		758		9,222	1989	11/05	40
Hampton Inn—Dulles Town Center, Sterling VA		5,168		7,371	2000	11/00	40
Holiday Inn—Dulles Airport, Sterling VA		22,123		34,864	1971	11/84	28
Holiday Inn—Gaithersburg MD		12,368		22,270	1972	6/75	45
Holiday Inn—National Airport, Arlington VA		12,178		10,736	1973	11/83	30
Holiday Inn Express—Herndon VA		2,028		4,017	1987	10/96	40
SpringHill Suites—Boca Raton FL		3,109		5,542	1999	9/99	40
SpringHill Suites—Dulles Airport, Sterling VA		647		21,285	2007	1/07	40
TownePlace Suites—Boca Raton FL		1,941		5,042	1999	6/99	40
TownePlace Suites—Dulles Airport, Sterling VA		1,854		5,823	1998	8/98	40
TownePlace Suites—Ft. Lauderdale FL		1,994		4,134	1999	10/99	40
TownePlace Suites—Gaithersburg MD		1,958		4,425	1999	6/99	40
The Hay Adams- Washington DC		3,737		75,000	1928	3/06	40
Subtotal—Hotels	$	114,596	$	302,555

157

	SCHEDULE III
CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIES—REAL ESTATE TRUST September 30, 2007 (Dollars in Thousands)	(continued)

Office and Industrial	Accumulated Depreciation		(1) Related Debt		Date of Construction	Date Acquired/ Transferred	Buildings and Improvements Depreciable Lives (Years)
900 Circle 75 Parkway—Atlanta GA	$	23,930	$	31,200	1985	12/85	35
1000 Circle 75 Parkway—Atlanta GA		3,444		4,582	1974	4/76	40
1100 Circle 75 Parkway—Atlanta GA		18,636		10,539	1982	9/82	40
8001 Wisconsin Avenue—Bethesda MD		208		—	1986	5/05	40
Garden Plaza—Bethesda, MD		24,768		36,888	1988	4/07	30
8201 Greensboro Drive- Tysons Corner VA		20,314		76,000	1985	4/86	35
Commerce Center—Ft. Lauderdale FL		2,518		3,481	1986	1/87	35
Dulles North—Loudoun County VA		2,850		4,610	1990	10/90	31.5
Dulles North Two—Loudoun County VA		3,407		7,950	1999	10/99	40
Dulles North Four—Loudoun County VA		4,135		7,805	2002	4/02	40
Dulles North Five—Loudoun County VA		1,318		6,243	2000	3/00	40
Dulles North Six—Loudoun County VA		820		4,168	2000	10/00	40
Loudoun Tech Center I—Loudoun County VA		910		8,500	2001	12/01	40
Sweitzer Lane—Laurel MD		1,729		9,828	1995	11/00	40
Tysons Park Place—Tysons Corner VA		12,961		25,250	1976	12/99	30
Subtotal—Office and Industrial	$	121,948	$	237,044
Purchase Leasebacks	Accumulated Depreciation		Related Debt		Date of Construction		Date Acquired/ Transferred
Country Club—Knoxville TN		—		—			5/76
Houston Mall—Warner Robbins GA		—		—			2/72
Subtotal—Purchase Leasebacks	$	—	$	—
Total Income—Producing Properties	$	236,544	$	539,599

158

	SCHEDULE III
CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIES—REAL ESTATE TRUST September 30, 2007 (Dollars in Thousands)	(continued)

Land Parcels	Accumulated Depreciation		Related Debt		Date of Construction	Date Acquired/ Transferred
Arvida Park of Commerce—Boca Raton FL	$	—	$	—		12/84 & 5/85
Ashburn Village—Loudoun Co VA		—		—		9/05
Cedar Green—Loudoun Co VA		—		—		10/00
Church Road—Loudoun Co VA		—		—		9/84 & 4/85
Circle 75—Atlanta GA		141		—		2/77 & 1/84
Crowne Plaza—Auburn Hills MI		—		—		8/85
Loudoun Tech II—Sterling VA						7/05
Overland Park—Overland Park KA		—		—		9/86
Prospect Industrial Park—Fort Lauderdale FL		—		—		1/77 & 2/85
Sterling Boulevard—Loudoun Co VA		—		—		10/83 & 8/84
Subtotal—Land Parcels	$	141	$	—
Construction in Progress	Accumulated Depreciation		Related Debt		Date of Construction	Date Acquired/ Transferred
Circle 75—Atlanta GA		—		—	11/06
Hampton Inn—Dulles North, Sterling VA		—		13,685	8/06
Tysons Park Place II—Fairfax VA		—		26,721	9/06
Subtotal—Construction in Progress		—	$	40,406
	$	236,685	$	580,005

NOTES:

(1) Includes hotel capital lease obligations of approximately $366.

(2) See Summary of Significant Accounting Policies for basis of recording investment properties and computing depreciation. Investment properties are discussed in Note 6 to Consolidated Financial Statements.

(3) A reconciliation of the basis of investment properties and accumulated depreciation follows.

159

	SCHEDULE III
CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIES—REAL ESTATE TRUST BASIS OF INVESTMENT PROPERTIES AND ACCUMULATED DEPRECIATION - REAL ESTATE TRUST (In thousands)	(continued)

	For the year ended September 30
Basis of investment properties (1)	2007			2006			2005
Balance at beginning of period	$	650,476		$	517,909		$	498,873
Additions (reductions during the period):
Capital expenditures and property acquisitions from nonaffiliates		95,103			165,843			21,770
Property acquisitions from affiliates		51,472			—			5,874
Sales to nonaffiliates		(7,580	)		(28,258	)		(7,353	)
Other		(7,823	)		(5,018	)		(1,255	)
Balance at end of period	$	781,648		$	650,476		$	517,909
Accumulated depreciation (1)
Balance at beginning of period	$	197,855		$	199,052		$	183,859
Additions (reductions during the period):
Depreciation expense		22,758			20,390			19,857
Sales to nonaffiliates		—			(16,797	)		(3,784	)
Accumulated depreciation on property acquisitions from affiliates		23,894			—			—
Other		(7,822	)		(4,790	)		(880	)
Balance at end of period	$	236,685		$	197,855		$	199,052

(1) Includes real estate held for sale.

160

SIGNATURES

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

	B.F. SAUL REAL ESTATE INVESTMENT TRUST
December 20, 2007	By:	/s/    B. FRANCIS SAUL II
		B. Francis Saul II Chairman of the Board

Pursuant to the requirements of the Securities Exchanges Act of 1934. This report had been signed below by the following persons on behalf of the registrant and in the capacities indicated on the dates shown. Each person whose signature appears below hereby constitutes and appoints Stephen R. Halpin, Jr. and John A. Spain as his attorney-in-fact and agent, with full power of substitution and resubstitution for him in any and all capacities, to sign any or all amendments to this Report and to file same, with exhibits thereto and other documents in connection therewith, granting unto such attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary in connection with such matters and hereby ratifying and confirming all that such attorney-in-fact and agent of his substitutes may do or cause to be done by virtue hereof.

Signature	Title	Date
/s/    B. FRANCIS SAUL II	Trustee, Chairman of the Board (Principal Executive	December 20, 2007
B. Francis Saul II	Officer)
/s/    STEPHEN R. HALPIN, JR.	Vice President and Chief Financial Officer (Principal	December 20, 2007
Stephen R. Halpin, Jr.	Financial Officer)
/s/    KENNETHD.SHOOP	Vice President, Treasurer and Chief Accounting	December 20, 2007
Kenneth D. Shoop	Officer (Principal Accounting Officer)
/s/    PHILIPD.CARACI	Trustee	December 20, 2007
Philip D. Caraci
/s/    GILBERT M. GROSVENOR	Trustee	December 20, 2007
Gilbert M. Grosvenor
/s/    GEORGE M. ROGERS, JR.	Trustee	December 20, 2007
George M. Rogers, Jr.
/s/    B. FRANCIS SAUL III	Trustee	December 20, 2007
B. Francis Saul III
/s/    JOHN R. WHITMORE	Trustee	December 20, 2007
John R. Whitmore

161