Saul B F Real Estate Investment Trust 10-Q 2008 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2008

OR

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

For the transition period from            to            

Commission File Number 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)

(301) 986-6000

(Registrant’s telephone number, including area code)

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

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

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	x	Smaller reporting company	¨

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

The number of Common Shares of Beneficial Interest, $1 Par Value, outstanding as of August 13, 2008, was 4,807,510.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited):
(a)	Consolidated Balance Sheets at June 30, 2008 and September 30, 2007	3
(b)	Consolidated Statements of Operations for the three and nine month periods ended June 30, 2008 and 2007	4
(c)	Consolidated Statements of Comprehensive Income and Changes in Shareholders’ Equity for the three and nine month periods ended June 30, 2008 and 2007	6
(d)	Consolidated Statements of Cash Flows for the nine month periods ended June 30, 2008 and 2007	7
(e)	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations:	19
(a)	Financial Condition	19
	Real Estate	19
	Banking	20
(b)	Liquidity and Capital Resources	27
	Real Estate	27
	Banking	29
(c)	Results of Operations
	Three months ended June 30, 2008 compared to three months ended June 30, 2007	32
	Nine months ended June 30, 2008 compared to nine months ended June 30, 2007	37
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42
Item 4.	Controls and Procedures	42
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	43
Item 1A.	Risk Factors	43
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 3.	Defaults Upon Senior Securities	43
Item 4.	Submission of Matters to a Vote of Security Holders	43
Item 5.	Other Information	43
Item 6.	Exhibits	44

2

Item 1. Financial Statements

Consolidated Balance Sheets

B. F. SAUL REAL ESTATE INVESTMENT TRUST

(In thousands, except per share and share amounts)	June 30, 2008			September 30, 2007
	(Unaudited)
ASSETS
Real Estate
Income-producing properties
Hotel	$	420,230		$	387,759
Office and industrial		267,898			265,651
Other		1,128			1,128
		689,256			654,538
Accumulated depreciation		(251,695	)		(236,685	)
		437,561			417,853
Land parcels		44,024			43,354
Construction in progress		91,656			83,756
Investment in Saul Holdings and Saul Centers		87,000			127,079
Cash and cash equivalents		10,743			8,889
Note receivable and accrued interest—related party		3,100			5,400
Other assets		69,036			65,555
Total real estate assets		743,120			751,886
Banking
Cash and other deposits		468,755			380,099
Loans held for securitization and/or sale		72,695			202,268
Investment securities (market value $212,963 and $211,745, respectively)		210,359			210,363
Mortgage-backed securities (market value $863,621 and $1,040,424, respectively)		904,684			1,053,433
Loans receivable (net of allowance for losses of $184,865 and $29,000, respectively)		11,591,039			11,637,789
Federal Home Loan Bank stock		90,058			115,327
Property and equipment, net		688,884			645,521
Goodwill and other intangible assets, net		45,125			45,425
Mortgage interest-only assets		307,236			314,111
Mortgage servicing assets		153,298			155,680
Other assets		363,770			329,047
Total banking assets		14,895,903			15,089,063
TOTAL ASSETS	$	15,639,023		$	15,840,949
LIABILITIES
Real Estate
Mortgage notes payable	$	611,176		$	579,639
Notes payable—secured		250,000			250,000
Revolving credit facilities outstanding		5,000			14,000
Other liabilities and accrued expenses		40,457			41,563
Deferred tax liability, net		46,396			37,970
Total real estate liabilities		953,029			923,172
Banking
Deposit accounts		11,240,028			10,949,577
Borrowings		639,928			563,898
Federal Home Loan Bank advances		1,445,725			2,007,274
Other liabilities		358,261			405,775
Capital notes—subordinated		175,000			175,000
Total banking liabilities		13,858,942			14,101,524
Commitments and contingencies
Minority interest held by affiliates		148,165			138,305
Minority interest—other		296,137			296,013
TOTAL LIABILITIES		15,256,273			15,459,014
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		326,490			325,675
		426,591			425,776
Less cost of 1,834,088 common shares of beneficial interest in treasury		(43,841	)		(43,841	)
TOTAL SHAREHOLDERS’ EQUITY		382,750			381,935
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	15,639,023		$	15,840,949

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

3

Consolidated Statements of Operations (Unaudited)

B. F. SAUL REAL ESTATE INVESTMENT TRUST

	For the Three Months Ended June 30,						For the Nine Months Ended June 30,
(In thousands, except per share amounts)	2008			2007			2008		2007
REAL ESTATE
Income
Hotels	$	44,042		$	42,257		$	115,700	$	110,279
Office and industrial (including $1,535, $1,586, $4,704 and $4,451 of rental income from banking segment, respectively)		11,824			11,593			35,404		31,933
Sales of townhomes		1,694			3,190			5,057		7,775
Other		189			417			560		1,355
Total income		57,749			57,457			156,721		151,342
Expenses
Direct operating expenses:
Hotels		26,155			24,539			73,666		68,620
Office and industrial properties		4,671			4,256			14,313		10,792
Land parcels and other		350			416			914		1,076
Cost of sales, townhomes		1,512			2,764			4,460		6,497
Interest and amortization of debt expense		14,736			14,090			43,497		40,298
Depreciation		6,818			5,700			18,992		16,611
Advisory, management and leasing fees—related parties		4,626			4,450			13,174		12,521
General and administrative		710			1,081			2,514		2,944
Total expenses		59,578			57,296			171,530		159,359
Equity in earnings of Saul Holdings and Saul Centers		2,581			3,117			9,183		9,156
Gain on partial sale of Saul Centers Stock		30,386			—			30,386		—
Gain on sale of land		—			—			—		—
Gain on sale of investment		—			325			2,727		1,534
REAL ESTATE OPERATING INCOME	$	31,138		$	3,603		$	27,487	$	2,673
BANKING
Interest income
Loans	$	158,369		$	187,645		$	535,521	$	549,660
Mortgage-backed securities		10,516			14,298			34,702		44,080
Other		4,620			5,839			16,569		18,119
Total interest income		173,505			207,782			586,792		611,859
Interest expense
Deposit accounts		50,075			65,328			176,392		188,629
Borrowings		15,907			30,999			76,061		95,837
Total interest expense		65,982			96,327			252,453		284,466
Net interest income		107,523			111,455			334,339		327,393
Provision (credit) for loan losses		121,382			(786	)		194,914		(1,777	)
Net interest (expense) income after provision (credit) for loan losses		(13,859	)		112,241			139,425		329,170
Other income
Deposit account servicing fees		44,400			39,581			129,553		113,497
Servicing, securitization and mortgage banking income		79,435			46,561			138,717		95,355
Asset management fees		11,219			9,876			33,453		28,308
Other		5,643			7,506			31,915		24,979
Total other income		140,697			103,524			333,638		262,139

Continued on following page.

4

Consolidated Statements of Operations (Unaudited) (Continued)

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

	For the Three Months Ended June 30,						For the Nine Months Ended June 30,
(In thousands, except per share amounts)	2008			2007			2008			2007
BANKING (Continued)
Operating expenses
Salaries and employee benefits	$	74,755		$	87,141		$	245,150		$	259,113
Servicing assets adjustments and other loan expenses		(20,388	)		21,615			23,545			72,328
Property and equipment (including $1,535, $1,586, $4,704 and $4,451 of rental expense paid to real estate segment, respectively)		19,024			17,788			56,199			48,987
Marketing		3,863			6,630			9,566			15,712
Data processing		11,880			10,557			36,483			31,846
Depreciation and amortization		12,231			11,389			36,952			39,653
Other		17,387			17,520			55,816			51,891
Total operating expenses		118,752			172,640			463,711			519,530
BANKING OPERATING INCOME	$	8,086		$	43,125		$	9,352		$	71,779
TOTAL COMPANY
Operating income	$	39,224		$	46,728		$	36,839		$	74,452
Income tax provision (benefit)		11,916			15,524			7,522			22,199
Income before minority interest		27,308			31,204			29,317			52,253
Minority interest held by affiliates		53			(4,309	)		2,096			(5,727	)
Minority interest—other		(7,341	)		(7,308	)		(21,964	)		(21,905	)
TOTAL COMPANY NET INCOME		20,020			19,587			9,449			24,621
Dividends: Real Estate Trust’s preferred shares of beneficial interest		(1,355	)		(1,355	)		(4,064	)		(4,064	)
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS	$	18,665		$	18,232		$	5,385		$	20,557
NET INCOME PER COMMON SHARE (BASIC AND DILUTED)	$	3.88		$	3.78		$	1.12		$	4.28
DISTRIBUTIONS DECLARED PER COMMON SHARE	$	0.34		$	0.34		$	1.03		$	1.03

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

5

Consolidated Statements of Comprehensive Income and Changes in Shareholders’ Equity (Unaudited)

B. F. SAUL REAL ESTATE INVESTMENT TRUST

	For the Three Months Ended June 30,						For the Nine Months Ended June 30,
(Dollars in thousands)	2008			2007			2008			2007
COMPREHENSIVE INCOME
Net income	$	20,020		$	19,587		$	9,449		$	24,621
Other comprehensive income		—			—			—			—
TOTAL COMPREHENSIVE INCOME	$	20,020		$	19,587		$	9,449		$	24,621
CHANGES IN SHAREHOLDERS’ EQUITY
PREFERRED SHARES OF BENEFICIAL INTEREST
Beginning and end of period (516,000 shares)	$	516		$	516		$	516		$	516
COMMON SHARES OF BENEFICIAL INTEREST
Beginning and end of period (6,641,598 shares)		6,642			6,642			6,642			6,642
PAID-IN SURPLUS
Beginning and end of period		92,943			92,943			92,943			92,943
RETAINED EARNINGS
Beginning of period		309,292			299,805			325,675			296,293
Net income		20,020			19,587			9,449			24,621
Adjustments:
Saul Holdings investment		179			1,278			543			4,401
Other		—			—			—			(1,917	)
Dividends:
Real Estate Trust preferred shares of beneficial interest		(1,355	)		(1,355	)		(4,064	)		(4,064	)
Real Estate Trust common shares of beneficial interest		(1,646	)		(1,646	)		(4,937	)		(4,937	)
Cumulative effect of a change in accounting principle, net of tax		—			—			(176	)		3,272
End of period		326,490			317,669			326,490			317,669
TREASURY SHARES
Beginning and end of period (1,834,088 shares)		(43,841	)		(43,841	)		(43,841	)		(43,841	)
TOTAL SHAREHOLDERS’ EQUITY	$	382,750		$	373,929		$	382,750		$	373,929

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

6

Consolidated Statements of Cash Flows (Unaudited)

B. F. SAUL REAL ESTATE INVESTMENT TRUST

	For the Nine Months Ended June 30,
(In thousands)	2008			2007
CASH FLOWS FROM OPERATING ACTIVITIES
Real Estate
Net income	$	17,835		$	1,715
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Gain on sale of investment		(2,727	)		—
Gain on partial sale of Saul Centers Stock		(30,386	)		—
Depreciation		18,992			16,611
Amortization of debt expense		1,995			1,739
Deferred tax provision		8,134			370
Gain on sale of property		—			(1,534	)
Decrease (increase) in accounts receivable and accrued income		145			(1,536	)
Increase in accounts payable and accrued expenses		9,118			6,680
Dividends and tax sharing payments		1,890			20,694
Other, net		(4,138	)		(2,940	)
		20,858			41,799
Banking
Net (loss) income		(8,386	)		22,906
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
Amortization of premiums, discounts and net deferred loan fees		12,921			27,583
Increase in income taxes payable		39,008			31,572
Depreciation and amortization		36,952			39,653
Provision (credit) for loan losses		194,914			(1,777	)
Minority interest held by affiliates		(2,096	)		5,727
Minority interest—other		7,500			7,500
Proceeds from sales of trading securities		248,539			166,234
Purchases and net fundings of loans held for securitization and/or sale		(1,348,081	)		(3,961,069	)
Proceeds from sales of loans held for securitization and/or sale		1,147,426			3,012,629
Decrease in mortgage interest-only assets		6,875			37,776
Decrease in mortgage servicing assets		2,382			10,317
(Increase) decrease in other assets		(21,489	)		5,332
Increase (decrease) in other liabilities		(86,524	)		20,460
Other		(666	)		447
		229,275			(574,710	)
Net cash provided by (used in) operating activities		250,133			(532,911	)
CASH FLOWS FROM INVESTING ACTIVITIES
Real Estate
Property acquisitions		—			(47,187	)
Development/redevelopment expenditures, net of $4,064 and $5,953, respectively allocated to cost of sales in 2008 and 2007		(43,191	)		(42,950	)
Capital expenditures		(14,960	)		(11,705	)
Property sales, net		—			1,810
Net repayments, note receivable—related party		2,300			4,600
Capital contribution to Bank		(48,000	)		—
Saul Centers stock sale proceeds, net		66,772			—
Distributions in excess of equity in earnings from Saul Holdings and Saul Centers		4,531			2,787
Purchases of Saul Holdings and Saul Centers		—			(28,358	)
Proceeds from other investments		5,870			—
Purchases of other investments		(5,036	)		(65	)
		(31,714	)		(121,068	)
Banking
Purchases of investment securities		—			(8,350	)
Proceeds from redemption of Federal Home Loan Bank Stock		219,007			215,953
Purchases of Federal Home Loan Bank Stock		(193,738	)		(224,333	)
Net principal collected on loans		2,997,304			3,582,299
Net fundings and purchases of loans receivable		(3,138,574	)		(3,391,753	)
Proceeds from sales of loans transferred to loans held for securitization and/or sale		—			2,052
Principal collected on mortgage-backed securities		146,450			148,258
Purchases of mortgage-backed securities		(1,028	)		(37,426	)
Proceeds from sales of automobiles subject to lease		6,071			38,625
Net purchases of property and equipment		(81,710	)		(87,514	)
Net proceeds from sales of property and equipment		2,139			26,433
Net proceeds from sales of real estate		53,392			12,226
Disbursements for real estate held for sale		(7,365	)		(10,680	)
Other		—			(5,151	)
		1,948			260,639
Net cash (used in) provided by investing activities		(29,766	)		139,571

Continued on following page.

7

Consolidated Statements of Cash Flows (Unaudited) (Continued)

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

	For the Nine Months Ended June 30,
(In thousands)	2008			2007
CASH FLOWS FROM FINANCING ACTIVITIES
Real Estate
Net repayments on secured revolving credit facilities	$	(9,000	)	$	—
Proceeds from mortgage financings		57,468			94,051
Principal curtailments and repayments of mortgages		(25,931	)		(25,167	)
Repayments of unsecured notes		—			(21,398	)
Costs of obtaining financings		(826	)		(2,283	)
Cash dividends paid on preferred stock		(4,064	)		(4,064	)
Cash dividends paid on common stock		(4,937	)		(4,937	)
		12,710			36,202
Banking
Proceeds from customer deposits and issuance of certificates of deposit		80,534,679			70,708,716
Customer withdrawals of deposits and payments for maturing certificates of deposit		(80,244,228	)		(70,164,687	)
Advances from the Federal Home Loan Bank		14,698,680			10,977,003
Repayments of advances from the Federal Home Loan Bank		(15,260,228	)		(10,790,787	)
Net increase (decrease) in other borrowings		76,030			(305,145	)
Capital contribution from parent companies		60,000			9,995
Cash dividends paid on preferred stock		(7,500	)		(7,500	)
Cash dividends paid on common stock		—			(20,000	)
		(142,567	)		407,595
Net cash (used in) provided by financing activities		(129,857	)		443,797
Net increase in cash and cash equivalents		90,510			50,457
Cash and cash equivalents at beginning of period		388,988			456,579
Cash and cash equivalents at end of period	$	479,498		$	507,036
Components of cash and cash equivalents at end of period as presented in the consolidated balance sheets:
Real Estate
Cash and cash equivalents	$	10,743		$	3,324
Banking
Cash and other deposits		468,755			503,712
Cash and cash equivalents at end of period	$	479,498		$	507,036
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest, net	$	298,971		$	317,411
Income taxes, net		50,296			(1,374	)
Shares of Saul Centers, Inc. common stock		—			28,358
Cash received during the period from:
Dividends on shares of Saul Centers, Inc. common stock		7,541			6,340
Distributions from Saul Holdings Limited Partnership		6,173			5,603
Supplemental disclosures of noncash activities:
Loans held for sale and/or securitization exchanged for trading securities		248,218			165,561
Loans receivable transferred to real estate acquired in settlement of loans		79,595			12,014
Loans held for sale and/or securitization transferred to loans receivable		4,353			—

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

8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. GENERAL:

The Trust has prepared its financial statements and other disclosures on a fully consolidated basis. The term “Trust” used in the text and the financial statements included herein refers to the consolidated entity, which includes B.F. Saul Real Estate Investment Trust and its subsidiaries, including Chevy Chase Bank, F.S.B. and its subsidiaries (“Chevy Chase” or the “Bank”). “Real Estate Trust” refers to B.F. Saul Real Estate Investment Trust and its subsidiaries, excluding Chevy Chase and Chevy Chase’s subsidiaries. The operations conducted by the Real Estate Trust are designated as “Real Estate,” while the business conducted by the Bank and its subsidiaries is identified by the term “Banking.” In the opinion of management, the consolidated financial statements reflect all adjustments necessary for a fair presentation of the Trust’s financial position and results of operations. All such adjustments are of a normal recurring nature. These financial statements and the accompanying notes should be read in conjunction with the Trust’s audited consolidated financial statements included in its Form 10-K for the fiscal year ended September 30, 2007. The results of operations for interim periods are not necessarily indicative of results to be expected for the year.

Certain reclassifications of prior periods’ information have been made to conform to the presentation for the nine months ended June 30, 2008, to ensure comparability of all periods presented.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

The following accounting policies should be read in conjunction with the Trust’s audited consolidated financial statements and the accompanying notes included in its Form 10-K for the fiscal year ended September 30, 2007.

REAL ESTATE INVESTMENT PROPERTIES

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.

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 June 30, 2008 and September 30, 2007, 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.

9

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):

Interest, real estate taxes and other carrying costs are capitalized on projects under development and construction. Once construction is substantially completed the assets are placed in service, their operating income, operating expenses, consisting mainly of real estate taxes, payroll, repairs and maintenance, utilities, insurance, franchise, marketing and other property related expenses and depreciation are included in current operations. Property operating expenses are charged to operations as incurred. Interest expense capitalized during the nine-month periods ended June 30, 2008 and 2007 totaled $549,000 and $1.5 million, respectively.

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 balance as of June 30, 2008 and September 30, 2007 is as follows:

Construction in Progress

(In thousands)	June 30, 2008		September 30, 2007
Tysons Park Place II	$	69,144	$	34,348
Circle 75 Townhomes		15,410		18,525
Circle 75 Infrastructure		7,102		7,066
Dulles Hampton Inn & Suites		—		23,817
Total	$	91,656	$	83,756

Construction of the Dulles Hampton Inn & Suites was substantially completed and the project was placed in service on October 18, 2007.

Construction of the Circle 75 Townhomes and Infrastructure were substantially complete as of January 1, 2008. Additional finishing costs will be incurred for the remaining townhomes upon execution of sales contracts.

The decrease in the Circle 75 Townhomes results from costs being expensed upon the sale of townhome units.

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”, 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.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

REAL ESTATE TRUST

On December 4, 2007, the FASB issued FAS No. 141 (Revised 2007), “Business Combinations” (“FAS No. 141(R)”). FAS No. 141(R) will change the accounting for business combinations. Under FAS 141(R), an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. FAS No. 141(R) also includes a substantial number of new disclosure requirements. FAS No. 141(R) applies prospectively to business combinations occurring during fiscal years beginning on or after December 15, 2008, which for the Real Estate Trust begins with the fiscal year ending September 30, 2010. FAS No. 141(R) will impact the Real Estate Trust’s financial statements depending on the level of acquisition activity in fiscal 2010 and beyond.

BANKING

In March 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”) effective for fiscal years and interim

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periods beginning after November 15, 2008. SFAS 161 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” to improve the transparency of financial reporting for derivative and hedging activities. SFAS 161 illustrates how derivative instruments affect an entity’s cash flows, financial performance and financial position. The Bank has not yet determined the impact, if any, of the adoption of SFAS 161 on the Bank’s financial condition or results of operations.

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interest in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. SFAS 160 establishes consistent accounting and reporting standards for the non-controlling (or minority) interest in a subsidiary and for the deconsolidation of a subsidiary. Management does not expect the adoption of SFAS 160 to have a material impact on the Bank’s financial condition or results of operations.

In February 2007, the FASB issued 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. The Bank has not decided for which assets, if any, it will elect fair value treatment.

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 are required to recognize contract-based values at their net present value. EITF 06-5 was effective for the Bank on October 1, 2007. The impact of the adoption was $220,000 and was recorded as a cumulative-effect adjustment to retained earnings on October 1, 2007.

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 SFAS 157 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 was effective for the Bank on October 1, 2007. The adoption of FIN 48 did not have a material impact on the Bank’s financial condition or results of operations.

3. CONSOLIDATED FINANCIAL STATEMENTS:

The accompanying financial statements include the accounts of the Real Estate Trust, which is involved in the ownership and development of income-producing properties. The accounts of the Bank have also been consolidated. Accordingly, the accompanying financial statements reflect the assets, liabilities, operating results and cash flows for two business operations: Real Estate and Banking. All significant inter-company transactions, except as disclosed elsewhere in the financial statements, have been eliminated in consolidation. Tax sharing and dividend payments between the Real Estate Trust and the Bank are presented gross in the Consolidated Statements of Cash Flows. For purposes of calculating primary and diluted earnings per share, weighted average common shares outstanding totaled 4,807,510 for all periods presented. The Trust has no common share equivalents. On January 17, 2008, the Trust declared a dividend on its common shares of $0.248 per share, totaling approximately $1.2 million, payable on January 18, 2008, to holders of record on December 31, 2007. On March 6, 2008, the Trust declared a dividend on its common shares of $0.436 per share, totaling approximately $2.1 million, payable on March 7, 2008, to holders of record on March 6, 2008. On June 19, 2008, the Trust declared a dividend on its common shares of $0.342 per share, totaling approximately $1.6 million, payable on June 20, 2008, to holders of record on June 19, 2008.

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4. TAXES:

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

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 current fiscal year. The Trust has evaluated the impact that FIN 48 has on the Trust’s financial statements, and as of October 1, 2007, has determined that the adoption of FIN 48 did not have a material impact on its financial condition or results of operations. Further, as of June 30, 2008, the Trust had no material unrecognized tax benefits. The Real Estate Trust recognizes penalties and interest accrued to unrecognized tax benefits, if any, as general and administrative expense, the Bank recognizes penalties and interest accrued to unrecognized tax benefits, if any, as other operating expense. With certain exceptions, the Trust is no longer subject to U.S. federal, state and local tax examinations by tax authorities for fiscal years before September 30, 2004.

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

As of June 30, 2008 the Real Estate Trust owned approximately 3,848,000 shares of Saul Centers, Inc. (“Saul Centers”), representing 21.6% of such company’s outstanding common stock. As of June 30, 2008, the market value of the total shares was approximately $181.0 million. The majority of these shares have been pledged as collateral with the Real Estate Trust’s credit line banks. During the nine-month period ended June 30, 2008, the Real Estate Trust received dividends of $7.5 million from Saul Centers. During the quarter ended June 30, 2008, the Real Estate Trust, through an underwritten public offering, sold 1.5 million shares of Saul Centers common stock, realizing proceeds of approximately $67.0 million and a gain of approximately $30.4 million.

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 million of mortgage debt and deferred interest associated with such properties, to a newly formed partnership, Saul Holdings Limited Partnership (“Saul Holdings Partnership”), in which as of June 30, 2008 the Real Estate Trust owns (directly and through its wholly owned subsidiaries) a 18.8% common limited partner interest in the form of units, other entities affiliated with the Real Estate Trust own a 4.5% common limited partner interest in the form of units and Saul Centers owns a 76.7% common general partner interest and a 100% preferred general partner interest. Under the Saul Holdings Partnership agreement, the limited partnership units are generally convertible on a one-for-one basis into common stock of Saul Centers. However, most of the units were not convertible as of June 30, 2008 because the conversion would cause the Real Estate Trust and certain affiliates of the Real Estate Trust to exceed the ownership limitation under Saul Centers articles of incorporation, which restricts the value of Saul Centers issued and outstanding equity securities the Real Estate Trust and affiliates 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 Partnership provides for quarterly distributions to the partners out of net cash flow. During the nine-month period ended June 30 2008, the Real Estate Trust received total cash distributions of $6.2 million from Saul Holdings Partnership. Substantially all of the Real Estate Trust’s ownership interest in Saul Holdings Partnership has been pledged as collateral with the Real Estate Trust’s credit line banks.

Pursuant to a reimbursement agreement among the partners of Saul Holdings Partnership and its subsidiary limited partnerships (collectively, the “Partnerships”), the Real Estate Trust and its subsidiaries that are partners in the Partnerships agreed to reimburse Saul Centers and the other partners in the event the Partnerships fail to make payments with respect to certain portions of the Partnerships’ debt obligations and Saul Centers or any such other partners personally make payments with respect to such debt obligations. At June 30, 2008, 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 the Saul Holdings Partnership will be able to make all payments due with respect to its debt obligations.

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5. INVESTMENT IN SAUL CENTERS INC. AND SAUL HOLDINGS LIMITED PARTNERSHIP – REAL ESTATE TRUST (Continued):

The unaudited condensed Consolidated Balance Sheets as of June 30, 2008 and September 30, 2007, and the unaudited Consolidated Statements of Operations for the six month period ended June 30, 2008 and 2007 of Saul Centers, Inc. follow:

SAUL CENTERS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)	June 30, 2008			September 30, 2007
Assets
Real estate investments	$	994,300		$	881,646
Accumulated depreciation		(244,196	)		(229,055	)
Other assets		101,935			72,432
Total assets	$	852,039		$	725,023
Liabilities and stockholders’ equity
Mortgage notes payable	$	565,194		$	528,604
Other liabilities		57,597			42,798
Total liabilities		622,791			571,402
Minority interests		3,747			5,091
Total stockholders’ equity		225,501			148,530
Total liabilities and stockholders’ equity	$	852,039		$	725,023

SAUL CENTERS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the Nine Months (1) Ended June 30,
(In thousands)	2008			2007
Revenue
Base rent	$	92,323		$	86,847
Other revenue		25,314			22,817
Total revenue		117,637			109,664
Expenses
Operating expenses		26,616			23,936
Interest and amortization of deferred debt expense		26,048			24,917
Depreciation and amortization		20,920			19,360
General and administrative		9,465			8,377
Total expenses		83,049			76,590
Operating income before minority interests and gain on sale of property		34,588			33,074
Gain on sale of property		344			—
Net operating income before minority interests		34,932			33,074
Minority interests		(6,294	)		(6,419	)
Net income		28,638			26,655
Preferred dividends		(7,883	)		(6,000	)
Net income available to common shareholders	$	20,755		$	20,655

(1) Saul Center’s year end is December 31. These statements of operations are computed by combining Saul Center’s 2007 fourth quarter and 2008 first and second quarter results.

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6. RELATED PARTY TRANSACTIONS – REAL ESTATE TRUST:

Under an existing unsecured note receivable from B.F. Saul Company, which was modified and amended on October 1, 2005, not to exceed $30.0 million, the Real Estate Trust received net curtailments of $2.3 million during the nine-month period ended June 30, 2008. At June 30, 2008 and September 30, 2007, the note balance totaled $3.1 million and $5.4 million, respectively. Interest is computed on the note at 200 basis points over a floating rate index. Interest earned on the note totaled $101,000 and $442,000 for the nine-month periods ended June 30, 2008 and 2007, respectively. The note is due and payable on September 30, 2015.

7. REAL ESTATE SOLD – REAL ESTATE TRUST:

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 six-month period ended March 31, 2007. The initial gain on this condemnation of $2.7 million was recorded in fiscal 2004.

8. GAIN ON SALE OF INVESTMENT – REAL ESTATE TRUST:

During the quarter ended June 30, 2008, the Real Estate Trust, through an underwritten public offering, sold 1.5 million shares of Saul Centers common stock, realizing proceeds of approximately $67.0 million and a gain of approximately $30.4 million.

During the quarter ended December 31, 2007, the Real Estate Trust redeemed an equity investment which resulted in a gain of approximately $2.7 million. Redemption proceeds of approximately $5.0 million were received in January 2008. The Real Estate Trust received additional final redemption proceeds of approximately $255,000 in April 2008. The Real Estate Trust’s other equity investments are included in Other Assets on the Balance Sheet.

9. MORTGAGE NOTES PAYABLE/SECURED REVOLVING CREDIT FACILITIES – REAL ESTATE TRUST:

The Real Estate Trust has a $75.0 million secured revolving credit line with an unrelated bank that matures on 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 at 150 basis points over the index. At June 30, 2008, the Real Estate Trust had no outstanding borrowings and unrestricted availability of $75.0 million.

The Real Estate Trust has an additional $75.0 million revolving credit line with an unrelated bank that matures on June 30, 2010, with provisions for extending the term for an additional year. This facility is also 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 at 150 basis points over the index. At June 30, 2008, the Real Estate Trust had $5.0 million in outstanding borrowings and unrestricted availability of $65.0 million. The Real Estate Trust was issued a $6.0 million letter of credit, which was reduced to $5.0 million during the quarter ended June 30, 2008, for the benefit of a mortgage lender as part of one of the mortgage financings completed during the quarter ended June 30, 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.

The Real Estate Trust has 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 bears 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 $34.8 million during the nine-month period ended June 30, 2008, bringing the balance outstanding under this loan at June 30, 2008 to $61.5 million.

On April 4, 2008, the Real Estate Trust closed on a $16.0 million mortgage note secured by the Dulles Hampton Inn & Suites. The note, which is due on April 15, 2023, bears interest at 6.5% and requires monthly interest only payments for the initial twelve months. Beginning in year two, monthly principal and interest payments of $108,034 are required with a balloon payment of $10.3 million due at maturity. The proceeds from the financing, along with approximately $4.7 million drawn from the revolving credit facilities were used to pay off the property’s outstanding $20.3 million construction loan which was used to finance the construction of the hotel. The Real Estate Trust received loan draws of $6.6 million on the construction loan during the nine-month period ended June 30, 2008.

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10. 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.

	Three Months Ended June 30,						Nine Months Ended June 30,
(In thousands)	2008			2007			2008			2007
INCOME
Hotels	$	44,042		$	42,257		$	115,700		$	110,279
Office and industrial properties		11,824			11,593			35,404			31,933
Residential		1,694			3,190			5,057			7,775
Other		189			417			560			1,355
	$	57,749		$	57,457		$	156,721		$	151,342
OPERATING INCOME (1)
Hotels	$	13,768		$	14,357		$	30,656		$	31,642
Office and industrial properties		4,460			5,004			13,494			14,564
Residential		182			426			597			1,278
Other		(167	)		(5	)		(371	)		262
		18,243			19,782			44,376			47,746
Equity in earnings of Saul Holdings and Saul Centers		2,581			3,117			9,183			9,156
Gain on partial sale of Saul Centers stock		30,386			—			30,386			—
Gain on sale of property		—			325			2,727			1,534
Interest and amortization of debt expense		(14,736	)		(14,090	)		(43,497	)		(40,298	)
Advisory, management and leasing fees—related parties		(4,626	)		(4,450	)		(13,174	)		(12,521	)
General and administrative		(710	)		(1,081	)		(2,514	)		(2,944	)
Operating income	$	31,138		$	3,603		$	27,487		$	2,673
INTEREST AND AMORTIZATION OF DEBT EXPENSE
Hotels	$	5,328		$	5,183		$	15,833		$	14,795
Office and industrial properties		3,700			3,541			11,958			10,526
Other		5,708			5,366			15,706			14,977
	$	14,736		$	14,090		$	43,497		$	40,298
DEPRECIATION
Hotels	$	4,119		$	3,361		$	11,378		$	10,017
Office and industrial properties		2,693			2,333			7,597			6,577
Other		6			6			17			17
	$	6,818		$	5,700		$	18,992		$	16,611
CAPITAL EXPENDITURES AND PROPERTY ACQUISITIONS
Hotels	$	2,894		$	9,214		$	18,404		$	28,019
Office and industrial properties		13,374			5,803			41,498			61,867
Residential, net of cost of goods sold		(575	)		1,287			(2,423	)		10,702
Other		97			500			672			1,254
	$	15,790		$	16,804		$	58,151		$	101,842
IDENTIFIABLE ASSETS (AT PERIOD END)
Hotels							$	328,983		$	319,022
Office and industrial properties								165,170			192,136
Residential								22,522			26,010
Other								226,445			185,405
							$	743,120		$	722,573

(1) Operating income includes income less direct operating expenses, cost of sales and depreciation.

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11. LOANS HELD FOR SECURITIZATION AND/OR SALE-THE BANK:

At June 30, 2008, loans held for securitization and/or sale were composed of single-family residential loans totaling $72.7 million. At September 30, 2007, loans held for securitization and/or sale were composed of single-family residential loans totaling $202.2 million and automobile loans totaling $108,000.

12. LOANS RECEIVABLE – THE BANK:

Loans receivable is composed of the following:

(In thousands)	June 30, 2008			September 30, 2007
Single-family residential	$	8,112,058		$	8,044,052
Home equity		1,475,303			1,583,170
Single-family/construction to permanent		427,778			457,446
Other real estate		374,059			357,265
Commercial		1,007,163			935,999
Automobile		223,337			128,823
Other consumer		43,167			43,818
		11,662,865			11,550,573
Deferred loan origination costs, net of unearned discounts		113,039			116,216
Allowance for losses on loans		(184,865	)		(29,000	)
		(71,826	)		87,216
Total	$	11,591,039		$	11,637,789

Cumulative deferred interest totaled $152.6 million and $93.3 million at June 30, 2008 and September 30, 2007, respectively.

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13. BUSINESS SEGMENT – 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.

(In thousands)	Retail Banking			Commercial Banking			Asset Management			Total
Three Months Ended June 30, 2008
Core operating income	$	170,437		$	12,062		$	11,232		$	193,731
Core operating expense		103,154			7,657			9,513			120,324
Core earnings		67,283			4,405			1,719			73,407
Non-core items		(63,985	)		(1,243	)		(93	)		(65,321	)
Operating income	$	3,298		$	3,162		$	1,626		$	8,086
Average assets	$	13,365,558		$	1,529,422		$	65,320		$	14,960,300

	Retail Banking		Commercial Banking		Asset Management			Total
Three Months Ended June 30, 2007
Core operating income	$	193,927	$	12,440	$	9,899		$	216,266
Core operating expense		157,158		7,774		8,673			173,605
Core earnings		36,769		4,666		1,226			42,661
Non-core items		501		66		(103	)		464
Operating income	$	37,270	$	4,732	$	1,123		$	43,125
Average assets	$	13,225,147	$	1,398,984	$	54,473		$	14,678,604

(In thousands)	Retail Banking			Commercial Banking			Asset Management			Total
Nine Months Ended June 30, 2008
Core operating income	$	510,277		$	37,480		$	33,501		$	581,258
Core operating expense		415,128			23,765			29,158			468,051
Core earnings		95,149			13,715			4,343			113,207
Non-core items		(101,997	)		(1,577	)		(281	)		(103,855	)
Operating (loss) income	$	(6,848	)	$	12,138		$	4,062		$	9,352
Average assets	$	13,570,079		$	1,474,241		$	64,170		$	15,108,490

	Retail Banking		Commercial Banking		Asset Management			Total
Nine Months Ended June 30, 2007
Core operating income	$	525,718	$	39,264	$	28,366		$	593,348
Core operating expense		474,635		23,335		26,325			524,295
Core earnings		51,083		15,929		2,041			69,053
Non-core items		2,579		459		(312	)		2,726
Operating income	$	53,662	$	16,388	$	1,729		$	71,779
Average assets	$	13,113,400	$	1,407,864	$	54,814		$	14,576,078

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

14. LITIGATION – THE BANK:

In 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 the litigation in which the Bank is a defendant may be material, the Bank denies liability and, in the opinion of management, litigation currently pending will not have a material impact on the financial condition or future operations of the Bank.

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.

18

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

The principal business activities of the Real Estate Trust are the ownership of 80% of the outstanding common stock of the Bank, whose assets accounted for 95% of the Trust’s consolidated assets at June 30, 2008, and the ownership and development of income-producing properties. By virtue of its ownership of a majority interest in the Bank, the Trust is a savings and loan holding company and subject to regulation, examination and supervision by the OTS.

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

FINANCIAL CONDITION

REAL ESTATE

The Real Estate Trust’s investment portfolio at June 30, 2008, consisted primarily of hotels, office projects, and land parcels. At June 30, 2008, the Real Estate Trust’s hotel portfolio, including the January 2007 and October 2007 newly constructed hotels, is comprised of 19 properties containing 3,438 available rooms. The office property portfolio consisted of 15 properties with a total gross leasable area of 2,170,000 square feet.

The hotel portfolio, excluding the newly constructed properties placed in service in January 2007 and October 2007, (“Same hotel properties – nine month period”) experienced an average occupancy of 68.6% and an average room rate of $142.69 during the nine-month period ended June 30, 2008, compared to an average occupancy of 72.1% and an average room rate of $138.68 during the same period in the prior year. REVPAR (revenue per available room) was $97.91 for the nine-month period ended June 30, 2008, a 2.1% decrease from REVPAR for the nine-month period ended June 30, 2007 of $100.06.

Office space in the Real Estate Trust’s office property portfolio was 90.1% leased at June 30, 2008, compared to a leasing rate of 88.1% at June 30, 2007. The majority of the increase is due to the re-leasing of an approximately 100,000 square foot, single tenant, building as of June 30, 2008. The prior tenant vacated this space on March 31, 2007. Rental income from this space commenced during the quarter ended June 30, 2008. At June 30, 2008, of the total gross leasable area of 2,170,000 square feet, 119,829 square feet (5.5%) and 355,167 square feet (16.4%) were subject to leases expiring in the remainder of fiscal 2008 and fiscal 2009, respectively.

19

BANKING

General. The Bank’s assets decreased by $216.6 million during the current quarter to $14.9 billion at June 30, 2008. The Bank recorded operating income $8.1 million during the quarter ended June 30, 2008, compared to operating income of $43.1 million during the quarter ended June 30, 2007. The decrease in operating income during the current quarter reflects a significant increase in the provision for loan losses, which was partially offset by an increase in servicing, securitization and mortgage banking income and a decrease in servicing assets adjustments and other loan expenses. The Bank recorded fair value write-ups of $57.6 million and $29.7 million on its interest-only assets and mortgage servicing assets, respectively, reflecting reduced actual and estimated prepayment speeds on mortgage loans caused by liquidity issues in the primary mortgage markets. Due to continuing adverse market conditions, the Bank did not securitize any residential mortgage loans in the quarter ended June 30, 2008. However, during the quarter ended June 30, 2008, the Bank sold $455.5 million of residential mortgage loans and recognized gains of $4.2 million. During the quarter ended June 30, 2007, the Bank securitized and/or sold $1.2 billion of loans and recognized gains of $20.5 million.

At June 30, 2008, the Bank’s tangible, core, tier 1 risk-based and total risk-based regulatory capital ratios were 6.38%, 6.38%, 9.29% and 12.47%, respectively. The Bank’s regulatory capital ratios exceeded regulatory requirements as well as the standards established for “well-capitalized” institutions under the prompt corrective action regulations issued pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”). See “Capital.”

During the quarter ended June 30, 2008, the Bank declared and paid a cash dividend on its Preferred Stock in the amount of $2.5 million. The Bank did not pay any dividends on its common stock during the quarter ended June 30, 2008.

Recent Developments

The ongoing turmoil in the credit markets and difficult conditions in the U.S. housing markets continued throughout the quarter ended June 30, 2008, and together with weak overall economic conditions, continues to negatively affect the Bank and its operations. Deteriorating conditions in the housing market and the general economy have contributed to increases in the Bank’s levels of delinquent and non-performing assets, charge-offs and the allowance for possible credit losses. During the quarter ended June 30, 2008, non-performing assets increased $190.8 million (63.5%) from the March quarter. As a result, management increased the allowance for possible credit losses by $100.8 million to $184.9 million. To the extent current housing market and general economic conditions continue or worsen, the Bank’s level of problem assets and credit losses are likely to increase.

In prior periods, the Bank securitized and sold a portion of the loans it originated. Since July 2007, as a result of a weak secondary market for mortgage loans, the Bank has been retaining in its own portfolio most of the adjustable rate loans it originates, while continuing to originate and sell in the secondary market all fixed and some adjustable rate loans.

Management has taken steps that it believes will help position the Bank to operate successfully in the current environment. These steps include efforts to reduce the Bank’s volume of loan originations, particularly residential mortgage loans originated through third-party or correspondent distribution channels by, for example, tightening its loan underwriting guidelines, limiting extended hours in certain retail deposit branches, revising certain fees and reducing staffing levels to reflect decreased hours and lower loan production. In addition, the Bank stopped originating payment option mortgage loans and residential construction to permanent loans in April 2008.

The Bank also has significantly increased its loan loss reserves in recent periods which, together with a $60 million cash capital contribution received by the Bank from its common stockholders on June 11, 2008, also should help position the Bank to operate successfully in the current difficult market conditions.

Based on a review of customer preferences, the Bank has decided not to exercise its option to extend its 10-year supermarket branch agreement with Giant Food, and will begin closing its 54 supermarket deposit branches in August 2008, resulting in additional cost savings. Because in most cases the Bank already has a traditional branch within two miles of a supermarket branch and offers a variety of self-service banking channels, such as online and telephone banking, management expects to be able to continue to serve the needs of the vast majority of supermarket branch depositors following closure of the supermarket branches.

20

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

Non-Performing Assets

(Dollars in thousands)

	June 30, 2008			March 31, 2008			September 30, 2007
Non-performing assets:
Non-accrual loans:
Residential mortgage	$	375,699		$	213,801		$	76,675
Home equity		10,004			10,143			5,559
Single-family/construction to permanent		34,390			20,844			3,972
Commercial		2,280			2,063			571
Other consumer		599			628			337
Total non-accrual loans (1)		422,972			247,479			87,114
Real estate acquired in settlement of loans		68,375			53,090			48,443
Total non-performing assets	$	491,347		$	300,569		$	135,557
Allowance for losses on loans	$	184,865		$	84,065		$	29,000
Ratios:
Non-accrual loans to total assets		2.84	%		1.64	%		0.58	%
Non-performing assets to total assets		3.30	%		1.99	%		0.90	%
Allowance for losses on loans to non-accrual loans (1)		43.71	%		33.97	%		33.29	%
Allowance for losses on loans to total loans receivable (2)		1.56	%		0.70	%		0.24	%

(1) Before deduction of allowances for losses.

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

Non-performing assets 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 increased to $491.3 million at June 30, 2008, from $300.6 million at March 31, 2008. The significant increase is concentrated in residential mortgage and, to a lesser extent, single-family/construction to permanent loans, and is due primarily to the continued softening in the housing market. Non-performing assets are likely to continue to 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 declining property values have reduced the ability of many borrowers to refinance their debt.

21

Delinquent Loans. At June 30, 2008, delinquent loans decreased to $195.4 million, or 1.7% of total loans, from $223.3 million, or 1.9% of total loans, at March 31, 2008. The following table sets forth information regarding the Bank’s delinquent loans at June 30, 2008.

		Principal Balance (Dollars in thousands) Loans Delinquent for
		30-59 days			60-89 days			Total
Residential mortgage		$	115,599		$	59,436		$	175,035
Home equity			8,849			3,595			12,444
Single-family/construction to permanent			795			2,667			3,462
Other real estate			—			—			—
Commercial			590			—			590
Other Consumer			2,592			1,303			3,895
	��
Total		$	128,425		$	67,001		$	195,426
Total as a Percentage of Loans(1)			1.1	%		0.6	%		1.7	%

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

Residential mortgage loans delinquent 30-89 days decreased to $175.0 million (286 loans) at June 30, 2008 from $183.8 million (319 loans) at March 31, 2008. The ratio of the number of delinquent mortgage loans to the total number of mortgage loans was 1.6% at June 30, 2008, a decrease from 1.8% at March 31, 2008. Home equity loans delinquent 30-89 days decreased to $12.4 million at June 30, 2008 from $16.5 million at March 31, 2008. Single-family/construction to permanent loans delinquent 30-89 days decreased to $3.5 million at June 30, 2008 from $19.0 million at March 31, 2008.

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 assets which 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 decreased to $2.8 million at June 30, 2008, compared to $3.7 million at March 31, 2008, primarily as a result of one commercial loan with a book value of $0.8 million which was reclassified to a non-accrual asset during the quarter ended June 30, 2008.

Troubled Debt Restructurings (“TDR”). At June 30, 2008, the Bank had four residential mortgage loans with an aggregate book balance of $2.6 million classified as troubled debt restructurings. In conjunction with its loan modification program, the Bank expects TDRs to increase in future periods.

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.” During the quarter ended June 30, 2008, the Bank recognized $17.7 million of interest income when borrowers made payments less than the amount of interest accrued, some of which was subsequently paid. As of June 30, 2008 and March 31, 2008, cumulative net deferred interest, which is included in loans receivable, totaled $152.6 million and $142.0 million, respectively.

The following table summarizes deferred interest activity:

	Three Months Ended June 30,						Nine Months Ended June 30,
	2008			2007			2008			2007
	(Dollars in thousands)
Balance at beginning of period	$	142,007		$	58,695		$	93,320		$	32,797
Additions		17,684			23,033			77,650			65,468
Sales		—			(3,441	)		—			(11,528	)
Repayments		(1,979	)		(334	)		(3,767	)		(962	)
Payoffs		(5,150	)		(5,811	)		(14,641	)		(13,633	)
Balance at end of period	$	152,562		$	72,142		$	152,562		$	72,142

22

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

Analysis of Allowance for and Charge-offs of Loans

(Dollars in thousands)

	Nine Months Ended June 30,						Three Months Ended June 30, 2008
	2008			2007
Balance at beginning of period	$	29,000		$	25,000		$	84,065
Provision (credit) for loan losses		194,914			(1,777	)		121,382
Charge-offs:
Residential mortgage		(26,548	)		(1,510	)		(14,057	)
Home equity		(12,314	)		(889	)		(5,828	)
Single-family/construction to permanent		(730	)		(301	)		(535	)
Commercial		(134	)		—			(60	)
Automobile		(1,094	)		(785	)		(399	)
Other consumer		(1,268	)		(1,155	)		(541	)
Total charge-offs		(42,088	)		(4,640	)		(21,420	)
Recoveries:
Home equity		242			130			89
Commercial		66			534			9
Automobile		2,094			4,652			552
Other consumer		637			1,101			188
Total recoveries		3,039			6,417			838
Net (charge-offs) recoveries		(39,049	)		1,777			(20,582	)
Balance at end of period	$	184,865		$	25,000		$	184,865
Provision (credit) for loan losses to average loans(1) (2)		2.19	%		(0.02	%)		4.10	%
Net loan charge-offs (recoveries) to average loans(1) (2)		0.44	%		(0.02	%)		0.70	%
Ending allowance for losses on loans to total loans(2) (3)		1.56	%		0.22	%		1.56	%

(1) Annualized

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

(3) Before deduction of allowance for losses.

Components of Allowance for Losses on Loans by Type

(Dollars in thousands)

	June 30, 2008				September 30, 2007
	Amount		Percent of Loans to Total Loans		Amount		Percent of Loans to Total Loans
Balance at end of period allocated to:
Residential mortgage	$	143,625	69.7	%	$	11,000	70.1	%
Home equity		13,730	12.6			3,400	13.5
Single-family/construction to permanent		12,905	3.6			850	3.9
Other real estate		1,547	3.2			1,373	3.0
Commercial		3,103	8.6			2,827	8.0
Automobile		1,100	1.9			950	1.1
Other Consumer		1,755	0.4			1,500	0.4
Unallocated		7,100	—			7,100	—
Total	$	184,865			$	29,000

23

At June 30, 2008, the Bank’s allowances for losses on loans totaled $184.9 million, an increase of $100.8 million from the level at March 31, 2008. The allowance for losses on loans represents management’s estimate of credit losses inherent in the Bank’s loan portfolio as of the balance sheet date. The Bank’s allowance consists of several key elements, which include the allocated allowance, specific allowances for identified potential problem loans, if any, and the unallocated allowance. Management reviews the adequacy of the allowance on loans using a variety of measures and tools including historical loss performance, delinquency status, current economic conditions, internal risk ratings and current underwriting policies and procedures.

The allowance for losses on residential mortgage loans was $143.6 million at June 30, 2008, an increase of $88.2 million from the level at March 31, 2008. Management employs various techniques and makes various assumptions when reviewing the residential mortgage loan portfolio to estimate the amount of inherent losses. These techniques and assumptions include, but are not limited to, the Bank’s historical loss experience on foreclosed real estate, the rate at which delinquent loans become more severely delinquent, changes in regional housing values, and changes in values of collateral securing individual loans. The estimated amount of inherent losses increased in the June quarter as a result of increases in the amount of non-accrual loans and also because of the continued decline in residential housing values. The allowance for losses on loans secured by real estate totaled $171.8 million at June 30, 2008, approximately 40.9% of total non-accrual real estate loans. During the three months ended June 30, 2008, the Bank recorded net charge-offs of $20.3 million on these assets, compared to net charge-offs of $0.6 million during the three months ended June 30, 2007. The allowance for losses on automobile and other consumer loans totaled $2.9 million at June 30, 2008, an increase of $0.1 million from the level at March 31, 2008.

The unallocated allowance for losses totaled $7.1 million at June 30, 2008, unchanged from the level at March 31, 2008. 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 portion of the allowance. The conditions evaluated in connection with the unallocated allowance include existing general economic and business conditions affecting key lending areas of the Bank, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience, regulatory examination results and findings of the Bank’s internal credit evaluations. At June 30, 2008, most of the unallocated allowance related to risks inherent in the mortgage loan portfolio, including, for example, geographic concentration and negative amortization features of certain loans.

24

Asset and Liability Management. The following table presents the Bank’s interest rate sensitivity gap at June 30, 2008. 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 shown that these deposits adjust to market prices over a much longer period of time. As a result, 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
Real estate loans:
Adjustable-rate	$	5,910,388		$	546,472		$	1,557,617		$	747,150			1,811		$	8,763,438
Fixed-rate		14,174			10,057			30,821			35,172			21,781			112,005
Home equity credit lines and second mortgages		1,248,800			41,146			133,105			91,581			111,496			1,626,128
Commercial		776,130			20,568			85,493			62,018			61,870			1,006,079
Consumer and other		74,202			46,935			98,854			42,394			5,869			268,254
Loans held for securitization and/or sale		72,695			—			—			—			—			72,695
Mortgage-backed securities		338,117			124,808			423,887			8,157			9,715			904,684
Other investments		113,859			—			210,359			—			—			324,218
Total interest-earning assets		8,548,365			789,986			2,540,136			986,472			212,542			13,077,501
Total non-interest earning assets		—			—			—			—			1,818,402			1,818,402
Total assets	$	8,548,365		$	789,986		$	2,540,136		$	986,472		$	2,030,944		$	14,895,903
Deposits:
Fixed maturity deposits	$	3,425,951		$	304,633		$	246,027		$	4,567		$	—		$	3,981,178
NOW, statement and passbook accounts		—			75,721			151,443			151,443			3,377,257			3,755,864
Money market deposit accounts		2,159,109			—			—			—			—			2,159,109
Borrowings:
Capital notes—subordinated		—			—			—			—			175,000			175,000
Other		1,889,096			18,362			62,551			32,342			83,303			2,085,654
Total interest-bearing liabilities		7,474,156			398,716			460,021			188,352			3,635,560			12,156,805
Total non-interest bearing liabilities		—			—			—			—			1,702,137			1,702,137
Minority interest		—			—			—			—			175,515			175,515
Stockholders’ equity		—			—			—			—			861,446			861,446
Total liabilities & stockholders’ equity	$	7,474,156		$	398,716		$	460,021		$	188,352		$	6,374,658		$	14,895,903
Gap	$	1,074,209		$	391,270		$	2,080,115		$	798,120		$	(3,423,018	)
Cumulative gap	$	1,074,209		$	1,465,479		$	3,545,594		$	4,343,714		$	920,696
Cumulative gap as a percentage of total assets		7.2	%		9.8	%		23.8	%		29.1	%		6.2	%

The interest sensitivity “gap” shown in the table represents the sum of all interest-earning assets minus all interest-bearing liabilities subject to repricing within the same period. The one-year gap, as a percentage of total assets, was 9.8% at June 30, 2008 compared to 8.1% at March 31, 2008.

Capital. At June 30, 2008, the Bank complied 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.

25

The following table shows the Bank’s regulatory capital levels at June 30, 2008, compared to the regulatory requirements in effect at that date. The information below is based upon the Bank’s understanding of the regulations and interpretations currently in effect and may be subject to change. The table contains information of the Bank only and does not include consolidation or elimination entries required for the Trust’s financial presentation.

Regulatory Capital

(Dollars in thousands)

						Minimum				Excess
	Actual					Capital Requirement				Capital
				As a %				As a %				As a %
	Amount			of Assets		Amount		of Assets		Amount		of Assets
Stockholders’ equity per financial statements	$	879,071
Minority interest in REIT Subsidiary (1)		144,000
		1,023,071
Adjustments for tangible and core capital:
Intangible assets		(63,462	)
Non-includable subsidiaries		(3,423	)
Non-qualifying purchased/originated loan servicing rights		(9,267	)
Total tangible capital		946,919		6.38	%	$	222,597	1.50	%	$	724,322	4.88	%
Total core capital (2)		946,919		6.38	%	$	593,592	4.00	%	$	353,327	2.38	%
Tier 1 risk-based capital (2)		946,919		9.29	%	$	406,361	4.00	%	$	540,558	5.29	%
Adjustments for total risk-based capital:
Subordinated capital debentures		175,000
Allowance for general loan losses		151,176
Total supplementary capital		326,176
Total available capital		1,273,095
Equity investments (3)		(3,148	)
Total risk-based capital (2)	$	1,269,947		12.47	%	$	812,722	8.00	%	$	457,225	4.47	%

(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 a property classified as real estate held for sale and an equity investment in a limited liability company which are treated as an equity investments 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. The following table sets forth the Bank’s REO at June 30, 2008, by the fiscal year in which the property was acquired through foreclosure.

Fiscal Year	(In thousands)
1990	$	2,150	(1)
1991		8,519	(2)
1995		20,401	(2)
2007		2,658
2008		34,647
Total REO	$	68,375

⁽¹⁾ The Bank treats this amount as an equity investment and deducts it from total capital for regulatory capital purposes.

⁽²⁾ The Bank received an extension of the holding periods of these properties through August 13, 2008. The Bank filed a request with the OTS on July 24, 2008 to further extend the holding periods of these properties.

26

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, the payment of interest on its indebtedness and the payment of capital improvement costs. The Real Estate Trust funds such shortfalls through a combination of external funding sources, primarily new financings, refinancing of maturing mortgage debt, proceeds from asset sales, dividends and distributions from Saul Centers and Saul Holdings Partnership, and dividends and tax sharing payments from the Bank. The Real Estate Trust receives quarterly distributions from its investment in Saul Holdings Partnership and dividends from its investment in Saul Centers. 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. However, the Real Estate Trust has, at its own option, elected 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 Partnership and Saul Centers’ operating performance and income. Although cash flows from operating activities, exclusive of Bank dividends and tax sharing payments, have been positive during the two most recent 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. Dividends received from the Bank are a component of funding sources available to the Real Estate Trust. The availability and amount of dividends in future periods is dependent upon, among other things, the Bank’s operating performance and income, and regulatory restrictions on such payments. The Real Estate Trust has not received a dividend payment from the Bank since March 2007.

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 nine-month period ended June 30, 2008, the Bank made tax sharing payments totaling $1.9 million. 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 the quarter ended June 30, 2008 the Real Estate Trust made a $48.0 million equity investment in the Bank. In addition, the other shareholders of the Bank made pro-rata equity investments keeping the overall ownership percentages of the Bank unchanged.

In recent years, the operations of the Real Estate Trust have generated net operating losses while the Bank has reported net income. Historically, the Trust’s consolidation of the Bank’s operations into the Trust’s federal income tax return resulted 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 2008 or in any future year, the Bank has taxable losses or unused credits, the Real Estate Trust would be obligated to reimburse the Bank the greater of (i) the tax benefit to the group using such tax losses or unused tax credits in the group’s consolidated federal income tax returns or (ii) the amount of the refund which the Bank would otherwise have been able to claim if it were not being included in the consolidated federal income tax return of the group. In addition, if the Real Estate Trust has taxable income it will be responsible for its share of any Federal or state tax liability.

As of June 30, 2008 the Real Estate Trust owned approximately 3,848,000 shares of Saul Centers, representing 21.6% of such company’s outstanding common stock. As of June 30, 2008, the market value of the total shares was approximately $181.0 million. The majority of these shares have been pledged as collateral with the Real Estate Trust’s credit line banks. During the nine-month period ended June 30, 2008, the Real Estate Trust received dividends of $7.5 million from Saul Centers.

During the quarter ended June 30, 2008, the Real Estate Trust, through an underwritten public offering, sold 1.5 million shares of Saul Centers common stock, realizing proceeds of approximately $67.0 million. The proceeds from the stock sale were used to pay down the Real Estate Trust’s outstanding revolving credit facilities.

As the owner, directly and through two wholly-owned subsidiaries, of a limited partnership interest in Saul Holdings Partnership the Real Estate Trust shares in cash distributions from operations and from capital transactions involving the sale of properties. The partnership agreement of Saul Holdings Partnership provides for quarterly cash distributions to the partners out of net cash flow. During the nine-month period ended June 30, 2008, the Real Estate Trust received total cash distributions of $6.2 million from Saul Holdings Partnership. Substantially all of the Real Estate Trust’s ownership interest in Saul Holdings Partnership has been pledged as collateral with the Real Estate Trust’s lines of credit banks.

The Real Estate Trust has a $75.0 million secured revolving credit line with an unrelated bank that matures on 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 at 150 basis points over the index. At June 30, 2008, the Real Estate Trust had no outstanding borrowings and unrestricted availability of $75.0 million.

27

The Real Estate Trust has an additional $75.0 million revolving credit line with an unrelated bank that matures on June 30, 2010, with provisions for extending the term for an additional year. This facility is also 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 at 150 basis points over the index. At June 30, 2008, the Real Estate Trust had $5.0 million in outstanding borrowings and unrestricted availability of $65.0 million. The Real Estate Trust was issued a $6.0 million letter of credit, which was reduced to $5.0 million during the quarter ended June 30, 2008, for the benefit of a mortgage lender as part of one of the mortgage financings completed during the quarter ended June 30, 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.

The maturity schedule for the Real Estate Trust’s outstanding debt at June 30, 2008 for the balance of fiscal 2008 and subsequent years is set forth in the following table:

Debt Maturity Schedule

(In thousands)

	Mortgage Notes		Notes Payable
Fiscal Year	Payable		Secured		Total
2008 (1)	$	1,932	$	—	$	1,932
2009		17,753		—		17,753
2010		13,378		5,000		18,378
2011		24,078		—		24,078
2012		18,037		—		18,037
Thereafter (2)		535,998		250,000		785,998
Total	$	611,176	$	255,000	$	866,176

(1) July 1, 2008 - September 30, 2008.

(2) Includes 100%, $61.5 million, of the Tysons Park Place II construction/permanent loan balance drawn to date.

Of the total mortgage debt outstanding at June 30, 2008, $549.6 million was non-recourse to the Real Estate Trust.

The Real Estate Trust has 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 $34.8 million during the nine-month period ended June 30, 2008, bringing the balance outstanding under this loan at June 30, 2008 to $61.5 million.

On April 4, 2008, the Real Estate Trust closed on a $16.0 million mortgage note secured by the Dulles Hampton Inn & Suites. The proceeds from the financing, along with approximately $4.7 million drawn from the revolving credit facilities were used to pay off the properties outstanding $20.3 million construction loan which was used to finance the construction of the hotel.

REAL ESTATE ACQUISITION, DISPOSITION, DEVELOPMENT AND CAPITAL EXPENDITURES

The Real Estate Trust owns various land parcels totaling 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. On October 18, 2007 the construction of the 170 room Dulles Hampton Inn & Suites in Northern Virginia was completed and the hotel commenced operation. During fiscal 2006, 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 $27.0 million per year for the next several years.

28

BANKING

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

At June 30, 2008, the estimated remaining collateral, after market value and other adjustments, of that portion of the Bank’s assets that may be pledged to the FHLB of Atlanta, Federal Reserve Bank of Richmond and various wholesale lenders totaled $5.3 billion, or 35.7% of total assets. The Bank can borrow from the FHLB of Atlanta an aggregate amount of up to 50% of the Bank’s total assets, provided that the Bank has sufficient collateral to pledge against the advances and subject to certain limitations and conditions imposed by the FHLB of Atlanta.

Also at June 30, 2008, the Bank had cash and other deposits totaling $468.8 million, or 3.1% of total assets.

The Bank also accesses a variety of other short-term and long-term liquidity sources, including securitizations and sales of loan receivables, when conditions are favorable. As part of its mortgage banking activities, the Bank sold $455.5 million of single-family residential mortgage loans during the June 2008 quarter. Generally, all long-term, fixed-rate residential mortgage loans originated during the current quarter have been or are in the process of being sold. Adjustable rate mortgage loans are either sold or placed into the Bank’s portfolio.

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

Loan Originations, Securitizations and Sales – Retained Interests and Servicing Assets.Recent and continuing 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 any residential mortgage loans in the quarter ended June 30, 2008. The outstanding trust certificate balances related to prior securitizations amounted to $5.7 billion at June 30, 2008.

As part of its loan origination, securitization and sale activities, the Bank generally receives or retains various interests in the loans sold, which may include servicing assets, securities, or interest-only assets, consisting of interest-only certificates and/or interest-only strips receivable. The Bank does not currently retain recourse relating to securitized loans and had no retained recourse at June 30, 2008 related to these transactions. The Bank records these interests as assets on its consolidated financial statements and determines the carrying value of the assets based on the estimated future cash flows expected to be received from the underlying assets. In accordance with the transaction documents, these cash flows are payable to the Bank before the claims of others. Periodically, the Bank obtains independent valuations as confirmation of management’s estimates of its values for interest-only and servicing assets. 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 June 30, 2008, those assets totaled 40.1% of the Bank’s core capital. The following tables summarize the carrying value of these assets at June 30, 2008 and March 31, 2008.

	June 30, 2008		March 31, 2008
	(in thousands)
Interest-only certificates	$	276,359	$	247,358
Interest-only strips receivable		30,877		23,245
Total interest-only assets		307,236		270,603
Servicing assets		153,298		126,446
Reserve accounts		4,287		7,432
Total	$	464,821	$	404,481

29

The following tables show the changes in the Bank’s servicing assets and interest-only assets for each of the periods shown:

Mortgage Servicing Assets Activity

(In thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Beginning balance	$	126,446		$	162,291		$	155,680		$	167,968	(1)
Additions		4,235			19,732			13,856			49,659
Accretion		3,746			3,958			12,707			12,362
Cash collected		(10,860	)		(21,968	)		(40,550	)		(67,182	)
Net fair value adjustment		29,731			452			11,605			1,658
Ending balance/Carrying value	$	153,298		$	164,465		$	153,298		$	164,465

⁽¹⁾ Includes the elimination of valuation allowances amounting to $39,196 as a result of the adoption of SFAS 156 on October 1, 2006.

The carrying value of the Bank’s servicing assets increased during the current quarter as a result of a $29.7 million increase in fair value, which was partially offset by $10.9 million in servicing fees, prepayment penalties and late charges collected. The $29.7 million increase in the fair value of mortgage servicing assets was caused by a decrease in estimated prepayment levels reflecting liquidity issues in the primary mortgage market, which are making it difficult for borrowers to obtain refinancing. In addition, $4.2 million of servicing rights was capitalized related to $421.0 million of mortgage loans sold where the Bank retained the servicing rights. The Bank did not purchase or sell in bulk any servicing rights during the current quarter.

Interest-Only Assets Activity

(In thousands)

	Three Months Ended June 30,						Nine Months Ended June 30,
	2008			2007			2008			2007
Beginning balance	$	270,603		$	299,516		$	314,111		$	344,317
Additions		—			38,894			—			100,005
Accretion		7,881			6,965			24,971			22,950
Cash received		(28,807	)		(37,214	)		(101,054	)		(114,845	)
Fair value adjustments		57,559			(1,620	)		69,208			(45,886	)
Ending balance/Carrying value	$	307,236		$	306,541		$	307,236		$	306,541

The carrying value of the Bank’s interest-only assets increased by $36.6 million during the current quarter as a result of a $57.6 million increase in the fair value of the interest-only assets and $7.9 million of accretion which were partially offset by $28.8 million in cash received. The $57.6 million increase in the fair value of interest-only assets was caused by lower estimated prepayment levels reflecting liquidity issues in the primary mortgage market.

30

Key assumptions and the sensitivity of the current fair value of single-family residential retained interests to an immediate 10 percent and 20 percent adverse change in those assumptions are as follows:

(Dollars in thousands)	June 30, 2008			March 31, 2008
Carrying value(1) (fair value)	$	311,523		$	278,035
Expected weighted-average life(2) (in years)		3.8			2.8
Prepayment Speed assumption(2)(3) (annual rate)
First twelve months		11.9	%		18.3	%
Next twelve months		11.9	%		17.3	%
Thereafter		17.9	%		21.5	%
Impact on fair value of 10% adverse change	$	(13,883	)	$	(17,189	)
Impact on fair value of 20% adverse change	$	(26,924	)	$	(32,553	)
Residual cash flow discount rate (annual)		12.0	%		12.0	%
Impact on fair value of 10% adverse change	$	(8,441	)	$	(5,556	)
Impact on fair value of 20% adverse change	$	(16,776	)	$	(12,250	)

⁽¹⁾ June 30, 2008 includes interest-only assets of $307,236 and reserve accounts of $4,287. March 31, 2008 includes interest-only assets of $270,603 and reserve accounts of $7,432.

⁽²⁾ Expected weighted average life and prepayment speed assumptions are based on the life of the securitization.

⁽³⁾ Represents Constant Prepayment Rate. 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.

These sensitivities are hypothetical and should be used with caution. Changes in the 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 table of a variation in a particular assumption on the fair value of interest-only strips receivable are 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.

Commitments and Contingencies.The Bank has obligations under recourse provisions related to the servicing of certain residential mortgage loans. At June 30, 2008 and March 31, 2008, recourse to the Bank under these arrangements totaled $2.7 million and $2.8 million, respectively.

In connection with the prior 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 investment grade 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 three months ended June 30, 2008, the Bank funded $5.0 million of negative amortization under these obligations, and received $15.6 million in principal payments representing previously funded negative amortization.

There were no material commitments for capital expenditures at June 30, 2008.

31

RESULTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2008 COMPARED TO THREE MONTHS ENDED JUNE 30, 2007

REAL ESTATE

The Real Estate Trust recorded operating income of $31.1 million in the quarter ended June 30, 2008 (the “2008 quarter”) compared to operating income of $3.6 million in the quarter ended June 30, 2007 (the “2007 quarter”). The results reflect the $30.4 million gain on sale of Saul Centers common stock, higher net earnings in the hotel portfolio and lower general and administrative expenses which were partially offset by increased interest and debt amortization, increased depreciation, reduced income generated from the sale of townhomes, lower other income, reduced earnings from the office and industrial portfolio and lower earnings from Saul Holdings Partnership and Saul Centers. The 2007 quarter also included a $325,000 gain on sale of a land parcel as a result of a condemnation.

Income after direct operating expenses from hotels increased $169,000, or 1.0%, in the 2008 quarter from the level achieved in the 2007 quarter. Total revenue for the 2008 quarter increased $1.8 million, or 4.2% over the 2007 quarter, with room sales increasing $1.1 million, or 3.3%, while food, beverage and other sales increased $684,000 or 7.7%. The average room rate, exclusive of the newly constructed hotel which was placed in service in October 2007 (“Same hotel properties – three month period”), increased 1.5% from $141.32 in the 2007 quarter to $143.40 in the 2008 quarter while occupancy decreased from 79.4% in the 2007 quarter to 77.5% in the 2008 quarter. The newly constructed hotel contributed approximately $1.5 million, or 85% of the increase in overall revenue. Revenue for the same hotel properties increased approximately $300,000, or 0.6%, in the 2008 quarter. Direct operating expenses increased approximately $1.6 million, or 6.6%, reflecting increased operating costs, such as payroll costs, food and beverage costs, property taxes and repairs and maintenance. In addition, operating costs associated with the newly constructed hotel is fully integrated into the 2008 quarterly results.

Income after direct operating expenses from office and industrial properties decreased $184,000, or 2.5%, in the 2008 quarter compared to the 2007 quarter. Total revenue increased $231,000, or 2.0%, in the 2008 quarter, largely due to increased expense recoveries which reflect increased operating expenses. Occupancy levels have increased in the 2008 quarter from 88.1% at June 30, 2007 to 90.1% at June 30, 2008. The majority of the increase in occupancy is due to the re-leasing of an approximately 100,000 square foot, single tenant, building as of June 30, 2008. The prior tenant vacated this space on March 31, 2007. Rental income from this space commenced during the 2008 quarter. The increased base rental income from this space of approximately $244,000 was offset by lower base rental income at other properties within the portfolio, particularly in the Atlanta region. Overall direct operating expenses increased $415,000, or 9.8%, due to higher repairs and maintenance, utility costs, leasing costs and property taxes.

Income from the sale of townhomes, after deducting the cost of sales, totaled $182,000 for the 2008 quarter compared to $426,000 for the 2007 quarter. Five units were sold during the 2008 quarter for a total sales value of $1.7 million. All direct costs and allocated infrastructure and soft costs, totaling $1.5 million, associated with these units were expensed during the 2008 quarter. During the 2007 quarter, nine units were sold for a total sales value of $3.2 million. Direct costs and allocated infrastructure and soft costs associated with the units sold during the 2007 quarter totaled $2.8 million.

Other income, which includes interest income, income from other real estate properties and other miscellaneous income, decreased $228,000, or 54.7%, due mainly to lower interest income in the 2008 quarter reflecting decreased cash balances in the quarter. Also included in the 2007 quarter was a $90,000 final payment received for various easements related to a land parcel in Northern Virginia.

Land parcels and other expense decreased $66,000, or 15.9%, in the 2008 quarter when compared to the 2007 quarter reflecting slightly lower expenses associated with the Trust’s portfolio of land holdings.

Interest and amortization of debt expense increased $646,000 in the 2008 quarter when compared to the 2007 quarter. The increase is due to higher mortgage interest and debt amortization of approximately $921,000, reflecting the Real Estate Trust’s refinancing activity during the fiscal year ended September 30, 2007 and reduced capitalized interest of $444,000 which was partially offset by lower line of credit interest of $719,000. The average balance of outstanding borrowings increased to $870.3 million in the 2008 quarter from $833.9 million in the 2007 quarter, reflecting higher mortgage balances which offset lower line of credit balances. The average cost of borrowings increased slightly from 6.87% in the 2007 quarter to 6.98% in the 2008 quarter.

Depreciation expense increased $1.1 million, or 19.6%, reflecting the October 2007 completion of construction of a hotel development, capital improvements in both the hotel and office and industrial portfolios and the write-off of certain other hotel and office and industrial assets which are no longer in service.

Advisory, management and leasing fees paid to related parties increased $176,000, or 4.0%, in the 2008 quarter when compared to the 2007 quarter. The advisory fee in the 2008 quarter increased $55,000 over the 2007 quarter due to a contractual increase in the monthly payments. The remainder of the increase, totaling $121,000, was due mainly to higher hotel management fees reflecting the increase in overall hotel revenue.

32

General and administrative expense decreased $371,000, or 34.3%, in the 2008 quarter compared to the 2007 quarter. The decrease reflects lower legal and other professional fees and lower predevelopment costs.

Earnings from Saul Holdings Partnership and Saul Centers totaled $2.6 million in the 2008 quarter as compared to $3.1 million in the 2007 quarter, a decrease of $536,000, or 17.2%. The decrease was primarily due to additional preferred dividends paid by Saul Centers as a result of its Series B preferred stock offering in March 2008. The additional preferred dividends offset increases in operating income generated from successful leasing activity as well as the acquisition, development and redevelopment activity of those entities.

During the 2008 quarter the Real Estate Trust, through an underwritten public offering, sold 1.5 million shares of Saul Centers common stock resulting in a gain of $30.4 million.

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 land 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 the quarter ended June 30, 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 the quarter ended March 31, 2006.

BANKING

Overview. The Bank recorded operating income of $8.1 million for the three months ended June 30, 2008 (the “2008 quarter”), compared to operating income of $43.1 million for the three months ended June 30, 2007 (the “2007 quarter”). The reduced income during the current quarter reflects a significant increase in the provision for loan losses as a result of deteriorating conditions in the housing market and U.S. economy which was partially offset by an increase in the value of its mortgage servicing rights and interest-only strip assets. Due to continuing adverse market conditions, the Bank did not securitize any residential mortgage loans in the 2008 quarter. However, during the 2008 quarter, the Bank sold $455.5 million of residential mortgage loans and recognized gains of $4.2 million. During the 2007 quarter, the Bank securitized and/or sold $1.2 billion of loans and recognized gains of $20.5 million.

Net Interest Income. Net interest income, before the provision for loan losses, decreased $3.9 million (or 3.5%) in the 2008 quarter. The Bank did not record any interest income on non-accrual loans during the 2008 quarter. The Bank would have recorded interest income of $6.9 million during the 2008 quarter if non-accrual assets had been current in accordance with their original terms. See “Financial Condition – Asset Quality – Non-Performing Assets.”

33

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

Net Interest Margin Analysis

(Dollars in thousands)

	Three Months Ended June 30,
	2008						2007
	Average				Yield/		Average				Yield/
	Balances		Interest		Rate		Balances		Interest		Rate
Assets:
Interest-earning assets:
Loans receivable, net (1)(2)	$	11,842,182	$	158,369	5.35	%	$	11,234,480	$	187,645	6.68	%
Mortgage-backed securities		931,042		10,516	4.52			1,196,490		14,298	4.78
Federal funds sold and securities purchased under agreements to resell		34,231		178	2.08			45,659		607	5.32
Trading securities		7,280		103	5.66			11,097		157	5.66
Investment securities		210,363		2,458	4.67			212,263		2,248	4.24
Other interest-earning assets		174,565		1,881	4.31			170,558		2,827	6.63
Total		13,199,663		173,505	5.26			12,870,547		207,782	6.46
Noninterest-earning assets:
Cash		343,189						374,894
Real estate held for investment or sale		60,182						38,947
Property and equipment, net		683,135						616,082
Automobiles subject to lease, net		914						15,807
Goodwill and other intangible assets, net		45,188						43,423
Other assets		628,029						718,904
Total assets	$	14,960,300					$	14,678,604
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits	$	2,383,824		1,039	0.17		$	2,368,444		1,695	0.29
Savings deposits		1,284,812		2,833	0.88			960,405		1,543	0.64
Time deposits		4,109,132		38,907	3.79			3,846,965		45,764	4.76
Money market deposits		2,179,614		7,296	1.34			2,433,847		16,326	2.68
Total deposits		9,957,382		50,075	2.01			9,609,661		65,328	2.72
Borrowings		2,370,747		15,907	2.68			2,449,800		30,999	5.06
Total liabilities		12,328,129		65,982	2.14			12,059,461		96,327	3.20
Noninterest-bearing items:
Noninterest-bearing deposits		1,431,539						1,385,004
Other liabilities		209,702						274,276
Minority interest		175,505						175,391
Stockholders’ equity		815,425						784,472
Total liabilities and stockholders’ equity	$	14,960,300					$	14,678,604
Net interest income			$	107,523					$	111,455
Net interest spread (3)					3.12	%					3.26	%
Net yield on interest-earning assets (4)					3.26	%					3.46	%
Interest-earning assets to interest-bearing liabilities					107.07	%					106.73	%

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

(2) Average balances include non-accrual loans.

(3) Equals the weighted average yield on total interest-earning assets minus the weighted average rate on total interest-bearing liabilities.

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

34

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

Volume and Rate Changes in Net Interest Income

(Dollars in thousands)

	Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007 Increase (Decrease) Due to Change in
	Volume (1)			Rate(1)			Total Change
Interest income:
Loans(2)	$	57,620		$	(86,896	)	$	(29,276	)
Mortgage-backed securities		(3,033	)		(749	)		(3,782	)
Securities purchased under agreements to resell		(125	)		(304	)		(429	)
Trading securities		(54	)		—			(54	)
Investment securities		(131	)		341			210
Other interest-earning assets		438			(1,384	)		(946	)
Total interest income		54,715			(88,992	)		(34,277	)
Interest expense:
Deposit accounts		14,741			(29,994	)		(15,253	)
Borrowings		(970	)		(14,122	)		(15,092	)
Total interest expense		13,771			(44,116	)		(30,345	)
Increase (decrease) in net interest income	$	40,944		$	(44,876	)	$	(3,932	)

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

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

Interest income in the 2008 quarter decreased $34.3 million (or 16.5%) from the 2007 quarter primarily as a result of lower average yields on loans receivable which was partially offset by higher average balances on those loans. A decrease in interest income on mortgage-backed securities caused primarily by lower average balances also contributed to the decrease in interest income.

The Bank’s net interest spread decreased to 3.12% in the 2008 quarter from 3.26% in the 2007 quarter. The ratio of average interest-earning assets to average interest-bearing liabilities increased slightly to 107.1% for the 2008 quarter, from 106.7% in the 2007 quarter.

Interest income on loans, the largest category of interest-earning assets, decreased to $158.4 million for the 2008 quarter from $187.6 million for the 2007 quarter, a decrease of 15.6%, due to lower average yields on loan balances. The average yield on the loan portfolio decreased to 5.35% for the 2008 quarter from 6.68% for the 2007 quarter. Interest income on residential mortgage loans decreased $13.4 million primarily due a 98 basis point reduction in the average rate earned on those loans (to 5.31% from 6.29%). Lower average balances of and average yields on home equity loans resulted in a $9.4 million (or 32.1%) decrease in interest income on those loans.

Interest income on mortgage-backed securities decreased $3.8 million (or 26.5%) primarily due to a $265.4 million decrease in average balances, coupled with a decrease in the average yields on those securities to 4.52% from 4.78%.

Interest expense on deposits decreased $15.3 million (or 23.3%) during the 2008 quarter. The decrease resulted primarily from a 71 basis point decrease in the average rate on deposits (to 2.01% from 2.72%) due to decreased rates paid by the Bank in response to lower market interest rates. A $347.7 million increase in average deposit balances partially offset the decrease in interest expense.

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Interest expense on borrowings decreased $15.1 million (or 48.7%) in the 2008 quarter compared to the 2007 quarter. Interest expense on advances from the FHLB of Atlanta decreased $9.3 million (or 45.4%) due primarily to lower average rates paid on the advances. Interest expense on other borrowings decreased $3.8 million (or 74.0%) due to lower average rates paid on those borrowings.

Provision for Loan Losses. During the 2008 quarter, the Bank recorded a provision for loan losses of $121.4 million, compared to a credit for loan losses of $0.8 million in the 2007 quarter. The provision reflects increased non-accrual loans and losses in the Bank’s portfolio of residential real estate loans. See “Financial Condition – Asset Quality – Allowances for Losses.”

Other income. Other income increased to $140.7 million in the 2008 quarter from $103.5 million in the 2007 quarter. The $37.2 million (or 35.9%) increase was primarily attributable to increases in servicing, securitization and mortgage banking income, deposit servicing fees and asset management fees.

Servicing, securitization and mortgage banking income increased to $79.4 million in the 2008 quarter, from $46.6 million in the 2007 quarter, a 70.6% increase. The Bank recorded a fair value write-up on its interest-only assets totaling $57.6 million in the 2008 quarter compared to a fair value write-down of $1.6 million in the 2007 quarter. The fair value write-up reflects lower estimated prepayment levels caused by liquidity issues in the primary mortgage market. Due to continuing adverse market conditions, the Bank did not securitize and sell any residential mortgage loans in the quarter ended June 30, 2008. However, during the 2008 quarter, the Bank sold $455.5 million of loans and recognized gains of $4.2 million. During the 2007 quarter, the Bank securitized and/or sold $1.2 billion of loans and recognized gains of $20.5 million.

Deposit servicing fees increased $4.8 million (or 12.2%) during the 2008 quarter primarily due to increased fees generated from the Bank’s branch and ATM network.

Operating Expenses. Operating expenses during the 2008 quarter decreased $53.9 million (or 31.2%) from the 2007 quarter. The decrease was largely due to decreases in servicing assets adjustments and other loan expenses and in salaries and employee benefits and was partially offset by an increase in property and equipment expenses.

Salaries and employee benefits decreased $12.4 million (or 14.2%) in the 2008 quarter primarily due to staffing reductions made in the first half of fiscal 2008.

Servicing assets adjustments and other loan expenses decreased $42.0 million in the 2008 quarter primarily due to the net fair value write-up on mortgage servicing rights in the 2008 quarter. The fair value write-up reflects lower estimated prepayment levels caused by liquidity issues in the primary mortgage market.

Property and equipment expense increased $1.2 million (or 6.9%) during the 2008 quarter primarily due to increased rent expense related to the retail branch network.

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NINE MONTHS ENDED JUNE 30, 2008 COMPARED TO NINE MONTHS ENDED JUNE 30, 2007

REAL ESTATE

The Real Estate Trust recorded operating income of $27.5 million in the nine months ended June 30, 2008 (the “2008 period”) compared to operating income of $2.7 million in the nine months ended June 30, 2007 (the “2007 period”). The results reflect the $30.4 million gain on sale of Saul Centers common stock, higher net earnings in the hotel portfolio and lower general and administrative expenses which were partially offset by increased interest and debt amortization, increased depreciation, reduced income generated from the sale of townhomes, increased advisory, management and leasing fees and lower other income. The 2008 period results also reflect a $2.7 million gain due to the redemption of an equity investment. The 2007 period results reflect $1.5 million of gains on sales of land parcels as a result of condemnation proceedings.

Income after direct operating expenses from hotels increased $375,000, or 0.9%, in the 2008 period from the level achieved in the 2007 period. Total revenue for the 2008 period increased $5.4 million, or 4.9% over the 2007 period, with room sales increasing $3.7 million, or 4.3%, while food, beverage and other sales increased $1.7 million or 7.1%. The average room rate, exclusive of the newly constructed hotels which were placed in service in January 2007 and October 2007 (“Same hotel properties – nine month period”), increased 2.9% from $138.68 in the 2007 period to $142.69 in the 2008 period while occupancy decreased from 72.1% in the 2007 period to 68.6% in the 2008 period. The newly constructed hotels contributed $5.5 million, to the increase in overall revenue. Same hotel properties revenues decreased approximately $122,000, or 0.1%. Direct operating expenses increased approximately $5.0 million, or 7.4%, reflecting increased operating costs, such as payroll costs, food and beverage costs, property taxes and repairs and maintenance. In addition, operating costs associated with the newly constructed hotels, are fully integrated into the results for the 2008 period.

Income after direct operating expenses from office and industrial properties decreased $50,000, or 0.2%, in the 2008 period compared to the 2007 period. Total revenue increased $3.5 million, or 10.9%, in the 2008 period. The property purchased on March 29, 2007 contributed $3.7 million to the revenue increase in the 2008 period. Occupancy levels have increased in the 2008 period from 88.1% at June 30, 2007 to 90.1% at June 30, 2008. The majority of the increase in occupancy is due to the re-leasing of an approximately 100,000 square foot, single tenant, building as of June 30, 2008. The prior tenant vacated this space on March 31, 2007. Rental income from this space commenced during the quarter ended June 30, 2008. The approximate $200,000 remaining decrease in total revenue for the office properties was caused by this vacancy which was partially offset by revenue increases at other office and industrial properties. Overall direct operating expenses increased $3.5 million, or 32.6%, due to higher repairs and maintenance, utility costs, ground rent and property taxes. Direct operating expenses for the same office properties increased $1.2 million, or 12.2%, due to higher repairs and maintenance, utility costs and property taxes.

Income from the sale of townhomes, after deducting the cost of sales, totaled $597,000 for the 2008 period compared to $1.3 million for the 2007 period. Fifteen units were sold during the 2008 period for a total sales value of $5.1 million. All direct costs and allocated infrastructure and soft costs, totaling approximately $4.5 million, associated with these units were expensed during the 2008 period. During the 2007 period, twenty-two units were sold for a total sales value of $7.8 million. Direct costs and allocated infrastructure and soft costs associated with the units sold during the 2007 period totaled $6.5 million.

Other income, which includes interest income, income from other real estate properties and other miscellaneous income, decreased $795,000, or 58.7%, due to lower interest income in the 2008 period reflecting decreased cash balances in the quarter. Also included in the 2007 period was a $90,000 final payment received for various easements related to a land parcel in Northern Virginia.

Land parcels and other expense decreased $162,000, or 15.1%, in the 2008 period when compared to the 2007 period reflecting slightly lower expenses associated with the Trust’s portfolio of land holdings.

Interest and amortization of debt expense increased $3.2 million in the 2008 period when compared to the 2007 period. The increase is due to higher mortgage interest and debt amortization of approximately $2.9 million, reflecting the Real Estate Trust’s refinancing activity during the fiscal year ended September 30, 2007 and reduced capitalized interest of $978,000 which was partially offset by lower line of credit interest of $521,000 and lower unsecured note interest of $200,000. The average balance of outstanding borrowings increased to $861.0 million in the 2008 period from $781.7 million in the 2007 period, reflecting higher mortgage balances which offset lower line of credit and unsecured note balances. The average cost of borrowings remained constant at 7.02% in both periods.

Depreciation expense increased $2.4 million, or 14.3%, reflecting the March 29, 2007 office acquisition, the January and October 2007 completion of construction of the two hotel developments, other capital improvements in both the hotel and office and industrial portfolios and the write-off of certain other hotel and office and industrial assets which are no longer in service.

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Advisory, management and leasing fees paid to related parties increased $653,000, or 5.2%, in the 2008 period when compared to the 2007 period. The advisory fee in the 2008 period increased $203,000 over the 2007 period due to a contractual increase in the monthly payments. The remainder of the increase, totaling $450,000, was due mainly to higher hotel and office management fees reflecting the increase in overall hotel and office revenue.

General and administrative expense decreased $430,000, or 14.6%, in the 2008 period compared to the 2007 period due to lower legal and other professional fees.

Earnings from Saul Holdings Partnership and Saul Centers totaled $9.2 million in both the 2008 and 2007 periods. Increases in operating income generated from successful leasing activity as well as the acquisition, development and redevelopment activity of those entities was offset by additional preferred dividends paid by Saul Centers as a result of its Series B preferred stock offering in March 2008.

During the quarter ended June 30, 2008, the Real Estate Trust, through an underwritten public offering, sold 1.5 million shares of Saul Centers common stock resulting in a gain of $30.4 million.

During the 2008 period, the Real Estate Trust redeemed an equity investment which resulted in a gain of approximately $2.7 million. Redemption proceeds of approximately $5.0 million were received in January 2008. The Real Estate Trust received additional final redemption proceeds of $255,000 in April of 2008. The Real Estate Trust’s other equity investments are included in Other Assets on the Balance Sheet.

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 land 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 the quarter ended June 30, 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 the quarter ended March 31, 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 included 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 the 2007 period. The initial gain on this condemnation of $2.7 million was recorded in fiscal 2004.

BANKING

Overview. The Bank recorded operating income of $9.4 million for the nine months ended June 30, 2008 (the “2008 period”), compared to operating income of $71.8 million for the nine months ended June 30, 2007 (the “2007 period”). The decline in net income was caused primarily by a significant increase in the provision for loan losses. The increased provision was partially offset by an increase in servicing, securitization and mortgage banking income, decreases in salaries and employee benefit expenses and servicing asset adjustments and other loan expenses. Due to continuing adverse market conditions, the Bank did not securitize and sell any residential mortgage loans in the period ended June 30, 2008. However, during the 2008 period, the Bank sold $1.4 billion of residential mortgage loans and recognized gains of $7.5 million. During the 2007 period, the Bank securitized and/or sold $3.2 billion of loans and recognized gains of $57.4 million.

Net Interest Income. Net interest income, before the provision for loan losses, increased $6.9 million (or 2.1%) in the 2008 period. The Bank recorded $1.2 million of interest income on non-accrual loans during the 2008 period. The Bank would have recorded additional interest income of $14.8 million during the 2008 period if non-accrual assets had been current in accordance with their original terms. See “Financial Condition – Asset Quality – Non-Performing Assets.”

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

Net Interest Margin Analysis

(Dollars in thousands)

	Nine Months Ended June 30,
	2008						2007
	Average				Yield/		Average				Yield/
	Balances		Interest		Rate		Balances		Interest		Rate
Assets:
Interest-earning assets:
Loans receivable, net(1)(2)	$	11,876,909	$	535,521	6.01	%	$	11,027,381	$	549,660	6.65	%
Mortgage-backed securities		991,949		34,702	4.66			1,233,327		44,080	4.77
Federal funds sold and securities purchased under agreements to resell		37,573		958	3.40			67,033		2,709	5.39
Trading securities		12,659		548	5.77			7,261		314	5.77
Investment securities		210,364		7,428	4.71			208,102		6,482	4.15
Other interest-earning assets		194,317		7,635	5.24			172,459		8,614	6.66
Total		13,323,771		586,792	5.87			12,715,563		611,859	6.42
Noninterest-earning assets:
Cash		357,031						379,906
Real estate held for investment or sale		55,481						37,918
Property and equipment, net		671,112						614,782
Automobiles subject to lease, net		2,984						30,510
Goodwill and other intangible assets, net		45,288						41,275
Other assets		652,823						756,124
Total assets	$	15,108,490					$	14,576,078
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Deposit accounts:
Demand deposits	$	2,306,340		3,850	0.22		$	2,320,567		4,878	0.28
Savings deposits		1,185,637		9,292	1.04			930,553		3,628	0.52
Time deposits		4,136,075		133,694	4.31			3,721,161		131,240	4.70
Money market deposits		2,159,213		29,556	1.83			2,419,742		48,883	2.69
Total deposits		9,787,265		176,392	2.40			9,392,023		188,629	2.68
Borrowings		2,703,140		76,061	3.75			2,586,694		95,837	4.94
Total liabilities		12,490,405		252,453	2.69			11,978,717		284,466	3.17
Noninterest-bearing items:
Noninterest-bearing deposits		1,397,570						1,383,094
Other liabilities		234,252						256,149
Minority interest		175,495						175,391
Stockholders’ equity		810,768						782,727
Total liabilities and stockholders’ equity	$	15,108,490					$	14,576,078
Net interest income			$	334,339					$	327,393
Net interest spread(3)					3.18	%					3.25	%
Net yield on interest-earning assets(4)					3.35	%					3.43	%
Interest-earning assets to interest-bearing liabilities					106.67	%					106.15	%

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

(2) Average balances include non-accrual loans.

(3) Equals the weighted average yield on total interest-earning assets minus the weighted average rate on total interest-bearing liabilities.

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

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

Volume and Rate Changes in Net Interest Income

(Dollars in thousands)

	Nine Months Ended June 30, 2008 Compared to Nine Months Ended June 30, 2007 Increase (Decrease) Due to Change in
	Volume (1)			Rate(1)			Total Change
Interest income:
Loans (2)	$	56,159			(70,298	)	$	(14,139	)
Mortgage-backed securities		(8,462	)		(916	)		(9,378	)
Securities purchased under agreements to resell		(952	)		(799	)		(1,751	)
Trading securities		234			—			234
Investment securities		71			875			946
Other interest-earning assets		1,462			(2,441	)		(979	)
Total interest income		48,512			(73,579	)		(25,067	)
Interest expense:
Deposit accounts		11,454			(23,691	)		(12,237	)
Borrowings		6,574			(26,350	)		(19,776	)
Total interest expense		18,028			(50,041	)		(32,013	)
Increase in net interest income	$	30,484		$	(23,538	)	$	6,946

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

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

Interest income in the 2008 period decreased $25.1 million (or 4.1%) from the 2007 period, primarily as a result of lower average yields on loans receivable. A decrease in interest income on mortgage-backed securities caused primarily by lower average balances, contributed to the decreased income.

The Bank’s net interest spread decreased slightly to 3.18% in the 2008 period from 3.25% in the 2007 period. The ratio of average interest-earning assets to average interest-bearing liabilities increased slightly to 106.7% for the 2008 period, from 106.2% for the 2007 period.

Interest income on loans, the largest category of interest-earning assets, decreased to $535.5 million for the 2008 period from $549.7 million for the 2007 period, a decrease of 2.6%, due to lower average yields. The average yield on the loan portfolio decreased to 6.01% for the 2008 period from 6.65% for the 2007 period. Interest income on residential mortgage loans increased $9.4 million primarily due a $676.7 million increase in average balances. Lower average balances of and average yields on home equity loans resulted in a $17.6 million (or 19.5%) decrease in interest income on those loans.

Interest income on mortgage-backed securities decreased $9.4 million (or 21.3%) primarily due to a $241.4 million decrease in average balances, coupled with a slight decrease in the average yields on those securities to 4.66% from 4.77%.

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Interest expense on deposits decreased $12.2 million (or 6.5%) during the 2008 period. The decrease resulted primarily from a 28 basis point decrease in the average rate on deposits (to 2.40% from 2.68%) due to decreased rates paid by the Bank in response to lower market interest rates partially offset by a $395.2 million increase in average deposit balances.

Interest expense on borrowings decreased $19.8 million (or 20.6%) in the 2008 period compared to the 2007 period. Interest expense on advances from the FHLB of Atlanta decreased $10.2 million (or 15.3%) due primarily to lower average rates paid on the advances which were partially offset by higher average balances. Interest expense on other borrowings decreased $6.6 million (or 44.8%) due to lower average rates paid on those borrowings.

Provision for Loan Losses. During the 2008 period, the Bank recorded a provision for loan losses of $194.9 million, compared to a credit for loan losses of $1.8 million in the 2007 period. 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 increased to $333.6 million in the 2008 period from $262.1 million in the 2007 period. The $71.5 million (or 27.3%) increase was primarily attributable to increases in servicing, securitization and mortgage banking income, deposit servicing fees and asset management fees and other non-interest income.

Servicing, securitization and mortgage banking income increased to $138.7 million in the 2008 period, from $95.4 million in the 2007 period, a 45.5% increase. The Bank recorded a fair value write-up on its interest-only assets totaling $69.2 million in the 2008 period compared to a fair value write-down of $45.9 million in the 2007 period. The $69.2 million write-up in fair value reflects lower estimated prepayment levels due to liquidity issues in the primary mortgage market. Due to continuing adverse market conditions, the Bank did not securitize and sell any residential mortgage loans in the period ended June 30, 2008. However, during the 2008 period, the Bank sold $1.4 billion of loans and recognized gains of $7.5 million. During the 2007 period, the Bank securitized and/or sold $3.2 billion of loans and recognized gains of $57.4 million.

Other income increased to $31.9 million in the 2008 period from $25.0 million in the prior corresponding period, a 27.8% increase. The increase resulted primarily from a gain of $14.0 million on the partial redemption of the Bank’s stock in VISA following VISA’s initial public offering during 2008, which was partially offset by a $6.4 million decrease in automobile rental income as a result of the Bank’s prior decision to discontinue automobile leases.

Deposit servicing fees increased $16.1 million (or 14.1%) during the 2008 period primarily due to increased fees generated from the Bank’s branch and ATM network.

Operating Expenses. Operating expenses during the 2008 period decreased $55.8 million (or 10.7%) from the 2007 period. The decrease was largely due to decreases in salaries and employee benefits and in servicing assets adjustments and other loan expenses which were partially offset by increases in property and equipment expenses.

Salaries and employee benefits decreased $14.0 million (or 5.4%) in the 2008 period due primarily to staff reductions. During the period, the Bank recorded $8.6 million of severance expense related to those staffing reductions.

Servicing assets adjustments and other loan expenses decreased $48.8 million (or 67.4%) in the 2008 period primarily due to lower actual and projected prepayment speeds on mortgage loans serviced for others.

Property and equipment expense increased $7.2 million (or 14.7%) during the 2008 period primarily due to increased rent expense related to the retail branch network.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information required by this Item is included in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Item 4. CONTROLS AND PROCEDURES

The Trust maintains disclosure controls and procedures that are designated to provide reasonable assurance 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 June 30, 2008. 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 June 30, 2008.

During the three months ended June 30, 2008 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.

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PART II

Item 1. 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 of the Trust.

In the normal course of business, the Bank is involved in certain 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 or the Trust.

On January 16, 2007, in Andrews v. Chevy Chase Bank, FSB, the U.S. District Court for the Eastern District of Wisconsin ruled against the Bank in a case involving alleged violations of the federal Truth-in-Lending Act. The Bank has appealed the decision and the district court has suspended further proceedings pending a ruling on the appeal. See Note 14 to the Condensed Consolidated Financial Statements included in Item 1 of Part I of this Form 10-Q.

Item 1A. RISK FACTORS

As of the quarter ended June 30, 2008, there were no additional material risks and no material changes to the risk factors discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended September 30, 2007.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

Item 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

Item 5. OTHER INFORMATION

None.

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Item 6. EXHIBITS

(a) Exhibits required by Item 601 of Regulation S-K are set forth below.

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.
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)	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.
	(c)	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.
	(d)	Amendment No. 3 to Amended and Restated Advisory Contract, made as of January 17, 2008 by and among the Trust and B. F. Saul Company, as filed as Exhibit 10(q) to the Trust’s December 31, 2007 Form 10-Q and is hereby incorporated by reference.
	(e)	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.
	(f)	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.
	(g)	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.
	(h)	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.
	(i)	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.

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(j)	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.
(k)	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.
(l)	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.
(m)	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.
(n)	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.
(o)	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.
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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SIGNATURES,

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	B. F. SAUL REAL ESTATE INVESTMENT TRUST
	(Registrant)
Date: August 13, 2008	Stephen R. Halpin, Jr.
	Stephen R. Halpin, Jr.
	Vice President and Chief Financial Officer (Principal Financial Officer)
Date: August 13, 2008	Kenneth D. Shoop
	Kenneth D. Shoop
	Vice President, Chief Accounting Officer and Treasurer (Principal Accounting Officer)

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