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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---

FORM 10-K

(Mark One)



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

For the fiscal year ended September 30, 2006



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

For the transition period from ________________ to ________________

Commission File
number 1-7184

B. F. SAUL REAL ESTATE INVESTMENT TRUST

(Exact name of registrant as specified in its charter)



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



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

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

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



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

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

N/A

(Title of class)

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

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

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

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

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

Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer  x

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

There were no Common Shares of Beneficial Interest held by non-affiliates of the registrant as ofMarch 31, 2006.

The number of Common Shares of Beneficial Interest, $1 Par Value, outstanding as of December 19, 2006 was 4,807,510.



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##### Table of Contents

TABLE OF CONTENTS

PART I



|                                                                                                                    |  |    
|------------------------------------------------------------------------------------------------------------------- |  | ---
|ITEM 1. BUSINESS                                                                                                    |  |    
|Overview                                                                                                            |  | 4  
|Real Estate                                                                                                         |  | 4  
|Banking                                                                                                             |  | 4  
|Federal Taxation                                                                                                    |  | 34 
|                                                                                                                    | 
|ITEM 1A. RISK FACTORS                                                                                               |  | 36 
|                                                                                                                    | 
|ITEM 1B. UNRESOLVED STAFF COMMENTS                                                                                  |  | 43 
|                                                                                                                    | 
|ITEM 2. PROPERTIES                                                                                                  |  | 44 
|Real Estate                                                                                                         |  | 44 
|Banking                                                                                                             |  | 44 
|                                                                                                                    | 
|ITEM 3. LEGAL PROCEEDINGS                                                                                           |  | 44 
|                                                                                                                    | 
|ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                         |  | 44 
|                                                                                                                    | 
|PART II                                                                                                             |  |    
|                                                                                                                    | 
|ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES |  | 45 
|                                                                                                                    | 
|ITEM 6. SELECTED FINANCIAL DATA                                                                                     |  | 45 
|                                                                                                                    | 
|ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                       |  | 48 
|Financial Condition                                                                                                 |  | 50 
|Real Estate                                                                                                         |  | 50 
|Banking                                                                                                             |  | 50 
|Liquidity and Capital Resources                                                                                     |  | 60 
|Real Estate                                                                                                         |  | 60 
|Banking                                                                                                             |  | 64 
|Results of Operations                                                                                               |  | 67 
|Fiscal 2006 Compared to Fiscal 2005                                                                                 |  | 67 
|Real Estate                                                                                                         |  | 67 
|Banking                                                                                                             |  | 68 
|Fiscal 2005 Compared to Fiscal 2004                                                                                 |  | 73 
|Real Estate                                                                                                         |  | 73 
|Banking                                                                                                             |  | 74 
|                                                                                                                    | 
|ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                 |  | 77 
|                                                                                                                    | 
|ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                 |  | 77 
|                                                                                                                    | 
|ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                        |  | 140
|                                                                                                                    | 
|ITEM 9A. CONTROLS AND PROCEDURES                                                                                    |  | 140
|                                                                                                                    | 
|ITEM 9B. OTHER INFORMATION                                                                                          |  | 140



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|                                                                                                        |  |    
|------------------------------------------------------------------------------------------------------- |  | ---
|PART III                                                                                                |  |    
|                                                                                                        | 
|ITEM 10. TRUSTEES AND EXECUTIVES OFFICERS OF THE TRUST                                                  |  | 141
|Executive Officers of the Trust Who Are Not Directors                                                   |  | 141
|Committees of the Board of Trustees                                                                     |  | 142
|                                                                                                        | 
|ITEM 11. EXECUTIVE COMPENSATION                                                                         |  | 142
|                                                                                                        | 
|ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |  | 146
|                                                                                                        | 
|ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                 |  | 146
|                                                                                                        | 
|ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                         |  | 148
|                                                                                                        | 
|PART IV                                                                                                 |  |    
|                                                                                                        | 
|ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                     |  | 149



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PART I



|ITEM 1. | BUSINESS
|------- | --------

OVERVIEW

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

The principal business activities of the Trust are the ownership of 80% of the outstanding common stock of Chevy Chase Bank, F.S.B. (Chevy Chase or the
Bank), whose assets accounted for 96% of the Trusts consolidated assets at September 30, 2006, and the ownership and development of income-producing properties. By virtue of its ownership of a majority interest in Chevy Chase,
the Trust is a savings and loan holding company and subject to regulation, examination and supervision by the Office of Thrift Supervision, also know as OTS. See BankingHolding Company Regulation.

The Trust recorded net income of $57.0 million in the fiscal year ended September 30, 2006, compared to a net income of $73.6 million in the fiscal year ended
September 30, 2005.

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

REAL ESTATE

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

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

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

BANKING

Chevy Chase Bank, F.S.B., referred to in this document as Chevy Chase or the Bank, is a
federally chartered and federally insured stock savings bank which at September 30, 2006 was conducting business from 265 full-service branch offices, including 54 grocery store banking centers, and more than 1,000 automated teller machines in
Maryland, Delaware, Virginia and the District of Columbia. The Banks home office is in McLean, Virginia and its executive offices are in Bethesda, Maryland, both suburban communities of Washington, DC. The Bank either directly or through a
wholly owned subsidiary also maintains two commercial loan production offices located in Baltimore, Maryland and Northern Virginia and seven mortgage loan production offices in the mid-Atlantic region. In addition, the Bank uses third party
originators to supplement its direct origination of loans. At September 30, 2006, the Bank had total assets of $14.2 billion, total deposits of $10.4 billion and total stockholders equity of $790.2 million. Based on total assets at
September 30, 2006, Chevy Chase is the largest full-service bank headquartered in the Washington, DC metropolitan area.

Chevy Chase is a consumer
oriented, full-service banking institution principally engaged in the business of attracting deposits from the public and using those deposits, together with borrowings and other funds, to make loans secured by real estate, primarily residential
mortgage loans, and other consumer loans. The Bank also has an active commercial lending program. During the past year, the Bank began offering small business loans through its deposit branches. The Banks principal deposit and retail lending
markets are located in the Washington, DC metropolitan area. The Banks wholesale activities include the acquisition of loans through third party originators. As a complement to its basic



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deposit and lending activities, the Bank provides related financial services to its customers, including securities brokerage and insurance products offered
through its subsidiaries. In addition, the Bank offers a variety of investment products and provides fiduciary services to a primarily institutional customer base through its subsidiary, ASB Capital Management LLC, and to a primarily high net worth
customer base through another subsidiary, Chevy Chase Trust Company.

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

Chevy Chase recorded operating income of $138.8 million for the year ended September 30, 2006, compared to operating income of $189.7 million for the year ended
September 30, 2005. At September 30, 2006, the Banks tangible, core, tier 1 risk-based and total risk-based regulatory capital ratios were 6.15%, 6.15%, 9.12% and 11.21%, respectively. The Banks regulatory capital ratios
exceeded the standards established for well-capitalized institutions under the prompt corrective action regulations established pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991, also known as
FDICIA.

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



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REAL ESTATE

Real
Estate Investments

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

The following tables set forth, at and for the periods indicated, certain information regarding the properties in the Real Estate Trusts investment portfolio at September 30, 2006.

Hotels



|                 |  |                                   |  |                          |  |                       |                          |  |                   |      |  |    |      |  |      |        |      |   |        |  |   |       
|---------------- |  | --------------------------------- |  | ------------------------ |  | --------------------- | ------------------------ |  | ----------------- | ---- |  | -- | ---- |  | ---- | ------ | ---- | - | ------ |  | - | ------
|                 |  | Name                              |  | Rooms (1)                |  | Average Occupancy (2) |                          |  | Average Room Rate
|                 |  |                                   |  | Year Ended September 30, |  |                       | Year Ended September 30,
|Location         |  |                                   |  | 2006                     |  |                       | 2005                     |  |                   | 2004 |  |    | 2006 |  | 2005 |        | 2004
|FLORIDA          |  |                                   |  |                          |  |                       |                          |  |                   |      |  |    |      |  |      |        |      |   |        |  |   |       
|Boca Raton       |  | Boca Raton SpringHill Suites      |  | 146                      |  | 72                    | %                        |  | 75                | %    |  | 64 | %    |  | $    | 102.43 |      | $ | 88.46  |  | $ | 79.78 
|Boca Raton       |  | Boca Raton TownePlace Suites      |  | 91                       |  | 71                    | %                        |  | 79                | %    |  | 73 | %    |  | $    | 106.32 |      | $ | 83.04  |  | $ | 68.70 
|Ft. Lauderdale   |  | Ft. Lauderdale TownePlace Suites  |  | 95                       |  | 72                    | %                        |  | 80                | %    |  | 83 | %    |  | $    | 99.99  |      | $ | 81.41  |  | $ | 65.20 
|MARYLAND         |  |                                   |  |                          |  |                       |                          |  |                   |      |  |    |      |  |      |        |      |   |        |  |   |       
|Gaithersburg     |  | Gaithersburg Holiday Inn          |  | 300                      |  | 68                    | %                        |  | 68                | %    |  | 63 | %    |  | $    | 91.71  |      | $ | 87.03  |  | $ | 82.91 
|Gaithersburg     |  | Gaithersburg TownePlace Suites    |  | 91                       |  | 68                    | %                        |  | 70                | %    |  | 78 | %    |  | $    | 101.36 |      | $ | 92.08  |  | $ | 77.63 
|MICHIGAN         |  |                                   |  |                          |  |                       |                          |  |                   |      |  |    |      |  |      |        |      |   |        |  |   |       
|Auburn Hills     |  | Auburn Hills Holiday Inn Select   |  | 190                      |  | 67                    | %                        |  | 62                | %    |  | 63 | %    |  | $    | 98.92  |      | $ | 97.92  |  | $ | 99.54 
|VIRGINIA         |  |                                   |  |                          |  |                       |                          |  |                   |      |  |    |      |  |      |        |      |   |        |  |   |       
|Arlington        |  | National Airport Crowne Plaza     |  | 308                      |  | 67                    | %                        |  | 65                | %    |  | 65 | %    |  | $    | 156.17 |      | $ | 137.10 |  | $ | 129.50
|Arlington        |  | National Airport Holiday Inn      |  | 280                      |  | 70                    | %                        |  | 68                | %    |  | 70 | %    |  | $    | 130.51 |      | $ | 120.03 |  | $ | 95.25 
|Herndon          |  | Herndon Holiday Inn Express       |  | 115                      |  | 79                    | %                        |  | 74                | %    |  | 71 | %    |  | $    | 113.91 |      | $ | 104.27 |  | $ | 89.69 
|McLean           |  | Tysons Corner Courtyard           |  | 229                      |  | 77                    | %                        |  | 74                | %    |  | 74 | %    |  | $    | 162.32 |      | $ | 151.02 |  | $ | 135.36
|McLean           |  | Tysons Corner Holiday Inn         |  | 316                      |  | 68                    | %                        |  | 65                | %    |  | 60 | %    |  | $    | 140.33 |      | $ | 124.22 |  | $ | 106.07
|Sterling         |  | Dulles Airport Hampton Inn        |  | 123                      |  | 78                    | %                        |  | 74                | %    |  | 71 | %    |  | $    | 117.55 |      | $ | 114.97 |  | $ | 87.90 
|Sterling         |  | Dulles Airport Holiday Inn        |  | 297                      |  | 73                    | %                        |  | 70                | %    |  | 70 | %    |  | $    | 122.94 |      | $ | 113.90 |  | $ | 89.27 
|Sterling         |  | Dulles Airport TownePlace Suites  |  | 95                       |  | 67                    | %                        |  | 72                | %    |  | 87 | %    |  | $    | 119.97 |      | $ | 111.16 |  | $ | 74.42 
|Sterling         |  | Cascades Marketplace Hampton Inn  |  | 152                      |  | 73                    | %                        |  | 72                | %    |  | 78 | %    |  | $    | 114.74 |      | $ | 113.30 |  | $ | 90.48 
|Sterling         |  | Dulles South Hampton Inn (3)      |  | 137                      |  | 68                    | %                        |  |                  |      |  |   |      |  | $    | 109.87 |      |   |       |  |   |      
|WASHINGTON, D.C. |  | The Hay Adams (4)                 |  | 145                      |  | 79                    | %                        |  |                  |      |  |   |      |  | $    | 401.64 |      |   |       |  |   |      
|PROPERTIES SOLD  |  |                                   |  |                          |  |                       |                          |  |                   |      |  |    |      |  |      |        |      |   |        |  |   |       
|Cincinnati       |  | Cincinnati Holiday Inn (5)        |  |                         |  | 49                    | %                        |  | 49                | %    |  | 51 | %    |  |      |       |      | $ | 70.12  |  | $ | 71.05 
|Rochester        |  | Rochester Airport Holiday Inn (6) |  |                         |  | 65                    | %                        |  | 65                | %    |  | 62 | %    |  |      |       |      | $ | 73.32  |  | $ | 71.66 
|Pueblo           |  | Pueblo Holiday Inn (7)            |  |                         |  |                      |                          |  |                  |      |  | 50 | %    |  |      |       |      |   |       |  | $ | 58.12 
|                 |  |                                   |  |                          |  |                       |                          |  |                   |      |  |    |      |  |      |        |      |   |        |  |   |       
|                 |  |                                   |  | 3,110                    |  | 70                    | %                        |  | 68                | %    |  | 66 | %    |  | $    | 128.88 |      | $ | 106.81 |  | $ | 91.67 
|                 |  |                                   |  |                          |  |                       |                          |  |                   |      |  |    |      |  |      |        |      |   |        |  |   |       



|(1) | Available rooms as of September 30, 2006.
|--- | -----------------------------------------



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



|(3) | Asset acquired November 1, 2005
|--- | -------------------------------



|(4) | Asset acquired March 24, 2006.
|--- | ------------------------------



|(5) | Asset sold January 19, 2006.
|--- | ----------------------------



|(6) | Asset sold December 16, 2005.
|--- | -----------------------------



|(7) | Asset sold December 9, 2004.
|--- | ----------------------------



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Office and Industrial



|                |  |                           |               |                       |  |                          |   |  |                     |   |  |      |   |  |         |     |  |         |    
|--------------- |  | ------------------------- | ------------- | --------------------- |  | ------------------------ | - |  | ------------------- | - |  | ---- | - |  | ------- | --- |  | ------- | ---
|Location        |  | Name                      |               | GrossLeasableArea (1) |  | Leasing Percentages      |   |  | Expiring Leases (1) |  
|                |  |                           | September 30, |                       |  | Year EndingSeptember 30, |  
|                |  |                           | 2006          |                       |  | 2005                     |   |  | 2004                |   |  | 2007 |   |  | 2008    |    
|FLORIDA         |  |                           |               |                       |  |                          |   |  |                     |   |  |      |   |  |         |     |  |         |    
|Fort Lauderdale |  | Commerce CenterPhase II  |               | 61,149                |  | 100                      | % |  | 92                  | % |  | 82   | % |  | 22,249  |     |  | 1,814   |    
|GEORGIA         |  |                           |               |                       |  |                          |   |  |                     |   |  |      |   |  |         |     |  |         |    
|Atlanta         |  | 900 Circle 75 Parkway     |               | 345,502               |  | 87                       | % |  | 84                  | % |  | 82   | % |  | 73,232  |     |  | 49,960  |    
|Atlanta         |  | 1000 Circle 75 Parkway    |               | 89,412                |  | 88                       | % |  | 87                  | % |  | 84   | % |  | 10,711  |     |  | 3,881   |    
|Atlanta         |  | 1100 Circle 75 Parkway    |               | 269,049               |  | 83                       | % |  | 90                  | % |  | 91   | % |  | 95,924  |     |  | 22,501  |    
|MARYLAND        |  |                           |               |                       |  |                          |   |  |                     |   |  |      |   |  |         |     |  |         |    
|Bethesda        |  | 8001 Wisconsin Avenue (3) |               | 12,131                |  | 100                      | % |  | 100                 | % |  |     |   |  | 2,250   |     |  | 4,060   |    
|Laurel          |  | Sweitzer Lane             |               | 150,020               |  | 100                      | % |  | 100                 | % |  | 100  | % |  | NONE    |     |  | NONE    |    
|VIRGINIA        |  |                           |               |                       |  |                          |   |  |                     |   |  |      |   |  |         |     |  |         |    
|McLean          |  | 8201 Greensboro Drive     |               | 360,854               |  | 98                       | % |  | 99                  | % |  | 93   | % |  | 24,781  |     |  | 71,011  |    
|McLean          |  | Tysons Park Place         |               | 247,581               |  | 91                       | % |  | 96                  | % |  | 91   | % |  | 12,451  |     |  | 25,195  |    
|Sterling        |  | Dulles North              |               | 59,886                |  | 100                      | % |  | 100                 | % |  | 100  | % |  | NONE    |     |  | 12,802  |    
|Sterling        |  | Dulles North Two          |               | 79,210                |  | 90                       | % |  | 100                 | % |  | 100  | % |  | 1.800   |     |  | NONE    |    
|Sterling        |  | Dulles North Four         |               | 100,207               |  | 100                      | % |  | 100                 | % |  | 100  | % |  | 100,207 |     |  | NONE    |    
|Sterling        |  | Dulles North Five         |               | 80,391                |  | 100                      | % |  | 100                 | % |  | 100  | % |  | NONE    |     |  | NONE    |    
|Sterling        |  | Dulles North Six          |               | 53,517                |  | 100                      | % |  | 100                 | % |  | 100  | % |  | NONE    |     |  | NONE    |    
|Sterling        |  | Loudoun Tech I            |               | 81,238                |  | 75                       | % |  | 24                  | % |  | 24   | % |  | NONE    |     |  | NONE    |    
|                |  |                           |               |                       |  |                          |   |  |                     |   |  |      |   |  |         |     |  |         |    
|                |  | Totals                    |               | 1,990,147             |  | 92                       | % |  | 91                  | % |  | 89   | % |  | 343,605 | (2) |  | 191,224 | (2)
|                |  |                           |               |                       |  |                          |   |  |                     |   |  |      |   |  |         |     |  |         |    



|(1) | Square feet
|--- | -----------



|(2) | Represents 17.3% and 9.6%, respectively, of the Real Estate Trusts office and industrial portfolio in terms of square footage as of September 30, 2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Acquired May 25, 2005.
|--- | ----------------------

Land Parcels



|                                                   |  |                                                                                      |  |                    |  |                                                                             
|-------------------------------------------------- |  | ------------------------------------------------------------------------------------ |  | ------------------ |  | ----------------------------------------------------------------------------
|Location                                           |  | Name                                                                                 |  | Acres              |  | Zoning                                                                      
|FLORIDA Boca Raton Fort Lauderdale                 |  | Arvida Park of Commerce Commerce
Center                                              |  | 6.51.6             |  | Mixed Use Office, Warehouse                                                 
|GEORGIA Atlanta                                    |  | Circle 75 (1)                                                                        |  | 96.6               |  | Residential, Office, Industrial                                             
|KANSAS Overland Park                               |  | Overland Park                                                                        |  | 136.6              |  | Residential, Office, Retail                                                 
|MICHIGAN Auburn Hills                              |  | Auburn Hills Holiday Inn                                                             |  | 0.5                |  | Commercial                                                                  
|VIRGINIA Ashburn McLean Sterling Sterling Sterling |  | Ashburn Village (2) Park Place II (1) Cedar Green Church Road Sterling Boulevard (1) |  | 88.43.810.232.09.4 |  | Mixed use Office, Industrial Commercial Office, Industrial Hotel, Industrial
|Sterling                                           |  | Loudoun Tech II (2)                                                                  |  | 7.4                |  | Commercial                                                                  
|                                                   |  |                                                                                      |  |                    |  |                                                                             
|                                                   |  | Total                                                                                |  | 393.0              |  |                                                                             
|                                                   |  |                                                                                      |  |                    |  |                                                                             



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



|(2) | Purchased in fiscal 2005
|--- | ------------------------



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Other Real Estate Investments

PURCHASE-LEASEBACK PROPERTIES (1)

APARTMENTS



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



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



|(2) | Square feet.
|--- | ------------

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

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

As of September 30, 2006, the Real Estate Trust owned, directly or through one of its wholly owned subsidiaries, 4,721,000 shares of Saul Centers representing 27.5%
of the companys outstanding common stock.

As of September 30, 2006 the Real Estate Trust owned, directly or through one of its wholly owned
subsidiaries, 4,378,000 units of limited partnership interests in Saul Holdings, representing a 19.4% limited partnership interest. The Real Estate Trust owns rights enabling it to convert its limited partnership interests in Saul Holdings into
shares of Saul Centers common stock on the basis of one share of Saul Centers common stock for each partnership unit. However, under the terms of the limited partnership agreement of Saul Holdings Limited Partnership, at the current
time, the units may not be converted into shares of Saul Centers common stock because the conversion would cause the Real Estate Trust and certain affiliates of the Trust to beneficially own collectively greater than 24.9% of the value of the
outstanding equity securities of Saul Centers.

The shares of Saul Centers common stock are listed on the New York Stock Exchange under trading
symbol BFS.

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

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



8



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##### Table of Contents

Competition

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

Environmental Matters

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

Holding Company Regulation

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

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

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

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

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

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



| |  |  | an amount equal to 5.0% of the Banks total assets at the time the Bank became undercapitalized, and
| | - |  | ------------------------------------------------------------------------------------------------------



9



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##### Table of Contents

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

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

BANKING

Regulation

Federal Home Loan Bank System. The Bank is a member
of the Federal Home Loan Bank (the FHLB) of Atlanta, which is one of 12 FHLBs administered by the Federal Housing Finance Board, an independent agency within the executive branch of the federal government. The FHLBs serve as central
credit facilities for their members. Their primary credit mission is to facilitate residential mortgage lending and support community and economic development activity in rural and urban communities. The Bank regularly obtains advances from the FHLB
of Atlanta. At September 30, 2006, the Bank had outstanding advances of $1.3 billion. See Note 23 to the Consolidated Financial Statements in this report and Deposits and Other Sources of Funds  Borrowings.

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



| |  |  | 1.0% of mortgage-related assets;
| | - |  | --------------------------------



| |  |  | $500; or
| | - |  | --------



| |  |  | 5.0% of outstanding advances.
| | - |  | -----------------------------

The Bank had an investment of $85.4
million in the capital stock of the FHLB of Atlanta at September 30, 2006. The Bank earned dividends on that stock of $7.0 million and $6.1 million during the years ended September 30, 2006 and 2005, respectively. In March 2006, the
Federal Housing Finance Board proposed regulations that would impose new limits on a FHLBs ability to issue capital stock and pay dividends. Under the proposal, FHLBs would be prevented from paying dividends unless they were able to maintain a
minimum level of retained earnings. Furthermore, FHLBs would be prohibited from issuing new capital stock if existing excess stock exceeded 1% of a FHLBs total assets. Excess stock is stock that is held by members and that exceeds the minimum
amount of FHLB stock they are required to hold. Final regulations have not yet been adopted and the Bank is unable to predict the extent to which any final regulations would limit the amount of dividends it may receive in the future from the FHLB of
Atlanta.

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

Liquidity Requirements.The Bank is required to maintain sufficient liquidity to ensure its safe and sound operation. Failure to do so could subject the Bank to monetary penalties imposed by the OTS. Management believes that the
Banks ratio of cash and cash equivalents and other liquid assets to deposits and short-term borrowings of 7.4% at September 30, 2006 was sufficient to ensure the Banks safe and sound operation.

Deposit Insurance Premiums. Under FDIC insurance regulations, the Bank is required to pay premiums for insurance of its deposit accounts. The FDIC uses a
risk-based premium system in which an institution pays premiums for deposit insurance on its insured deposits based on its placement in one of several risk categories based on its overall supervisory rating and its capital category under the prompt
corrective action regulations. See Prompt Corrective Action. Institutions placed in the lowest-risk category paid no premiums (other than the FICO assessments discussed below) in 2005 or 2006.

Several important changes have been made to the federal deposit insurance system as a result of enactment of The Federal Deposit Insurance Reform Act of 2005:



| |  |  | On March 31, 2006, the FDIC merged its previously separate insurance funds for commercial banks (the Bank Insurance Fund) and thrifts (the Savings Association Insurance Fund)
to form the Deposit Insurance Fund, or DIF.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The reserve level of the DIF will be set annually by the FDIC in a range between 1.15% to 1.50% of insured deposits, instead of being fixed at 1.25% as required under prior law. The
FDIC has set the reserve level at 1.25% for 2007. As of June 30, 2006, the DIF reserve level was 1.23%. If the reserve level of the insurance fund falls below 1.15%, or is expected to do so within six months, the FDIC must adopt a restoration
plan that will restore the DIF to a 1.15% ratio generally within five years rather than immediately as under prior law. If the reserve level exceeds 1.35%, the FDIC may return some of the excess in the form of dividends to insured institutions.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The FDIC now has the ability to assess risk-based premiums on all insured institutions, including those that are in the lowest risk category.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Effective April 1, 2006, deposit insurance coverage for self-directed retirement accounts increased to $250,000.
| | - |  | ----------------------------------------------------------------------------------------------------------------



10



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##### Table of Contents

| |  |  | A one-time initial assessment credit against future premiums will be granted to institutions that have made past contributions to the fund. Based on preliminary calculations
published by the FDIC, the Bank will receive a credit of approximately $5.9 million.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

On November 2, 2006, the FDIC adopted significant
changes to its risk-based deposit insurance assessment regulations that will take effect January 1, 2007. The number of risk categories into which institutions will be placed has been reduced from nine to four and these broad categories will
continue to be based on overall supervisory ratings and prompt corrective action categories. Highly rated, well-capitalized institutions generally will remain in the lowest risk category; however, deposit insurance premiums for those institutions
will initially range between five and seven basis points depending on a variety of factors. For institutions like the Bank, those factors are supervisory ratings in various categories and long-term debt ratings. The Banks specific premium will
be determined by a mathematical formula incorporating those factors, subject to supervisory adjustments of up to 0.5 basis points. Institutions in the three higher risk categories will initially pay premiums of 10, 28 or 43 basis points. Based on
its total deposits at September 30, 2006, the Banks deposit insurance premiums for calendar 2007 likely would range between zero and $1.4 million in calendar 2007, after giving effect to the available credit, and are likely to be
significantly higher in future years after the credit expires.

Commercial banks and thrifts continue to be required to share in the payment of interest
due on Financing Corporation (FICO) bonds used to provide liquidity to the savings and loan industry in the 1980s. Annual FICO assessments added to deposit insurance premiums ranged from 1.26 to 1.34 basis points during the Banks
2006 fiscal year.

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

Regulatory Capital

The Bank is
subject to:



| |  |  | a minimum tangible capital requirement;
| | - |  | ---------------------------------------



| |  |  | a minimum core (or leverage) capital requirement; and
| | - |  | -----------------------------------------------------



| |  |  | a minimum risk-based capital requirement.
| | - |  | -----------------------------------------

Each of these requirements
generally must be no less stringent than the capital standards for national banks. At September 30, 2006, the Banks tangible capital ratio was 6.15%, its core (or leverage) capital ratio was 6.15%, and its total risk-based capital ratio
was 11.21%, compared to the minimum requirements of 1.50%, 4.00% and 8.00%, respectively.

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

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

Under OTS regulations, servicing assets can be included
in core capital in an amount up to 100% of core capital. Non-mortgage servicing assets are subject to a sublimit of 25% of core capital. For these purposes, servicing assets are valued at the lesser of 90% of fair market value or 100% of the current
unamortized book value. At September 30, 2006, the Bank had qualifying servicing assets with a carrying value of $162.4 million, which constituted 18.7% of core capital at that date.

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

There are
currently four categories of risk-weightings:



| |  |  | 0% for cash and similar assets;
| | - |  | -------------------------------



| |  |  | 20% for qualifying mortgage-backed securities;
| | - |  | ----------------------------------------------



| |  |  | 50% for qualifying residential permanent real estate loans; and
| | - |  | ---------------------------------------------------------------



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

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



11



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##### Table of Contents

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

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



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



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



| |  |  | apply a ratings-based approach that sets capital requirements for positions in securitizations according to their relative risk exposure.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------

At September 30, 2006, the Bank had credit enhancing interest-only strips receivable of $0.1 million, which constituted 0.01% of Tier 1 capital.

The Bank may use supplementary capital to satisfy the risk-based capital requirement up to an amount equal to its core capital. Supplementary capital includes cumulative
perpetual preferred stock, qualifying non-perpetual preferred stock, qualifying subordinated debt, and allowances for loan losses up to a maximum of 1.25% of risk-weighted assets. At September 30, 2006, the Bank had $25.0 million in its
allowance for loan losses, all of which was includable as supplementary capital.

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



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



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

The Bank uses the second option for its 6-7/8% subordinated debentures due 2013 and must continue
to use that option for any future issuances as long as the prior issuance remains outstanding. At September 30, 2006, the Bank had $175.0 million in maturing subordinated capital instruments, all of which was includable as supplementary
capital.

All or a portion of the assets of each of the Banks subsidiaries are generally consolidated with the assets of the Bank for regulatory
capital purposes unless all of the Banks investments in, and extensions of credit to, those subsidiaries are deducted from capital. The Banks investments in, and loans to, subsidiaries engaged in activities not permissible for a national
bank are, with certain exceptions, deducted from capital under each of the three regulatory capital requirements. The Banks real estate development subsidiaries are its only subsidiaries engaged in activities not permissible for a national
bank. At September 30, 2006, the Banks investments in, and loans to, these non-includable subsidiaries totaled approximately $3.1 million, all of which was deducted from tangible capital.

OTS capital regulations also require a 100% deduction from total capital of all equity investments that are not permissible for national banks. At September 30,
2006, the Bank had one property with a book value of $2.1 million which was treated as an equity investment for regulatory capital purposes.

OTS capital
regulations provide a five-year holding period for real estate acquired in settlement of loans (REO or real estate held for sale) to qualify for an exception from treatment as an equity investment. The five year period may be
extended by the OTS. If an REO property is considered an equity investment, its then-current book value is deducted from total capital. Accordingly, if the Bank is unable to dispose of any REO property prior to the end of its applicable five-year
holding period and is unable to obtain an extension of that five-year holding period from the OTS, the Bank could be required to deduct the then-current book value of such REO property from risk-based capital. In July 2006, the Bank received from
the OTS additional extensions through July 31, 2007, of the holding periods for certain of its REO properties acquired through foreclosure in fiscal years 1990 and 1995. See Managements Discussion and Analysis of Financial Condition
and Results of Operations  Financial Condition  Capital.

OTS policies generally require that the Bank occupy at least 25% of an office
building in order for it to be considered a permissible investment in office premises and for the Bank to avoid having to deduct its investment in the building from total capital. OTS also provides a five-year grace period after a building is no
longer sufficiently occupied by the Bank before it must either be sold or treated as an equity investment and deducted from total capital. The Bank owns an office building substantially all of which was occupied by the Bank until completion of the
Banks new headquarters building in December 2001. The Bank plans to sell the building to the Real Estate Trust. If the Bank is unable to complete the sale by December 31, 2006 and does not obtain an extension of the five year grace period
from the OTS, the book value of the building, which was



12



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##### Table of Contents

$26.9 million at September 30, 2006, would have to be deducted from the Banks total capital on December 31, 2006. See Managements
Discussion and Analysis of Financial Condition and Results of Operations  Financial Condition  Capital.

On September 5, 2006, the
OTS and the other U.S. federal financial institution regulators proposed detailed regulations to implement for the largest U.S. banks the Basel Committee on Banking Supervisions revised risk-based capital framework. That new framework,
referred to as Basel II, replaces the Basel Committees 1988 risk-based capital accord, which forms the basis for the current risk-based capital requirements of the OTS and the other U.S. federal financial institution regulators. The Basel II
proposal is designed to improve the risk sensitivity of the existing risk-based capital requirements and to enhance the risk measurement and management practices of large internationally active U.S. banking organizations. Key components of the
proposed U.S. version of Basel II include the following:



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



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



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



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



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

Chevy Chase will not be subject to the Basel II requirements.

In part to
address competitive concerns raised by Basel II, the OTS and the other federal banking agencies will be seeking public comment on proposed changes to existing Basel I risk-based capital requirements that could apply to the vast majority of U.S.
banks not subject to Basel II. The adoption of the proposed rules, generally referred to as Basel IA, would be voluntary, and institutions could choose to remain under the existing Basel I risk-based capital system.

According to a draft released on December 5, 2006, Basel 1A would include the following principal modifications to the existing Basel 1 system that applies to Chevy
Chase:



| |  |  | adding three new risk-weights (35, 75 and 150 percent) to the existing five risk-weights,
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | expanding the use of external credit ratings as an indicator of credit risk for externally-rated exposures,
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | expanding the range of collateral and guarantors that may qualify an exposure for a lower risk-weighting,
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | using loan-to-value ratios (LTV) ratios for assigning risk-weightings to residential mortgages,
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | increasing the capital requirements for certain short-term commitments,
| | - |  | -----------------------------------------------------------------------



| |  |  | assessing a risk-based capital charge to reflect the risks in securitizations backed by revolving retail exposures with early amortization provisions, and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | removing the 50% limit on the risk-weight for certain derivatives.
| | - |  | ------------------------------------------------------------------

Implementation of Basel II in the United States is not scheduled to begin until January 2008. The Bank is unable to predict at this time whether or in what form any final changes to the capital requirements will be adopted by the OTS or
their potential impact on the Bank.

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

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

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



13



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##### Table of Contents

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

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

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

At September 30, 2006, the Banks leverage ratio of 6.15%, its tier 1 risk-based ratio of 9.12%, and its total risk-based capital ratio of
11.21% exceeded the minimum ratios established for well-capitalized institutions.

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



| |  |  | the Banks premises and equipment used to conduct the Banks business;
| | - |  | ----------------------------------------------------------------------



| |  |  | liquid assets up to 20% of total assets; and
| | - |  | --------------------------------------------



| |  |  | intangible assets, including goodwill.
| | - |  | --------------------------------------

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

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

The Bank had 89.9% of its assets invested in qualified thrift investments at September 30, 2006, and met the QTL test in each of the
previous 12 months.

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



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



| |  |  | establish any new branch office at any location at which a national bank could not establish a branch office;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | obtain new advances from the FHLB; or
| | - |  | -------------------------------------



| |  |  | pay dividends beyond the amounts permissible if it were a national bank.
| | - |  | ------------------------------------------------------------------------

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

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

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

Dividends and Other Capital Distributions. OTS regulations limit the ability of the Bank to make capital distributions. Capital
distributions include payment of dividends, stock repurchases, cash-out mergers, repurchases of subordinated debt and other distributions



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charged against the capital accounts of an institution. The regulations do not apply to interest or principal payments on debt, including interest or
principal payments on the Banks outstanding subordinated debentures.

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

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



| |  |  | the Bank would be undercapitalized following the distribution;
| | - |  | --------------------------------------------------------------



| |  |  | the capital distribution raises safety and soundness concerns; or
| | - |  | -----------------------------------------------------------------



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

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

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

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

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

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



| |  |  | $50.0 million;
| | - |  | --------------



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



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

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

See Managements Discussion and Analysis of Financial Condition and
Results of Operations  Financial Condition  Capital and Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

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

Lending Limits. The Bank generally is prohibited from lending to one borrower and its related entities amounts in excess of 15% of unimpaired
capital and unimpaired surplus. The Bank may lend an additional 10% for loans fully secured by readily marketable collateral. The Banks regulatory lending limit was approximately $160.6 million at September 30, 2006, and no group
relationships exceeded this limit at that date.

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



| |  |  | restrict its rate of asset growth;
| | - |  | ----------------------------------



| |  |  | prohibit asset growth entirely;
| | - |  | -------------------------------



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| |  |  | require the institution to increase its ratio of tangible equity to assets;
| | - |  | ---------------------------------------------------------------------------



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



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

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

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

On September 29, 2006, the OTS and the other
federal banking regulators published guidance on the risks relating to nontraditional mortgage products, which include the Banks payment option and interest-only loan products. The guidance addresses:



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



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



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

Although the Bank already had implemented many of the key aspects of the new guidance, full implementation, could adversely affect the
Banks ability to compete effectively for these types of loans, particularly if other lenders, including non-federally regulated lenders, do not implement the new standards as rigorously.

On December 6, 2006, the OTS issued final guidance requiring thrifts actively engaged in commercial real estate (CRE) lending to identify and monitor
their CRE loan concentrations, establish internal concentration limits, and implement appropriate risk management procedures based on the size and risks of their CRE portfolios. The guidance also identifies criteria that will be used by the OTS to
identify those institutions with CRE concentration risk that may be subject to enhanced supervisory review. Based on those criteria, the Bank does not expect its existing CRE lending activities to be subject to enhanced review and does
not expect the new guidance to have a material effect on its operations.

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



| |  |  | semi-annual assessments for all savings institutions;
| | - |  | -----------------------------------------------------



| |  |  | examination fees for certain affiliates of savings institutions;
| | - |  | ----------------------------------------------------------------



| |  |  | application fees;
| | - |  | -----------------



| |  |  | securities filing fees; and
| | - |  | ---------------------------



| |  |  | publication fees.
| | - |  | -----------------

Of these fees, the semi-annual assessments are the
most significant, totaling $2.3 million for the Bank for the 12 month period ending December 31, 2006.

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

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



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

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

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

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



| |  |  | administrative expenses of the receiver;
| | - |  | ----------------------------------------



| |  |  | any deposit liability of the institution;
| | - |  | -----------------------------------------



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



| |  |  | any obligation subordinated to depositors or general creditors which is not a stockholder obligation; and
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | any obligation to stockholders arising as a result of their status as stockholders.
| | - |  | -----------------------------------------------------------------------------------

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

Federal Reserve System

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

Prior to December 23, 2005, the first $7.0 million of the Banks transaction accounts were subject to a 0% reserve requirement. A 3% reserve ratio was applied
to new transaction accounts over $7.0 million, up to and including $47.6 million. Any net transaction accounts over $47.6 million were subject to a 10% reserve requirement. Effective December 23, 2005, the FRB increased the amount of
transaction accounts subject to a 0% reserve requirement from $7.0 million to $7.8 million and increased the low reserve tranche from $47.6 million to $48.3 million. Effective December 21, 2006, the first $8.5 million of net
transaction accounts will be exempt from reserve requirements. A 3% reserve ratio will be applied to net transaction accounts over $8.5 million up to and including $45.8 million. A 10% reserve ratio will be applied to net transaction accounts in
excess of $45.8 million. The Bank met its reserve requirements for each period during the year ended September 30, 2006.

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

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

Community Reinvestment Act

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



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The Bank is committed to fulfilling its CRA obligation by providing access to a full range of credit-related products and
services to all segments of its community. Based on the last OTS examination covering the period from January 2003 through December 2004, the Bank received an Outstanding CRA rating. The Bank anticipates that its next CRA examination
will take place in 2007.

Other Aspects of Federal Law

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

Holding Company Regulation

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

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

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

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

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

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



| |  |  | an amount equal to 5.0% of the Banks total assets at the time the Bank became undercapitalized, or
| | - |  | -----------------------------------------------------------------------------------------------------



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

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

Recently Issued Accounting Standards

In September 2006, the Financial Accounting Standards Board (FASB) ratified Emerging Issues Task Force (EITF) consensus 06-5,



18



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##### Table of Contents

Accounting for Purchases of Life Insurance  Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin
No. 85-4 (EITF 06-5). EITF 06-5 eliminates the diversity in policyholder calculations of the amount that would be realized under a life insurance contract if that contract were terminated. Under EITF 06-5, policyholders will
be required to recognize contract-based values at their net present value. EITF 06-5 is effective for fiscal years beginning after December 15, 2006. Management does not expect the adoption of EITF 06-5 to have a material impact on the
Banks financial condition or results of operations.

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

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 clarifies the requirements
of SFAS No. 109, Accounting for Income Taxes, relating to the recognition of income tax benefits. FIN 48 provides a two-step approach to recognizing and measuring tax benefits when realization of the benefits is uncertain. The first
step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management does not expect the adoption of FIN 48 to have
a material impact on the Banks financial condition or results of operations.

In March 2006, the FASB issued SFAS No. 156, Accounting for
Servicing of Financial Assets (SFAS 156). SFAS 156 amends SFAS 140 to require an entity (i) to initially measure all separately recognized servicing assets and servicing liabilities at fair value, if practicable; (ii) to
separately present servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position; and (iii) to provide additional disclosures for all separately recognized servicing assets and servicing
liabilities. In addition, SFAS 156 permits an entity to irrevocably choose either the amortization method or the fair value measurement method for the subsequent measurement of each class of separately recognized servicing assets and servicing
liabilities. SFAS 156 is effective as of the beginning of the first fiscal year that begins after September 15, 2006. As a result of the adoption of SFAS 156 on October 1, 2006, the Bank will identify its mortgage servicing rights
(MSRs) relating primarily to residential mortgage loans as a class of servicing rights and will elect to apply fair value accounting to this class of MSRs. Presently, this class, which also includes servicing rights related to home
equity and home improvement loans, represents all of the Banks MSRs. The impact of the adoption, which represents the difference between the fair value and the carrying amount of the MSRs, net of any related valuation allowance, is $4,181, net
of related income taxes, and was recorded as a cumulative-effect adjustment to retained earnings on October 1, 2006.

In February 2006, the FASB
issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS 155). SFAS 155 amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133) and
SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140) by eliminating SFAS 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial
Interests in Securitized Financial Assets. SFAS 155 permits fair value measurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided that the whole instrument is accounted for on
a fair value basis and eliminates a restriction on the passive derivative instruments that a qualifying special-purpose entity may hold. SFAS 155 applies to all financial instruments acquired or issued after the beginning of any fiscal year
beginning after September 15, 2006, and upon adoption for existing bifurcated hybrid financial instruments not being used in hedging relationships. The adoption of this statement is not expected to have a material effect on the Banks
financial condition or results of operations.

Market Area

The Banks principal deposit and lending markets are located in the Washington, DC metropolitan area. Service industries and federal, state and local governments employ a significant portion of the Washington, DC area labor force,
while a substantial number of the nations 500 largest corporations have some presence in the area. The Washington, DC areas seasonally unadjusted unemployment rate is generally below the national rate and was 3.0% in September 2006,
compared to the national rate of 4.6%.

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

As of June 30,
2006, according to the most recently published industry statistics, Chevy Chase ranked fifth in market share in the Washington, DC metropolitan area with approximately 9.0% of deposits. At the same date, Chevy Chase had the largest market share of
deposits in Montgomery County, ranked third in market share of deposits in Prince Georges County and ranked seventh in market share in Fairfax County. The per capita incomes of Montgomery and Fairfax Counties rank among the highest of counties
and equivalent jurisdictions nationally. These



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two counties are also the Washington, DC areas largest suburban employment centers, with a substantial portion of their labor force consisting of
federal, state and local government employees. Private employment is concentrated in service and retail trade centers. The unemployment rate in each of Montgomery, Prince Georges and Fairfax Counties in September 2006 was 2.7%, 4.0% and 2.2%,
respectively, each of which was below the national rate of 4.6%. The individual state rates were 4.0% for Maryland and 3.2% for Virginia for the same month.

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

Investment and Other Securities

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

The Bank classifies its investment securities and mortgage-backed
securities as either held-to-maturity, available-for-sale or trading at the time such securities are acquired. All its investment securities and mortgage-backed securities were classified as held-to-maturity at
September 30, 2006 and 2005.

As part of its mortgage banking activities, the Bank exchanges loans held for sale for mortgage-backed securities and
then sells the mortgage-backed securities, which are classified as trading securities, to third party investors in the month of issuance. Gains and losses on sales of trading securities are determined using the specific identification method. There
were no mortgage-backed securities classified as trading securities at September 30, 2006 and 2005.

Lending and Leasing Activities

Loan Portfolio Composition. At September 30, 2006, the Banks loan portfolio totaled $10.6 billion, which represented 74.8% of its total assets. All
references in this report to the Banks loan portfolio refer to loans, whether they are held for sale and/or securitization or for investment, and exclude mortgage-backed securities. Loans collateralized by single-family residences constituted
83.8% of the loan portfolio and 62.1% of total assets at September 30, 2006. The following table sets forth information concerning the Banks loan portfolio, net of unfunded commitments, for the periods indicated.

Loan Portfolio

(Dollars in
thousands)



|                                    |  |               |            |   |           |       |   |         |   |            |           |  |       |         |  |   |            |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  
|----------------------------------- |  | ------------- | ---------- | - | --------- | ----- | - | ------- | - | ---------- | --------- |  | ----- | ------- |  | - | ---------- | - |  | ------- | - |  | --------- | --------- | - | ------- | ----- | - | --------- | - | --------- | - |  | ----- | -
|                                    |  | September 30, |           
|                                    |  | 2006          |            |   | 2005      |       |   | 2004    |   |            | 2003      |  |       | 2002    | 
|                                    |  | Balance       |            |   | % ofTotal |       |   | Balance |   |            | % ofTotal |  |       | Balance |  |   | % ofTotal  |   |  | Balance |   |  | % ofTotal |           |   | Balance |       |   | % ofTotal |  
|Residential Mortgage (1)            |  | $             | 7,107,302  |   |           | 67.7  | % |         | $ | 7,530,315  |           |  | 68.9  | %       |  | $ | 7,166,935  |   |  | 68.6    | % |  | $         | 5,761,993 |   |         | 64.7  | % |           | $ | 4,545,519 |   |  | 59.0  | %
|Home equity (1)(2)                  |  |               | 1,690,421  |   |           | 16.1  |   |         |   | 1,796,489  |           |  | 16.4  |         |  |   | 1,721,999  |   |  | 16.5    |   |  |           | 1,336,776 |   |         | 15.0  |   |           |   | 1,090,325 |   |  | 14.1  |  
|Other real estate                   |  |               | 607,451    |   |           | 5.8   |   |         |   | 358,937    |           |  | 3.3   |         |  |   | 261,997    |   |  | 2.5     |   |  |           | 253,791   |   |         | 2.8   |   |           |   | 280,777   |   |  | 3.6   |  
|Commercial (2)                      |  |               | 987,850    |   |           | 9.4   |   |         |   | 1,035,972  |           |  | 9.5   |         |  |   | 920,178    |   |  | 8.8     |   |  |           | 888,847   |   |         | 10.0  |   |           |   | 803,168   |   |  | 10.4  |  
|Automobile loans (1)                |  |               | 60,756     |   |           | 0.6   |   |         |   | 149,253    |           |  | 1.4   |         |  |   | 300,516    |   |  | 2.9     |   |  |           | 589,024   |   |         | 6.6   |   |           |   | 855,735   |   |  | 11.0  |  
|Other consumer                      |  |               | 46,755     |   |           | 0.4   |   |         |   | 53,742     |           |  | 0.5   |         |  |   | 70,140     |   |  | 0.7     |   |  |           | 84,606    |   |         | 0.9   |   |           |   | 140,222   |   |  | 1.9   |  
|                                    |  |               |            |   |           |       |   |         |   |            |           |  |       |         |  |   |            |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  
|                                    |  |               | 10,500,535 |   |           | 100.0 | % |         |   | 10,924,708 |           |  | 100.0 | %       |  |   | 10,441,765 |   |  | 100.0   | % |  |           | 8,915,037 |   |         | 100.0 | % |           |   | 7,715,746 |   |  | 100.0 | %
|                                    |  |               |            |   |           |       |   |         |   |            |           |  |       |         |  |   |            |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  
|Unearned premiums and discounts     |  |               | 441        |   |           |       |   |         |   | 654        |           |  |       |         |  |   | 894        |   |  |         |   |  |           | 1,428     |   |         |       |   |           |   | 1,690     |   |  |       |  
|Net deferred loan origination costs |  |               | 112,419    |   |           |       |   |         |   | 125,210    |           |  |       |         |  |   | 116,124    |   |  |         |   |  |           | 80,320    |   |         |       |   |           |   | 57,627    |   |  |       |  
|Allowance for loan losses           |  |               | (25,000    | ) |           |       |   |         |   | (28,640    | )         |  |       |         |  |   | (37,750    | ) |  |         |   |  |           | (58,397   | ) |         |       |   |           |   | (66,079   | ) |  |       |  
|                                    |  |               |            |   |           |       |   |         |   |            |           |  |       |         |  |   |            |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  
|                                    |  |               | 87,860     |   |           |       |   |         |   | 97,224     |           |  |       |         |  |   | 79,268     |   |  |         |   |  |           | 23,351    |   |         |       |   |           |   | (6,762    | ) |  |       |  
|                                    |  |               |            |   |           |       |   |         |   |            |           |  |       |         |  |   |            |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  
|Total loans receivable              |  | $             | 10,588,395 |   |           |       |   |         | $ | 11,021,932 |           |  |       |         |  | $ | 10,521,033 |   |  |         |   |  | $         | 8,938,388 |   |         |       |   |           | $ | 7,708,984 |   |  |       |  
|                                    |  |               |            |   |           |       |   |         |   |            |           |  |       |         |  |   |            |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  



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



|(2) | Net of undisbursed portion of loans.
|--- | ------------------------------------



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##### Table of Contents

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

Contractual Principal Repayments of Loans. The
following table shows the scheduled contractual principal repayments of the Banks loans at September 30, 2006. The entire balance of loans held for securitization and/or sale is shown in the year ending September 30, 2006, because
those loans are expected to be sold in less than one year.

Contractual Principal Repayments

(In thousands)



|                                          |  |                                                     |            |                                                                    |   |                    |  |   |         |  |   |          
|----------------------------------------- |  | --------------------------------------------------- | ---------- | ------------------------------------------------------------------ | - | ------------------ |  | - | ------- |  | - | ---------
|                                          |  | PrincipalBalanceOutstanding atSeptember 30, 2006(1) |            | Approximate Principal Repayments Due in Years Ending September 30,
|                                          |  | 2007                                                |            | 2008-2011                                                          |   | 2012 andThereafter
|Single family residential                 |  | $                                                   | 6,648,885  |                                                                    | $ | 6,600              |  | $ | 38,078  |  | $ | 6,604,207
|Home equity                               |  |                                                     | 1,690,421  |                                                                    |   | 13,377             |  |   | 130,681 |  |   | 1,546,363
|Other real estate                         |  |                                                     | 607,451    |                                                                    |   | 515,236            |  |   | 91,806  |  |   | 409      
|Commercial                                |  |                                                     | 987,850    |                                                                    |   | 738,377            |  |   | 249,473 |  |   |         
|Automobile loans                          |  |                                                     | 60,756     |                                                                    |   | 37,602             |  |   | 23,154  |  |   |         
|Other consumer                            |  |                                                     | 46,754     |                                                                    |   | 7,961              |  |   | 27,893  |  |   | 10,900   
|Loans held for securitization and/or sale |  |                                                     | 458,418    |                                                                    |   | 458,418            |  |   |        |  |   |         
|                                          |  |                                                     |            |                                                                    |   |                    |  |   |         |  |   |          
|Total loans receivable(2)                 |  | $                                                   | 10,500,535 |                                                                    | $ | 1,777,571          |  | $ | 561,085 |  | $ | 8,161,879
|                                          |  |                                                     |            |                                                                    |   |                    |  |   |         |  |   |          
|Fixed-rate loans                          |  | $                                                   | 1,862,674  |                                                                    | $ | 876,006            |  | $ | 519,509 |  | $ | 467,159  
|Adjustable-rate loans                     |  |                                                     | 8,179,443  |                                                                    |   | 443,147            |  |   | 41,576  |  |   | 7,694,720
|Loans held for securitization and/or sale |  |                                                     | 458,418    |                                                                    |   | 458,418            |  |   |        |  |   |         
|                                          |  |                                                     |            |                                                                    |   |                    |  |   |         |  |   |          
|Total loans receivable(2)                 |  | $                                                   | 10,500,535 |                                                                    | $ | 1,777,571          |  | $ | 561,085 |  | $ | 8,161,879
|                                          |  |                                                     |            |                                                                    |   |                    |  |   |         |  |   |          



|(1) | Of the total amount of loans outstanding at September 30, 2006, which were due after one year, an aggregate principal balance of approximately $1.0 billion had fixed interest
rates and an aggregate principal balance of approximately $7.7 billion had adjustable interest rates.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Before deduction of allowance for loan losses, unearned premiums and discounts and deferred loan origination fees (costs).
|--- | --------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Actual payments may not reflect scheduled contractual principal repayments due to the effect of loan refinancings,
prepayments and enforcement of due-on-sale clauses. Although the Banks single-family residential loans historically have had stated maturities of generally 30 to 40 years, those loans normally have remained outstanding for substantially
shorter periods because of these factors. Due-on-sale clauses give the Bank the right to declare a conventional loan  one that is neither insured by the Federal Housing Administration nor partially guaranteed by the Veterans
Administration  immediately due and payable in the event, among other things, that the borrower sells the property securing the loan without the consent of the Bank. At September 30, 2006, excluding loans held for securitization and/or
sale, aggregate principal repayments of $1.3 billion against all loans are contractually due within the next year. Of this amount, $876.0 million is due on fixed-rate loans and $443.1 million is due on adjustable-rate loans.

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

Origination, Purchase and Sale of Real Estate Loans

(In thousands)



|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|---------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                 |  | For the Year Ended September 30, |           
|                                                                 |  | 2006                             |            |   | 2005 |   |            | 2004 | 
|Real estate loan originations and purchases:                     |  |                                  |            |   |      |   |            |      |  |   |            |  
|Single family residential                                        |  | $                                | 6,763,942  |   |      | $ | 8,815,453  |      |  | $ | 9,137,785  |  
|Home equity(1)                                                   |  |                                  | 1,043,003  |   |      |   | 1,180,981  |      |  |   | 1,165,108  |  
|Other real estate(1)                                             |  |                                  | 597,801    |   |      |   | 393,470    |      |  |   | 273,478    |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Total originations and purchases                                 |  |                                  | 8,404,746  |   |      |   | 10,389,904 |      |  |   | 10,576,371 |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Principal repayments                                             |  |                                  | (2,836,637 | ) |      |   | (2,998,545 | )    |  |   | (2,211,833 | )
|Sales                                                            |  |                                  | (5,135,271 | ) |      |   | (6,296,737 | )    |  |   | (5,795,564 | )
|Loans transferred to real estate acquired in settlement of loans |  |                                  | (4,653     | ) |      |   | (4,657     | )    |  |   | (3,377     | )
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                 |  |                                  | (7,976,561 | ) |      |   | (9,299,939 | )    |  |   | (8,010,774 | )
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Transfers to mortgage-backed securities(2)                       |  |                                  | (708,752   | ) |      |   | (555,155   | )    |  |   | (767,226   | )
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Increase (decrease) in real estate loans                         |  | $                                | (280,567   | ) |      | $ | 534,810    |      |  | $ | 1,798,371  |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  



|(1) | Net of undisbursed portion of loans.
|--- | ------------------------------------



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

Single-Family Residential Real Estate Lending (Excluding Home Equity Lending). The Bank originates a variety of loans secured by single-family residences. At September 30, 2006, $8.8 billion, or 83.8%, of
the Banks loan portfolio consisted of loans secured by first or second mortgages on such properties, as compared to $9.3 billion, or 85.3%, at September 30, 2005. Of these amounts, $2.7 million and $3.7 million consisted of FHA-insured or
VA-guaranteed loans at September 30, 2006 and 2005, respectively. At September 30, 2006 and 2005, the Bank had $467.6 million and $1.7 billion, respectively, of single-family residential loans held for securitization and/or sale to
investors. Approximately 32.5% of the principal balance of the Banks single-family residential real estate loans at September 30, 2006 were secured by properties located in California.

The Bank originates a wide variety of conventional residential mortgage loans, as well as FHA and VA loans, through its wholly owned mortgage banking subsidiary, B.F.
Saul Mortgage Company, and through Chevy Chase Mortgage, a division of the Bank. The Bank currently offers fixed-rate loans with maturities of 10 to 40 years and adjustable-rate residential mortgage loans with maturities ranging from 30 to 40 years.

Most of the Banks single-family residential mortgage loans are originated by third parties. The Bank determines the specific loan products and rates
under which the third party originates the loan, and subjects the loan to the Banks underwriting criteria and review. During the year ended September 30, 2006, approximately $4.6 billion of loans settled under this program.



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##### Table of Contents

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

In
recent years, the Bank has significantly expanded its origination of residential ARMs with interest rates that adjust monthly, semi-annually and annually, most of which provide a borrower with a variety of monthly payment options. Certain of these
loans have a payment option that could result in interest being added to the principal of the loan, or negative amortization. Certain other of these loans have a payment option that allows the borrower to make an interest only payment.
During fiscal years 2006 and 2005, the Bank originated $6.7 billion and $8.8 billion, respectively, of mortgage loans, of which $4.3 billion and $5.1 billion, respectively, contained terms that permit negative amortization and, $1.3 billion and $2.4
billion, respectively, contain terms which allow the borrower to make an interest only payment but do not permit negative amortization.

At
September 30, 2006, loans with a negative amortization option totaled $2.8 billion, which includes approximately $32.8 million of cumulative deferred interest. The amount of deferred interest has increased significantly in recent periods as the
rise in short-term interest rates has led more borrowers with payment option ARMs to elect to make minimum monthly payments that are less than the amount of interest accrued for that month. Each loan contains terms which limit the amount of negative
amortization to a percentage of the original loan amount, generally 10%.

In addition, the Bank originates construction permanent loans, which are loans to
individuals who are in the process of building their single family homes. During fiscal years 2006 and 2005, the Bank originated $434.8 million and $250.2 million, respectively, of these loans, the principal amount of which the Bank disburses as
construction progresses. During the construction phase, these loans permit the borrower to make an interest-only payment but do not permit negative amortization. Upon completion of construction, the loan will convert to a permanent mortgage, which
may permit the borrower to make an interest-only payment or incur negative amortization.

The Bank is enhancing its monitoring of the risks associated with
these interest-only and payment option mortgage products, and has established terms for loans it originates (including caps on the amount of negative amortization) designed to minimize credit risk without adversely affecting the Banks
competitive position. Increased emphasis of these ARM products has been a key part of managements efforts to focus on originating mortgage loans with interest rates that adjust more frequently in order to reduce the Banks interest-rate
risk. At September 30, 2006, 96.1% of the Banks single-family residential loans were comprised of ARMs and 42.8% of the Banks single-family residential loans were comprised of ARMs that have interest rates which adjust annually or
more frequently.

The OTS and the other federal banking regulators have issued guidance concerning non-traditional mortgage products such as
interest-only and payment option ARMs. See Business  RegulationSafety and Soundness Standards.

Loan securitizations and/or sales
provide the Bank with liquidity and additional funds for lending, enabling the Bank to increase the volume of loans originated and thereby increase loan interest and fee income as well as gains on sales of loans. Sales of mortgage loans totaled $5.4
billion and $6.5 billion during the fiscal years ended September 30, 2006 and 2005, respectively. The marketability of loans, loan participations and mortgage-backed securities depends on purchasers investment limitations, general market
and competitive conditions, mortgage loan demand and other factors.

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

From time to time, as part of its capital and liquidity management plans, the Bank may consider swapping loans held in its portfolio for lower risk-weighted mortgage-backed securities and retaining those
securities in its portfolio rather than selling them. During fiscal years 2006, 2005 and 2004, the Bank exchanged $486.0 million, $364.6 million and $108.6 million, respectively, of single-family residential loans held in its portfolio for
mortgage-backed securities, which the Bank retained for its own portfolio.

When the Bank sells a residential loan or loan participation and retains
servicing, or purchases mortgage servicing assets from third parties, it collects and remits loan payments, makes certain insurance and tax payments on behalf of borrowers and otherwise services the loans. The servicing fee generally ranges from
0.25% to 0.50% per year of the outstanding loan principal amount. The Bank also typically derives income from temporary investment for its own account of loan collections pending remittance to the participation or loan purchaser. At
September 30, 2006 and 2005, the Bank was servicing residential loans totaling $13.7 billion and $13.4 billion, respectively, for other investors. See Loan Servicing.



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##### Table of Contents

Sales of Mortgage-Backed Securities. The Bank originates and sells mortgage-backed securities pursuant to its
normal mortgage banking operations. The securities are generally sold in the same month as they are issued. The securities are formed from conforming mortgage loans originated for sale or from conforming mortgage loans resulting from the
borrowers election to convert from an adjustable-rate loan to a fixed-rate loan. Mortgage-backed securities held for sale in conjunction with mortgage banking activities are classified as trading securities. During the years ended
September 30, 2006 and 2005, the Bank originated and sold $213.1 million and $192.1 million, respectively, of mortgage-backed securities and recognized gains of $1.8 million and $2.3 million, respectively. As a result of the sale of trading
securities in the month such securities are formed, the Consolidated Statements of Cash Flows in this report reflect proceeds from the sales of trading securities, even though there are no balances of such securities at September 30, 2006.

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

From time to time, the Bank may purchase home equity and credit line loans from other
lenders as a way to supplement its direct origination of these loans. During fiscal years 2006 and 2005, the Bank made no such purchases.

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

Commercial Real Estate and Real Estate Construction Lending. Commercial real estate, real estate
construction and ground loans are originated directly by the Bank. The Bank also participates in loans originated by other banks. Aggregate balances of residential and commercial construction, ground and commercial real estate and multifamily loans
were $607.5 million and $358.9 million at September 30, 2006 and 2005, respectively. The Bank provides financing, at market rates, to certain purchasers of its real estate owned. Additionally, the Bank finances the construction of residential
real estate, principally single-family detached homes and townhouses, with generally a specified number of pre-sales required. Loan concentrations among types of real estate are reviewed and approved by the Banks Credit Risk Management
Committee.

At September 30, 2006, the Bank held $211.1 million (34.7% of total commercial real estate and real estate construction loans) of
participations or syndications in commercial real estate and real estate construction loans originated by other financial institutions, a decrease from $224.6 million (62.6% of total commercial real estate and real estate construction loans) at
September 30, 2005.

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

Business development
efforts of the Banks Commercial Banking Group have been concentrated in the major industry groups in the metropolitan Washington, DC and Baltimore areas, as well as a broad base of businesses and community service organizations. In addition,
management believes that the ability to offer a broader variety of investment products and fiduciary services to institutional customers through the Banks subsidiaries, ASB Capital Management LLC and Chevy Chase Trust Company, will continue to
enhance the operations of the Commercial Banking Group. Commercial loans totaled $987.9 million and $1.0 billion at September 30, 2006 and 2005, respectively.

At September 30, 2006, the Bank held $103.8 million (10.5% of total commercial loans) of participations or syndications in commercial loans originated by other financial institutions, an increase from $98.4 million (9.5% of total
commercial loans) at September 30, 2005.

Federal laws and regulations limit the Banks commercial loan portfolio to 20% of assets, with any
excess over 10% consisting of small business loans. At September 30, 2006, the Banks commercial loan portfolio represented 7.0% of its assets, with 0.8% consisting of small business loans.

Other Consumer Lending Activities. In addition to the types of loans described above, Chevy Chase currently offers a variety of other consumer loans, including
overdraft lines of credit and other unsecured loans for traditional consumer purchases and needs. The Bank does not offer its own credit card loans, but has an agreement with another financial institution pursuant to which that institution issues
credit cards in the Banks name to the Banks local customers. The Banks portfolios of automobile loans and other consumer loans totaled $60.8 million and $46.8 million, respectively, at September 30, 2006, which accounted for a
combined 1.0% of total loans at that date.

The Bank stopped originating subprime automobile loans in November 2000. The Banks subprime automobile
lending portfolio, which totaled $108,000 at September 30, 2006, represents 0.01% of its Tier 1 capital. The Bank continues its collection efforts on the remaining portfolio.

Federal laws and regulations limit the Banks secured and unsecured consumer loans to 35% of its total assets. Home improvement, secured deposit account and educational loans are not included in the 35% limit. At
September 30, 2006, the Bank complied with this limit.



24



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##### Table of Contents

Automobile Leasing. Effective March 2003, the Bank stopped originating indirect automobile leases and the Bank
continues its collection efforts on that existing portfolio. At September 30, 2006 and 2005, the Banks portfolio of automobiles subject to lease totaled $55.4 million and $185.0 million, respectively. In addition to credit risk associated
with a lessees possible default under the lease, the Bank is exposed to the risk that the value of the vehicle at maturity of the lease may be less than the future residual value as estimated by the Bank at the inception of the lease. To
reduce that risk, the Bank (a) purchased insurance in the full amount of the estimated residual value to protect the Bank against possible future decreases in residual values, and (b) used estimates of residual value that did not exceed
published industry estimates unless that excess was also insured. Although the Bank insured residual values, limitations in the insurance policy and other factors have resulted and may continue to result in losses at lease maturity that may not be
fully covered by that insurance.

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

The approval process for all types of real estate loans includes appraisals or evaluations of the properties securing the loans and a review of all applicants and
guarantors financial information and credit and payment history. In the case of certain residential mortgage loans, the Banks policies permit use of reduced documentation, including reliance on the borrowers representations of his
or her income without independent verification.

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

The Bank generally makes residential mortgage loans in amounts up to 97% of the value of owner-occupied single-family homes. In some circumstances, the Bank originates a
first and second residential mortgage loan simultaneously, provided that the aggregate loan amount does not exceed 100% of the value of the residential property. The Bank generally lends up to 95% of the lesser of the acquisition cost or the
appraised value of the completed project to finance the construction of homes. The loan-to-value (LTV) ratio generally applied by the Bank to commercial real estate loans and multifamily residential loans has been 80% of the appraised
value of the completed project. Currently, the Bank offers home equity loans and credit line loans up to 100% maximum LTV ratio. However, it is the Banks policy to insure all newly originated home equity loans and credit lines with an LTV
ratio equal to or greater than 90%.

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

OTS regulations require institutions to adopt internal real estate lending policies, including LTV limitations
conforming to specific guidelines established by the OTS. The Banks current lending policies conform to these regulations. The OTS recently issued guidance for nontraditional mortgage loans of the type made by the Bank. See Business
 RegulationSafety and Soundness Standards.

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

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

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

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



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##### Table of Contents

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

The underwriting procedures are designed to provide a basis for assessing the borrowers ability and willingness to repay the loan. In conducting this assessment, the Bank considers the borrowers ratio of
debt to income, various credit scoring models and an evaluation of the borrowers credit history through a review of a credit report compiled by a recognized consumer credit reporting bureau. The borrowers equity in the collateral and the
terms of the loan are also considered. The Banks guidelines are intended only to provide a basis for lending decisions, and exceptions to the guidelines may, within certain limits, be made based upon the credit judgment of the Banks
lending officer. The Bank periodically conducts audits to ensure compliance with its established underwriting policies and procedures.

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

During fiscal year 2006, the Bank securitized and sold $4.2
billion in residential mortgage loans, a decrease of 20.8% from fiscal 2005. Outstanding trust certificate balances decreased by 5.4% to $8.5 billion at September 30, 2006. In connection with its loan origination, securitization and sale
activities, the Bank generally receives or retains various interests in the sold loans, which may include servicing assets, securities, or interest-only certificates and/or interest-only strips receivable (collectively, interest-only
assets). The Bank sometimes retains a limited amount of recourse relating to securitized loans through one or more means, most often through the establishment of reserve accounts. The Bank records those interests as assets on its financial
statements and determines the carrying value of the assets based on future cash flows expected to be received by the Bank from the underlying assets. Periodically, the Bank obtains independent valuations as confirmation of managements
estimates of its values for interest-only and servicing assets. Most of these cash flows are payable to the Bank before the claims of others, while a small portion are subordinated to those claims. The Banks policy is to limit the aggregate
amount of mortgage servicing rights and interest-only assets arising out of the securitization and sale of certain of the Banks ARMs to 75% of the Banks core capital. At September 30, 2006, those assets totaled 53% of the
Banks core capital. The tables below summarize the carrying value of these assets at September 30, 2006 and 2005.



|                                |  |                    |         |              |   |       |  |   |        
|------------------------------- |  | ------------------ | ------- | ------------ | - | ----- |  | - | -------
|                                |  | September 30, 2006
|                                |  | Not Subordinated   |         | Subordinated |   | Total
|                                |  | (in thousands)    
|Interest-only certificates      |  | $                  | 294,597 |              | $ |      |  | $ | 294,597
|Interest-only strips receivable |  |                    | 49,595  |              |   | 125   |  |   | 49,720 
|                                |  |                    |         |              |   |       |  |   |        
|Total interest-only assets      |  |                    | 344,192 |              |   | 125   |  |   | 344,317
|Servicing assets                |  |                    | 168,059 |              |   |      |  |   | 168,059
|Reserve accounts                |  |                    | 17,960  |              |   | 2,540 |  |   | 20,500 
|                                |  |                    |         |              |   |       |  |   |        
|Total                           |  | $                  | 530,211 |              | $ | 2,665 |  | $ | 532,876
|                                |  |                    |         |              |   |       |  |   |        



|                                |  |                    |         |              |   |       |  |   |        
|------------------------------- |  | ------------------ | ------- | ------------ | - | ----- |  | - | -------
|                                |  | September 30, 2005
|                                |  | Not Subordinated   |         | Subordinated |   | Total
|                                |  | (in thousands)    
|Interest-only certificates      |  | $                  | 271,460 |              | $ |      |  | $ | 271,460
|Interest-only strips receivable |  |                    | 75,772  |              |   | 995   |  |   | 76,767 
|                                |  |                    |         |              |   |       |  |   |        
|Total interest-only assets      |  |                    | 347,232 |              |   | 995   |  |   | 348,227
|Servicing assets                |  |                    | 164,592 |              |   |      |  |   | 164,592
|Reserve accounts                |  |                    | 18,704  |              |   | 4,711 |  |   | 23,415 
|                                |  |                    |         |              |   |       |  |   |        
|Total                           |  | $                  | 530,528 |              | $ | 5,706 |  | $ | 536,234
|                                |  |                    |         |              |   |       |  |   |        



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##### Table of Contents

During fiscal year 2006, the Bank took reductions totaling $90.9 million to the carrying value of its servicing assets
and interest only assets primarily as a result of higher actual prepayments and an increase in estimated future prepayments of loans underlying those assets. Prepayment levels remained high because of the continued flattened or inverted yield curve,
that is, the difference between short-term interest rates on the one hand, which determine interest rates on the adjustable rate mortgages generated by the Bank, and long-term interest rates on the other hand, which determine the interest rates on
mortgages with interest rates fixed for longer periods. Historical experience has shown that prepayment speeds on adjustable rate loans are generally correlated to the steepness of the yield curve. The steeper the yield curve, the less likely the
loan will prepay. The flatter or more inverted the yield curve, the less attractive adjustable rate loans are to consumers and prepayments tend to increase. In addition, as prepayment penalty periods expire, buyers are more likely to prepay their
loans. For further information concerning the Banks loan servicing rights and loan securitization transactions, see Notes 16 and 17 to the Consolidated Financial Statements in this report.

The securitization transactions contain provisions that allow Chevy Chase to purchase the remaining assets and terminate the transaction when the remaining balance of
the certificates reaches a specified percentage of the original balance (so called clean up call). Management anticipates that three transactions will reach that threshold during fiscal 2007 and, if the Bank exercises its option, the
Bank will purchase loans with aggregate values of approximately $120 million. To the extent the loans meet the eligibility criteria for future securitization transactions, subsequent to purchase they will be included in the pool from which loans are
selected for securitization.

Loan Servicing.The Banks investment in servicing assets is periodically evaluated for impairment. The Bank
stratifies its servicing assets for purposes of evaluating impairment by taking into consideration relevant risk characteristics, including loan type and note rate. The Bank evaluates its servicing assets for impairment based on fair value. To
measure the fair value of its servicing assets, the Bank uses either third party market prices or discounted cash flow analyses using market-based assumptions for servicing fee income, servicing costs, prepayment rates and discount rates.

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

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

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



|                                             |  |                                           |            |      |   |            |  |   |           
|-------------------------------------------- |  | ----------------------------------------- | ---------- | ---- | - | ---------- |  | - | ----------
|                                             |  | As of or for the Year Ended September 30,
|                                             |  | 2006                                      |            | 2005 |   | 2004      
|                                             |  | (in thousands)                           
|Residential                                  |  | $                                         | 13,666,622 |      | $ | 13,445,665 |  | $ | 11,319,875
|Home equity                                  |  |                                           | 4,758      |      |   | 7,244      |  |   | 10,815    
|Automobile                                   |  |                                           |           |      |   | 27,494     |  |   | 150,957   
|                                             |  |                                           |            |      |   |            |  |   |           
|Total amount of loans serviced for others(1) |  | $                                         | 13,671,380 |      | $ | 13,480,403 |  | $ | 11,481,647
|                                             |  |                                           |            |      |   |            |  |   |           
|Servicing and securitization income          |  | $                                         | 94,623     |      | $ | 150,739    |  | $ | 201,139   
|                                             |  |                                           |            |      |   |            |  |   |           

---

|(1) | The carrying value of the Banks servicing assets and interest-only strips receivable at September 30, 2006, 2005 and 2004 was $512.4 million, $512.8
million and $435.7 million, respectively.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Banks level of servicing and securitization income varies based in large part on the
amount of the Banks securitization activities with respect to these loan types and with changes in prepayment speeds on the underlying loans. As the Bank securitizes and sells assets, acquires servicing assets either through origination or
purchase, or sells mortgage loans and retains the servicing rights on those loans, the level of servicing and securitization income generally increases. During fiscal year 2006, the Bank securitized and sold $4.2 billion of loan receivables through
new securitization trusts compared to $5.3 billion during fiscal year 2005. Gains recognized from these securitizations represent a significant portion of the Banks earnings. See Managements Discussion and Analysis of Financial
Condition and Results of Operations  Results of Operations - Other Income.



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##### Table of Contents

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

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

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

Delinquencies, Foreclosures and Allowances for Losses

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

See Managements Discussion and Analysis of Financial Condition and Results of
Operations  Financial Condition  Asset Quality  Delinquent Loans for a discussion of the Banks delinquent loan portfolio at September 30, 2006.

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

The allocated allowance is assessed on both homogeneous and non-homogeneous loan portfolios. The range is calculated by applying loss and delinquency factors to the
outstanding loan balances of these portfolios. Loss factors are based on analyses of the historical performance of each loan category and an assessment of portfolio trends and conditions, as well as specific risk factors impacting the loan
portfolios. Each homogeneous portfolio, such as single-family residential loans or automobile loans, is evaluated collectively.

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

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

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

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

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



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##### Table of Contents

The Federal Financial Institutions Examination Council (FFIEC), which is composed of the OTS and the other
federal banking agencies, has issued guidelines regarding the appropriate levels of general valuation allowances that should be maintained by insured institutions and guidance on the design and implementation of loan loss allowance methodologies and
supporting documentation practices. The Bank believes that its levels of general valuation allowances at September 30, 2006, and its procedures, comply with the guidelines.

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

Deposits and Other Sources of Funds

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

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

Chevy Chase attracts deposits through its branch network and advertisements, and
offers depositors access to their accounts through more than 1,020 ATMs, including more than 200 ATMs located in grocery stores. These ATMs significantly enhance the Banks position as a leading provider of convenient service in its primary
market area. The Bank is a member of the STAR®ATM network which offers
nationwide access, and the PLUS®ATM network, which offers worldwide access.
In addition, the Bank has a partnership agreement with a regional grocery store chain that authorizes the Bank to provide in-store banking centers at potentially all of its Maryland, Virginia, Delaware and Washington, DC area stores. As of
September 30, 2006, the Bank operates 54 in-store banking centers as part of this agreement.

The Bank obtains deposits primarily from customers
residing in Montgomery and Prince Georges Counties in Maryland and in Northern Virginia. Approximately 61% of the Banks deposits at September 30, 2006 were obtained from depositors residing in Maryland, and approximately 25% from
depositors residing in Virginia.



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##### Table of Contents

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

Deposit Analysis

(Dollars in thousands)



|                                       |  |               |            |           |       |   |         |      |           |  |       |         |  |           |           |  |         |   |           |   |           |         |       |           |  |   |           |  |       |  
|-------------------------------------- |  | ------------- | ---------- | --------- | ----- | - | ------- | ---- | --------- |  | ----- | ------- |  | --------- | --------- |  | ------- | - | --------- | - | --------- | ------- | ----- | --------- |  | - | --------- |  | ----- | -
|                                       |  | September 30, |           
|                                       |  | 2006          |            |           | 2005  |   |         | 2004 |           |  | 2003  |         |  | 2002      |          
|                                       |  | Balance       |            | % ofTotal |       |   | Balance |      | % ofTotal |  |       | Balance |  | % ofTotal |           |  | Balance |   | % ofTotal |   |           | Balance |       | % ofTotal | 
|Non-interest bearing checking accounts |  | $             | 1,316,980  |           | 12.6  | % |         | $    | 1,346,455 |  | 13.8  | %       |  | $         | 1,181,722 |  | 13.3    | % |           | $ | 951,844   |         | 11.8  | %         |  | $ | 779,634   |  | 10.5  | %
|Interest-bearing checking accounts     |  |               | 2,313,152  |           | 22.2  |   |         |      | 2,438,147 |  | 24.9  |         |  |           | 2,244,724 |  | 25.4    |   |           |   | 1,951,281 |         | 24.0  |           |  |   | 1,656,522 |  | 22.3  |  
|Money market deposit accounts          |  |               | 2,403,060  |           | 23.0  |   |         |      | 2,521,949 |  | 25.8  |         |  |           | 2,364,768 |  | 26.7    |   |           |   | 2,321,026 |         | 28.7  |           |  |   | 1,953,312 |  | 26.3  |  
|Savings accounts                       |  |               | 953,663    |           | 9.1   |   |         |      | 1,153,152 |  | 11.8  |         |  |           | 1,214,307 |  | 13.7    |   |           |   | 1,150,444 |         | 14.2  |           |  |   | 1,028,262 |  | 13.8  |  
|Certificate accounts, less than $100   |  |               | 2,088,368  |           | 20.0  |   |         |      | 1,520,829 |  | 15.5  |         |  |           | 1,238,733 |  | 14.0    |   |           |   | 1,207,728 |         | 14.9  |           |  |   | 1,416,739 |  | 19.0  |  
|Certificate accounts, $100 or more     |  |               | 1,370,541  |           | 13.1  |   |         |      | 801,236   |  | 8.2   |         |  |           | 610,864   |  | 6.9     |   |           |   | 518,182   |         | 6.4   |           |  |   | 603,116   |  | 8.1   |  
|                                       |  |               |            |           |       |   |         |      |           |  |       |         |  |           |           |  |         |   |           |   |           |         |       |           |  |   |           |  |       |  
|Total deposits                         |  | $             | 10,445,764 |           | 100.0 | % |         | $    | 9,781,768 |  | 100.0 | %       |  | $         | 8,855,118 |  | 100.0   | % |           | $ | 8,100,505 |         | 100.0 | %         |  | $ | 7,437,585 |  | 100.0 | %
|                                       |  |               |            |           |       |   |         |      |           |  |       |         |  |           |           |  |         |   |           |   |           |         |       |           |  |   |           |  |       |  

Average Cost of Deposits



|                      |  |                          |   |  |      |   |  |      |  
|--------------------- |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                      |  | Year Ended September 30, |  
|                      |  | 2006                     |   |  | 2005 |   |  | 2004 |  
|Checking deposits     |  | 0.25                     | % |  | 0.22 | % |  | 0.21 | %
|Money market deposits |  | 2.20                     | % |  | 1.42 | % |  | 0.74 | %
|Savings deposits      |  | 0.41                     | % |  | 0.28 | % |  | 0.27 | %
|Time deposits         |  | 3.94                     | % |  | 2.59 | % |  | 1.91 | %
|Total deposits        |  | 2.03                     | % |  | 1.19 | % |  | 0.79 | %
|                      |  |                          |   |  |      |   |  |      |  



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

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



|                                 |  |                          |             |   |      |   |             |      |  |   |             |  
|-------------------------------- |  | ------------------------ | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                 |  | Year Ended September 30, |            
|                                 |  | 2006                     |             |   | 2005 |   |             | 2004 | 
|                                 |  | (in thousands)           |            
|Deposits to accounts             |  | $                        | 83,202,385  |   |      | $ | 72,320,724  |      |  | $ | 53,155,374  |  
|Withdrawals from accounts        |  |                          | (82,689,839 | ) |      |   | (71,484,397 | )    |  |   | (52,459,012 | )
|                                 |  |                          |             |   |      |   |             |      |  |   |             |  
|Net cash to accounts             |  |                          | 512,546     |   |      |   | 836,327     |      |  |   | 696,362     |  
|Interest credited to accounts    |  |                          | 151,450     |   |      |   | 90,323      |      |  |   | 58,251      |  
|                                 |  |                          |             |   |      |   |             |      |  |   |             |  
|Net increase in deposit balances |  | $                        | 663,996     |   |      | $ | 926,650     |      |  | $ | 754,613     |  
|                                 |  |                          |             |   |      |   |             |      |  |   |             |  

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

The following table sets forth, by weighted average interest
rates, the type and amounts of deposits as of September 30, 2006, which will mature during the fiscal years indicated.

Weighted
Average Interest Rates of Deposits

(Dollars in thousands)



|                                          |  |                                            |           |                     |                  |   |        |                      |                     |  |       |        |  |                     |           |  |        |   |                     |   |            |  |      |  
|----------------------------------------- |  | ------------------------------------------ | --------- | ------------------- | ---------------- | - | ------ | -------------------- | ------------------- |  | ----- | ------ |  | ------------------- | --------- |  | ------ | - | ------------------- | - | ---------- |  | ---- | -
|                                          |  | Checking and Money Market Deposit
Accounts |           |                     | Savings Accounts |   |        | Certificate Accounts |                     |  | Total |       
|Maturing During Year Ending September
30, |  | Amount                                     |           | WeightedAverageRate |                  |   | Amount |                      | WeightedAverageRate |  |       | Amount |  | WeightedAverageRate |           |  | Amount |   | WeightedAverageRate |  
|2007                                      |  | $                                          | 6,033,192 |                     | 1.17             | % |        | $                    | 953,663             |  | 0.47  | %      |  | $                   | 3,209,438 |  | 4.54   | % |                     | $ | 10,196,293 |  | 2.17 | %
|2008                                      |  |                                            |          |                     |                 |   |        |                      |                    |  |      |        |  |                     | 145,378   |  | 4.08   |   |                     |   | 145,378    |  | 4.08 |  
|2009                                      |  |                                            |          |                     |                 |   |        |                      |                    |  |      |        |  |                     | 66,692    |  | 3.82   |   |                     |   | 66,692     |  | 3.82 |  
|2010                                      |  |                                            |          |                     |                 |   |        |                      |                    |  |      |        |  |                     | 28,254    |  | 3.89   |   |                     |   | 28,254     |  | 3.89 |  
|2011                                      |  |                                            |          |                     |                 |   |        |                      |                    |  |      |        |  |                     | 9,147     |  | 3.98   |   |                     |   | 9,147      |  | 3.98 |  
|                                          |  |                                            |           |                     |                  |   |        |                      |                     |  |       |        |  |                     |           |  |        |   |                     |   |            |  |      |  
|Total                                     |  | $                                          | 6,033,192 |                     | 1.17             | % |        | $                    | 953,663             |  | 0.47  | %      |  | $                   | 3,458,909 |  | 4.50   | % |                     | $ | 10,445,764 |  | 2.21 | %
|                                          |  |                                            |           |                     |                  |   |        |                      |                     |  |       |        |  |                     |           |  |        |   |                     |   |            |  |      |  



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##### Table of Contents

The following table summarizes maturities of certificate accounts in amounts of $100,000 or greater as of
September 30, 2006.



|                          |  |                        |           |                       |      |  
|------------------------- |  | ---------------------- | --------- | --------------------- | ---- | -
|Year Ending September 30, |  | Amount                 |           | Weighted Average Rate |     
|                          |  | (Dollars in thousands) |           |                       |     
|2007                      |  | $                      | 1,301,661 |                       | 4.74 | %
|2008                      |  |                        | 36,675    |                       | 4.47 | %
|2009                      |  |                        | 24,002    |                       | 3.98 | %
|2010                      |  |                        | 6,800     |                       | 3.88 | %
|2011                      |  |                        | 1,403     |                       | 4.19 | %
|                          |  |                        |           |                       |      |  
|Total                     |  | $                      | 1,370,541 |                       | 4.71 | %
|                          |  |                        |           |                       |      |  

The following table represents the amounts of deposits by various interest rate categories as of
September 30, 2006 maturing during the fiscal years indicated.

Maturities of Deposits by Interest Rates

(In thousands)



|                                            |  |                                                    |            |      |   |         |  |      |        |      |   |        |  |   |       |  |   |           
|------------------------------------------- |  | -------------------------------------------------- | ---------- | ---- | - | ------- |  | ---- | ------ | ---- | - | ------ |  | - | ----- |  | - | ----------
|                                            |  | Accounts Maturing During Year Ending September 30,
|Interest Rate                               |  | 2007                                               |            | 2008 |   | 2009    |  | 2010 |        | 2011 |   | Total 
|Non-interest bearing checking deposits (0%) |  | $                                                  | 1,316,980  |      | $ |        |  | $    |       |      | $ |       |  | $ |      |  | $ | 1,316,980 
|0.01% to 1.99%                              |  |                                                    | 4,036,610  |      |   |        |  |      |       |      |   |       |  |   |      |  |   | 4,036,610 
|2.00% to 2.99%                              |  |                                                    | 372,871    |      |   | 5,103   |  |      | 91     |      |   |       |  |   |      |  |   | 378,065   
|3.00% to 3.99%                              |  |                                                    | 1,762,746  |      |   | 70,014  |  |      | 41,969 |      |   | 20,442 |  |   | 4,832 |  |   | 1,900,003 
|4.00% to 4.99%                              |  |                                                    | 1,802,683  |      |   | 40,629  |  |      | 22,472 |      |   | 7,812  |  |   | 4,315 |  |   | 1,877,911 
|5.00% to 5.99%                              |  |                                                    | 904,403    |      |   | 29,632  |  |      | 2,160  |      |   |       |  |   |      |  |   | 936,195   
|                                            |  |                                                    |            |      |   |         |  |      |        |      |   |        |  |   |       |  |   |           
|Total                                       |  | $                                                  | 10,196,293 |      | $ | 145,378 |  | $    | 66,692 |      | $ | 28,254 |  | $ | 9,147 |  | $ | 10,445,764
|                                            |  |                                                    |            |      |   |         |  |      |        |      |   |        |  |   |       |  |   |           

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

Extensions of credit may be obtained pursuant to several different credit programs, each of which has its own rate and range of maturities. Advances must be secured by
eligible collateral with a value, as determined by the FHLB of Atlanta, at least equal to 100% of Chevy Chases outstanding advances. The Bank had outstanding FHLB advances of $1.3 billion at September 30, 2006.

From time to time the Bank enters into repurchase agreements, which are treated as financings. The Bank sells securities, which are usually mortgage-backed securities,
and agrees to buy back the same securities at a specified time, which is generally within seven to 90 days. The Bank pays a stated interest rate for the use of the funds for the specified time period. The obligation to repurchase the securities sold
is reflected as a liability and the securities underlying the agreements are included in assets in the Consolidated Statements of Financial Condition in this report. These arrangements are, in effect, borrowings by the Bank secured by the securities
sold. The Bank had outstanding repurchase agreements of $458.3 million at September 30, 2006.



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



|                                                    |  |                        |         |   |      |   |         |  
|--------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                    |  | September 30,          |        
|                                                    |  | 2006                   |         |   | 2005 |  
|                                                    |  | (Dollars in thousands) |        
|Securities sold under repurchase agreements:        |  |                        |         |   |      |   |         |  
|Balance at year-end                                 |  | $                      | 458,307 |   |      | $ | 191,034 |  
|Average amount outstanding during the year          |  |                        | 232,824 |   |      |   | 119,791 |  
|Maximum amount outstanding at any month-end         |  |                        | 458,307 |   |      |   | 191,109 |  
|Weighted average interest rate during the year      |  |                        | 4.32    | % |      |   | 2.61    | %
|Weighted average interest rate on year-end balances |  |                        | 5.18    | % |      |   | 3.59    | %

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

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



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

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

Subsidiaries

OTS regulations generally permit the Bank to make investments in service corporation subsidiaries in an
amount not to exceed 3.0% of the Banks assets, provided that any investment in excess of 2.0% of assets serves primarily community, inner city or community development purposes. These regulations also permit the Bank to make conforming
loans to those subsidiaries and joint ventures in an amount not to exceed 50% of the Banks regulatory capital. At September 30, 2006, 2.0% and 3.0% of the Banks assets was equal to $282.8 million and $424.2 million,
respectively, and the Bank had $33.3 million invested in its service corporation subsidiaries.

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

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

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

Real
Estate Activities.Manor Investment LLC, a subsidiary of the Bank, invests in real estate projects. See Managements Discussion and Analysis of Financial Condition and Results of Operations  Financial Condition  Asset
Quality.

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



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

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

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

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

Special Purpose Subsidiaries.At September 30, 2006, Chevy Chase Real Estate, LLC, (CCRE) a wholly owned
subsidiary of Chevy Chase, held 100% of the common stock of nine subsidiaries, five of which are active, and a majority of which were formed for the sole purpose of acquiring title to various real estate projects pursuant to foreclosure or
deed-in-lieu of foreclosure. The Banks aggregate investment in these subsidiaries was $26.2 million at September 30, 2006. CCRE is an operating subsidiary and, therefore, the Banks investment in CCRE is not subject to the 3.0%
service corporation investment limit discussed above.

Employees

The Bank and its subsidiaries had 4,238 full-time and 782 part-time employees at September 30, 2006. The Bank provides its employees with a comprehensive range of employee benefit programs, including group health
benefits, life insurance, disability insurance, paid sick leave, certain free deposit services and certain loan discounts. See Executive Compensation for a discussion of certain compensation programs available to the Banks
executive officers. None of the Banks employees is represented by a collective bargaining agreement. The Bank believes that its employee relations are good.

Competition

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

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

According to the most recently published industry statistics, at June 30, 2006, Chevy Chase had the fifth largest market share, with approximately 9,0% of deposits, in the Washington DC metropolitan area. At that
same date, the Bank had the largest market share, with approximately 25.5% of deposits, in Montgomery County, Maryland, ranked third in market share, with approximately 14.0% of deposits, in Prince Georges County, Maryland and ranked sixth in
market share, with approximately 4.8% of deposits in Fairfax County, Virginia, excluding single branch institutions. Based on publicly available information, Chevy Chase estimates that, in the Washington, DC metropolitan area, it is one of the
leaders in market share of single-family residential mortgage and home equity credit line loans.

Federal Taxation

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

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



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

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

The Bank made net tax sharing payments to the Trust totaling $2.0 million in fiscal year 2006. At September 30, 2006 and 2005, the estimated net tax sharing payment
payable to the Trust by the Bank was $4.7 million and $1.8 million, respectively.

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

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

State Taxation

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



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|ITEM 1A. | RISK FACTORS
|-------- | ------------

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

Risks Relating to Our Banking Business

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

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

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

Changes in interest rates and other market conditions, and the relationship between short- and long-term interest rates,
also can affect the value of the Banks loans and other interest-sensitive assets, including interests it retain in its securitization transactions, mortgage and non-mortgage servicing rights, and its ability to realize gains on the sale and
securitization of assets. For example, at September 30, 2006, the Banks assets included $168.1 million in loan servicing assets and $344.3 million in interest only assets, the value of which is based on market interest rates and depends
on the accuracy of its various assumptions concerning items such as prepayment rates, credit losses and interest rates. If actual results differ from its assumptions, the value of those assets, as well as our earnings, could be adversely affected.
For example, primarily because short-term interest rates have remained close to or at times even higher than long-term rates in recent periods, prepayments of its adjustable rate mortgage loans have been higher than anticipated and the Bank recorded
write downs in the value of its interest only assets of $89.0 million during fiscal 2006 fiscal and $121.0 million in fiscal 2005. The Banks ability to originate adjustable rate mortgage loans also suffers when short-term interest rates are
similar to or higher than longer-term rates.

For further discussion of interest rate risk considerations, refer to Managements Discussion and
Analysis of Financial Condition and Results of Operations  Financial Condition  Asset and Liability Management elsewhere in this Form 10-K.

The Banks payment option and interest-only mortgage loans subject it to additional risks.

In recent years,
the Bank has significantly expanded its origination of adjustable rate mortgage loans that permit borrowers to defer payment of principal and interest. Many of these loans have a payment option that could result in interest being added to the
principal of the loan, or negative amortization. Others allow the borrower to make an interest only payment. These features, coupled with the adjustable interest rates on these loans, could cause borrowers payments to increase
substantially. In the absence of offsetting factors, such as higher wages, those increased payments could result in higher defaults and require increases in the Banks allowance for loan losses. The potential for significant increases in the
payments required to be made by these borrowers, coupled with the relative complexity of these products when compared to traditional mortgage loans, could subject it to increased litigation and reputation risk, particularly in an environment of
rising interest rates and declining property values. These loans also can result, under certain circumstances, in the Banks recognition as interest income payments that have not yet been made by the borrowers, which may lead to future losses
if the borrowers ultimately fail to make those payments. At September 30, 2006, cumulative deferred interest totaled $32.8 million.

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

For a further discussion of these lending activities, refer to Business Lending and Leasing Activities  Single Family Residential Real Estate
Lending elsewhere in this Form 10-K.

The Bank depends on asset securitizations for additional liquidity and for other purposes, and the success
of these transactions depends on its ability to correctly predict prepayment rates.

In the Banks securitization transactions, it typically
recognizes gain on the sale and a related retained interest in a securitized pool of loans that it sells (sometimes through another entity that it establishes) to a special purpose vehicle, typically a trust, which, in turn, sells security interests
in the pool. The value of the retained interest that it recognizes depends on several assumptions regarding the future performance of the securitized



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pool. The value of the Banks retained interest may increase or decrease materially if actual prepayment rates differ from its original assumptions or
if market interest rates change. As a result, the Banks financial condition may be adversely affected by its inability to make accurate assumptions regarding the future performance of the securitized pool.

The Banks continued ability to access the asset-backed securitization markets depends on several factors, including:



| |  |  | its ability to originate additional loans for securitization and sale;
| | - |  | ----------------------------------------------------------------------



| |  |  | conditions in the securities markets, generally;
| | - |  | ------------------------------------------------



| |  |  | conditions in the asset-backed securitization markets;
| | - |  | ------------------------------------------------------



| |  |  | its ability to obtain third-party credit enhancement;
| | - |  | -----------------------------------------------------



| |  |  | its ability to adequately service the securitized loans; and
| | - |  | ------------------------------------------------------------



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

An inability to access the securitization markets could adversely affect the Banks financial condition and results of operations.

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

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

The requirement to meet minimum regulatory capital ratios is particularly important to the Banks operations. The
Banks capital ratios at September 30, 2006, satisfied the regulatory requirements and were sufficient to meet the standards for classification as a well capitalized institution, the highest of five categories under the
OTSs prompt corrective action regulations. For further information about its regulatory capital levels, refer to Managements Discussion and Analysis of Financial Condition and Results of Operations  Financial
Condition Capital elsewhere in this Form10-K.

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

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

For further information about our regulatory capital requirements, including potential changes to those requirements, refer to Business  Regulation 
Regulatory Capital elsewhere in this Form 10-K.

Recent reform of the federal deposit insurance system is likely to increase the Banks cost of
FDIC insurance in future years, although it will have a credit available to offset most of the increase in calendar year 2007. For further information about its FDIC insurance premiums, refer to Business  Regulation  Deposit
Insurance Premiums in this report.

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

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

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

Many of its competitors are substantially larger and have substantially more resources than it does.

For further information about our competitive environment, please see BusinessCompetition in this report.



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

In recent years, non-interest income, which is reflected as Other Income on the Banks consolidated statements of
operations, has been an important source of its revenues. The Bank has earned non-interest income primarily from loan servicing and deposit servicing fees, gains on sales of loans and mortgage-backed securities, and automobile rental income. For the
fiscal years ended September 30, 2006, 2005 and 2004, it recognized non-interest income of approximately $394.9 million, $442.6 million and $539.5 million, respectively. Its ability to generate non-interest income depends upon market interest
rates, consumer preferences, the demand for mortgage and other loans and leases, conditions in the loan sale market, the level of securitized receivables and other factors, many of which are beyond its control. The amount of this income, therefore,
can fluctuate substantially which can be a particular problem for the Bank because of its relatively high proportion of fixed costs such as the payments required on its preferred stock and subordinated debt. A significant decrease in its
non-interest income could adversely affect the Banks results of operations and financial condition.

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

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

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

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

Risks Relating to Our Real Estate Business

If we do
not continue to receive dividends and tax sharing payments from the Bank our business and financial condition could be adversely affected.

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



| |  |  | The Banks operating performance and income, which may be adversely affected by changes in interest rates, the continued growth of the Banks commercial loan portfolio,
which is riskier than residential mortgage loans, and the concentration of the Banks business in the Washington, DC area;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | restrictions imposed by the Banks regulators, including the fact that the regulators may not permit the Bank to pay dividends if it does not remain well
capitalized;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | restrictions on the Banks ability to pay dividends imposed by the indentures for its outstanding subordinated debt; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------



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

If the Bank does not pay sufficient dividends or make sufficient payments under the tax sharing agreement, we will need to raise funds from
other sources. In fiscal 2006 and 2005, the Bank paid us $32.0 million and $39.2 million, respectively, in dividends and $2.0 million and $2.1 million, respectively, in tax sharing payments.

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

Historically, we have had operating losses before accounting for gains from the sale of properties and before the consolidation of the Bank into our
financial statements. For fiscal 2006 and 2005, the loss from continuing operations was $2.0 million and $7.4 million, respectively. If we continue to operate at a loss and we do not receive dividends and tax sharing payments from the Bank or funds
from other sources, our business and financial condition could be adversely affected.



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

During the past five fiscal
years, we had sufficient funds available to pay our required interest, debt and ground rent expenses. On a consolidated basis, our total available earnings exceeded our fixed charges by $125.0 million, $172.0 million, $185.3 million, $122.3 million
and $73.2 million in fiscal years 2006, 2005, 2004, 2003 and 2002, respectively. However, the fixed charges of our real estate operations exceeded the earnings generated by our real estate operations, with the exception of fiscal 2006, for four of
our last five fiscal years. We cannot assure that, in future fiscal years, the revenues generated by our real estate operations will exceed the fixed charges of our real estate operations. As a result, during each of the past five fiscal years,
except fiscal year 2006, the Real Estate Trust depended on the receipt of dividends and tax sharing payments from the Bank to pay its fixed charges, including payment of principal and interest on the notes. Excluding the dividend and tax sharing
payments from the Bank, the Real Estate Trusts fixed charges would have exceeded its available earnings by $2.3 million, $17.9 million, $8.8 million and $15.3 million in fiscal years 2005, 2004, 2003 and 2002, respectively. If the Real Estate
Trust is unable to fund any future shortfall between available earnings and required payments with payments from the Bank or from other sources, our business and financial condition could be adversely affected.

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

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

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

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

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

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



| |  |  | economic downturns in the areas where our properties are located;
| | - |  | -----------------------------------------------------------------



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



| |  |  | changes in tenant preferences that reduce the attractiveness of our properties to tenants;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | zoning or regulatory restrictions;
| | - |  | ----------------------------------



| |  |  | decreases in market rental rates;
| | - |  | ---------------------------------



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



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



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



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Our development activities are inherently risky.

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

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



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



| |  |  | Failure or inability to obtain construction or permanent financing on favorable terms;
| | - |  | --------------------------------------------------------------------------------------



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



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



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

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

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

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

As of September 30, 2006, we had
approximately $488.3 million of mortgage debt outstanding, secured by the majority of our operating properties, $250.0 million of notes secured by our investment in the Bank and $21.4 million of unsecured notes.

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



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



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



| |  |  | make it difficult to satisfy our debt service requirements;
| | - |  | -----------------------------------------------------------



| |  |  | limit our ability to make distributions on our outstanding common and preferred stock;
| | - |  | --------------------------------------------------------------------------------------



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



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



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

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

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

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



| |  |  | relating to the maintenance of the property securing the debt;
| | - |  | --------------------------------------------------------------



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



| |  |  | restricting our ability to assign or further encumber the properties securing the debt; and
| | - |  | -------------------------------------------------------------------------------------------



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

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

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



| |  |  | limit the amount of debt so that interest expense coverage is not less than 1.25 to 1 on a trailing four quarter basis;
| | - |  | -----------------------------------------------------------------------------------------------------------------------

As of September 30, 2006, we were in compliance with all such covenants. If we were to breach any of our debt covenants and did not cure the breach within any
applicable cure period, our lenders could require us to repay the debt immediately, and, if the debt is secured, could



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##### Table of Contents

immediately begin proceedings to take possession of the property securing the loan. Some of our debt arrangements are cross-defaulted, which means that the
lenders under those debt arrangements can put us in default and require immediate repayment of their debt if we breach and fail to cure a covenant under certain of our other debt obligations. As a result, any default under our debt covenants could
have an adverse effect on our financial condition, our results of operations and our ability to meet our obligations.

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

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

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

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

Our insurance coverage on our properties may be inadequate.

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

As a consequence of the September 11, 2001 terrorist attacks and other significant losses incurred by the insurance industry, the availability of insurance coverage
has decreased and the prices for insurance have increased. As a result, we may be unable to renew or duplicate our current insurance coverage in adequate amounts or at reasonable prices. In addition, insurance companies may no longer offer coverage
against certain types of losses, such as losses due to terrorist acts and toxic mold, or, if offered, the expense of obtaining these types of insurance may not be justified. We therefore may cease to have insurance coverage against certain types of
losses and/or there may be decreases in the limits of insurance available. If an uninsured loss or a loss in excess of our insured limits occurs, we could lose all or a portion of the capital we have invested in a property, as well as the
anticipated future revenue from the property, but still remain obligated for any mortgage debt or other financial obligations related to the property. We cannot guarantee that material losses in excess of insurance proceeds will not occur in the
future. If any of our properties were to experience a catastrophic loss, it could seriously disrupt our operations, delay revenue and result in large expenses to repair or rebuild the property. Also, due to inflation, changes in codes and
ordinances, environmental considerations and other factors, it may not be feasible to use insurance proceeds to replace a building after it has been damaged or destroyed. Events such as these could adversely affect our results of operations and our
ability to meet our obligations.

We may be required to make payments to the Bank.

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

As of September 30, 2006, the amount of the tax sharing payments that the Real Estate Trust received from the Bank and that is subject to recapture should the Bank have future tax losses is $11.5 million. In future years, the amount of
the tax sharing payments that is subject to recapture will vary based on the actual amounts of taxable income and losses generated by the Real Estate Trust and by the Bank.

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



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Other Risks

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

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



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##### Table of Contents

|ITEM 1B. | UNRESOLVED STAFF COMMENTS
|-------- | -------------------------

The Trust has not received any written
comments from the Securities and Exchange Commission staff regarding its periodic or current reports in the 180 days preceding September 30, 2006 that remain unresolved.



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##### Table of Contents

|ITEM 2. | PROPERTIES
|------- | ----------

REAL ESTATE

A list of the investment properties of the Real Estate Trust is set forth under Item 1. BusinessReal
EstateReal Estate Investments.

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

BANKING

At September 30, 2006, the Bank conducted its business from its home office at 7926 Jones Branch Drive, McLean,
Virginia and its executive offices at 7501 Wisconsin Avenue, Bethesda, Maryland; its operations centers at 6151 and 6200 Chevy Chase Drive, and 14601 Sweitzer Lane, Laurel, Maryland; and 265 full-service offices located in Maryland, Virginia,
Delaware and the District of Columbia. On that date, the Bank owned the building and land for 50 of its branch offices and leased its remaining 215 branch offices. Chevy Chase leases the office facilities at 7926 Jones Branch Drive, 6200 Chevy Chase
Drive and 14601 Sweitzer Lane. Chevy Chase leases office facilities at 1919 M Street, NW, Washington, DC, which previously housed a subsidiary that relocated to the Banks executive offices during 2005. Chevy Chase owns the building and leases
the land at 7501 Wisconsin Avenue. In addition, the Bank leases office space in which its subsidiaries are housed. The office facility leases have various terms expiring from fiscal years 2006 to 2033 and the ground leases have terms expiring from
fiscal years 2029 to 2081. The Bank owns the building and land for its operations center at 6151 Chevy Chase Drive, Laurel, Maryland. The Bank also owns the office building and leases the land at 7700 Old Georgetown Road, Bethesda, Maryland, and
leases the office facilities at 7735 Old Georgetown Road, Bethesda, Maryland. Both of these office facilities were occupied by Bank personnel prior to the consolidation into the Banks corporate headquarters. The Bank has leased or is in the
process of leasing or subleasing these facilities to third parties. See Note 9 to the Consolidated Financial Statements in this report for lease expense and commitments, and Managements Discussion And Analysis - Of Financial Condition And
Results Of Operations - Capital in this report for a discussion of the regulatory treatment of one of the Banks office buildings.

At
September 30, 2006, the net book value of the Banks office facilities, including leasehold improvements, was $343.5 million, net of accumulated depreciation of $168.6 million. The Bank owns additional assets, including furniture and data
processing equipment. At September 30, 2006, these other assets had a book value of $258.1 million, net of accumulated depreciation of $164.2 million. The Bank also has operating leases, primarily for certain data processing equipment and
software. Those leases have month-to-month or year-to-year terms. See Note 18 to the Consolidated Financial Statements in this report.

The Bank also owns
automobiles which are leased to third parties. The leases are accounted for as operating leases with lease payments recognized as rental income. At September 30, 2006, automobiles subject to lease had a book value $55.4 million, net of
accumulated depreciation of $55.3 million. See Note 19 to the Consolidated Financial Statements in this report.



|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------

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

During the year, the Bank
settled for $16.1 million a seven year old class action lawsuit related to its prior credit card business which the Bank sold in 1998. The settlement completely resolves the case and the settlement amount includes plaintiffs counsel legal
fees, the administrative costs of the claims and notification process as well as payment of alleged damages. While the Bank did not admit any wrongdoing and believed it would be successful if the case proceeded to be adjudicated on the merits, it
elected to settle to eliminate the uncertainty and significant costs of further litigation.



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

No matters
were submitted to a vote of security holders during the fourth quarter of the fiscal year ended September 30, 2006.



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PART II



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

There currently is no established public trading market for Common Shares. At December 15, 2006, there were seven corporate holders of record of Common Shares. All
holders of Common Shares at such date were affiliated with the Trust. The Trust has no common share equivalents. The Trust declared the following common dividends during fiscal 2006. On January 19, 2006, the Trust declared a dividend on its
common shares of $0.248 per share, totaling approximately $1.2 million, payable on January 20, 2006, to holders of record on December 30, 2005. On March 9, 2006, the Trust declared a dividend on its common shares of $0.4362 per share,
totaling approximately $2.1 million, payable on March 17, 2006, to holders of record on March 10, 2006. On June 22, 2006, the Trust declared a dividend on its common shares of $0.342 per share, totaling approximately $1.6 million,
payable on June 23, 2006, to holders of record on June 19, 2006. On September 21, 2006, the Trust declared a dividend on its common shares of $0.342 per share, totaling $1.6 million, payable on September 22, 2006, to holders of
record on September 18, 2006. The Trust declared the following dividends during fiscal 2005. On January 20, 2005, the Trust declared a dividend on its common shares of $0.248 per share, totaling approximately $1.2 million, payable on
January 21, 2005, to holders of record on December 30, 2004. In addition, on March 10, 2005, the Trust declared a dividend on its common shares of $0.4362 per share, totaling approximately $2.1 million, payable on March 18, 2005,
to holders of record on March 11, 2005. On June 23, 2005 the Trust declared a dividend on its common shares of $0.342 per share, totaling $1.6 million, payable on June 24, 2005, to holders of record on June 20, 2005. On
September 22, 2005 the Trust declared a dividend on its common shares of $0.342 per share, totaling $1.6 million, payable on September 23, 2005, to holders of record on September 20, 2005. In fiscal 2004 the Trust declared a dividend
on its Common Shares of approximately $0.092 per share, totaling approximately $440,000, on September 23, 2004, payable on September 24, 2004 to holders of record on September 20, 2004. No other Common Share dividends were paid during
fiscal 2004. See Item 12. Security Ownership of Certain Beneficial Owners and Management.



|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------

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



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SELECTED FINANCIAL DATA



|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|--------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                            |  | Year Ended September 30, |        
|(In thousands, except per share amounts and other data)                     |  | 2006                     |         |   | 2005 |   |         | 2004 |  |   | 2003    |   |  | 2002 |        
|STATEMENT OF OPERATIONS DATA:                                               |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Real Estate:                                                                |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Revenues                                                                    |  | $                        | 169,637 |   |      | $ | 139,504 |      |  | $ | 123,646 |   |  | $    | 112,628 |   |  | $ | 113,706 |  
|Operating expenses                                                          |  |                          | 182,134 |   |      |   | 155,381 |      |  |   | 156,851 |   |  |      | 141,602 |   |  |   | 140,064 |  
|Equity in earnings of unconsolidated entities, net                          |  |                          | 10,051  |   |      |   | 8,246   |      |  |   | 7,788   |   |  |      | 7,248   |   |  |   | 8,811   |  
|Impairment loss on investments                                              |  |                          |        |   |      |   |        |      |  |   |        |   |  |      | (998    | ) |  |   | (188    | )
|Gain on sales of property                                                   |  |                          | 416     |   |      |   | 263     |      |  |   | 2,769   |   |  |      | 9,079   |   |  |   |        |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Real estate operating loss                                                  |  |                          | (2,030  | ) |      |   | (7,368  | )    |  |   | (22,648 | ) |  |      | (13,645 | ) |  |   | (17,735 | )
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Banking:                                                                    |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Interest income                                                             |  |                          | 735,003 |   |      |   | 572,763 |      |  |   | 441,271 |   |  |      | 451,551 |   |  |   | 541,399 |  
|Interest expense                                                            |  |                          | 318,171 |   |      |   | 207,193 |      |  |   | 163,022 |   |  |      | 205,479 |   |  |   | 273,186 |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net interest income                                                         |  |                          | 416,832 |   |      |   | 365,570 |      |  |   | 278,249 |   |  |      | 246,072 |   |  |   | 268,213 |  
|Credit (provision) for loan losses                                          |  |                          | 9,004   |   |      |   | 11,569  |      |  |   | 14,522  |   |  |      | (18,422 | ) |  |   | (51,367 | )
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net interest income after credit (provision) for loan losses                |  |                          | 425,836 |   |      |   | 377,139 |      |  |   | 292,771 |   |  |      | 227,650 |   |  |   | 216,846 |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Other income:                                                               |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Deposit servicing fees                                                      |  |                          | 144,548 |   |      |   | 136,279 |      |  |   | 129,107 |   |  |      | 122,473 |   |  |   | 113,640 |  
|Servicing, securitization and mortgage banking income                       |  |                          | 158,781 |   |      |   | 171,842 |      |  |   | 216,052 |   |  |      | 144,158 |   |  |   | 100,522 |  
|Automobile rental income                                                    |  |                          | 35,196  |   |      |   | 81,963  |      |  |   | 157,034 |   |  |      | 235,360 |   |  |   | 242,646 |  
|Other                                                                       |  |                          | 56,394  |   |      |   | 52,516  |      |  |   | 37,301  |   |  |      | 37,850  |   |  |   | 32,094  |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total other income                                                          |  |                          | 394,919 |   |      |   | 442,600 |      |  |   | 539,494 |   |  |      | 539,841 |   |  |   | 488,902 |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Operating expenses                                                          |  |                          | 681,952 |   |      |   | 630,044 |      |  |   | 601,050 |   |  |      | 621,301 |   |  |   | 602,166 |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Banking operating income                                                    |  |                          | 138,803 |   |      |   | 189,695 |      |  |   | 231,215 |   |  |      | 146,190 |   |  |   | 103,582 |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total Company:                                                              |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income from continuing operations before income taxes and minority interest |  |                          | 136,773 |   |      |   | 182,327 |      |  |   | 208,567 |   |  |      | 132,545 |   |  |   | 85,847  |  
|Income tax provision                                                        |  |                          | 39,663  |   |      |   | 59,141  |      |  |   | 70,480  |   |  |      | 46,658  |   |  |   | 23,777  |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income from continuing operations before minority interest                  |  |                          | 97,110  |   |      |   | 123,186 |      |  |   | 138,087 |   |  |      | 85,887  |   |  |   | 62,070  |  
|Minority interest held by affiliates                                        |  |                          | (13,597 | ) |      |   | (19,516 | )    |  |   | (23,070 | ) |  |      | (13,926 | ) |  |   | (9,671  | )
|Minority interest  other                                                   |  |                          | (29,141 | ) |      |   | (29,071 | )    |  |   | (37,195 | ) |  |      | (26,160 | ) |  |   | (25,313 | )
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income from continuing operations                                           |  |                          | 54,372  |   |      |   | 74,599  |      |  |   | 77,822  |   |  |      | 45,801  |   |  |   | 27,086  |  
|Discontinued real estate operations, net of income taxes                    |  |                          | 2,590   |   |      |   | (1,001  | )    |  |   | (1,122  | ) |  |      | (811    | ) |  |   | (1,179  | )
|Cumulative effect of change in accounting principle, net of income taxes    |  |                          |        |   |      |   |        |      |  |   |        |   |  |      | 897     |   |  |   |        |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total company net income                                                    |  | $                        | 56,962  |   |      | $ | 73,598  |      |  | $ | 76,700  |   |  | $    | 45,887  |   |  | $ | 25,907  |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income available to common shareholders                                 |  | $                        | 51,544  |   |      | $ | 68,180  |      |  | $ | 71,282  |   |  | $    | 40,469  |   |  | $ | 20,489  |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income (loss) per common share:                                         |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income from continuing operations                                           |  | $                        | 10.18   |   |      | $ | 14.39   |      |  | $ | 15.06   |   |  | $    | 8.38    |   |  | $ | 4.48    |  
|Discontinued operations                                                     |  |                          | 0.54    |   |      |   | (0.21   | )    |  |   | (0.23   | ) |  |      | (0.17   | ) |  |   | (0.24   | )
|Cumulative effect of change in accounting principle                         |  |                          |        |   |      |   |        |      |  |   |        |   |  |      | 0.19    |   |  |   |        |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income per common share (Basic and Diluted)                             |  | $                        | 10.72   |   |      | $ | 14.18   |      |  | $ | 14.83   |   |  | $    | 8.40    |   |  | $ | 4.24    |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  

Continued on following page.



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SELECTED FINANCIAL DATA

(Continued)



|                                                        |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|------------------------------------------------------- |  | ------------------------ | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | - |  | ---- | ---------- | - |  | - | ---------- | -
|                                                        |  | Year Ended September 30, |           
|(In thousands, except per share amounts and other data) |  | 2006                     |            |   | 2005 |   |            | 2004 |  |   | 2003       |   |  | 2002 |           
|BALANCE SHEET DATA:                                     |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Assets:                                                 |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Real estate assets                                      |  | $                        | 662,812    |   |      | $ | 465,830    |      |  | $ | 458,169    |   |  | $    | 429,285    |   |  | $ | 437,514    |  
|Income-producing properties, net (1)                    |  |                          | 373,093    |   |      |   | 270,828    |      |  |   | 273,360    |   |  |      | 275,005    |   |  |   | 285,308    |  
|Land parcels                                            |  |                          | 44,582     |   |      |   | 48,029     |      |  |   | 41,654     |   |  |      | 42,425     |   |  |   | 44,020     |  
|Construction in progress                                |  |                          | 34,946     |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Banking assets                                          |  |                          | 14,141,121 |   |      |   | 14,244,961 |      |  |   | 13,270,847 |   |  |      | 11,779,440 |   |  |   | 11,273,252 |  
|Total company assets                                    |  |                          | 14,803,933 |   |      |   | 14,710,791 |      |  |   | 13,729,016 |   |  |      | 12,208,725 |   |  |   | 11,710,766 |  
|Liabilities:                                            |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Real estate liabilities                                 |  |                          | 832,379    |   |      |   | 660,219    |      |  |   | 676,301    |   |  |      | 652,856    |   |  |   | 663,376    |  
|Mortgage notes payable (1)                              |  |                          | 488,339    |   |      |   | 294,328    |      |  |   | 311,316    |   |  |      | 322,437    |   |  |   | 326,232    |  
|Notes payable - secured                                 |  |                          | 250,000    |   |      |   | 250,000    |      |  |   | 250,000    |   |  |      | 203,800    |   |  |   | 201,750    |  
|Notes payable - unsecured                               |  |                          | 21,398     |   |      |   | 57,760     |      |  |   | 56,428     |   |  |      | 55,349     |   |  |   | 55,156     |  
|Banking liabilities                                     |  |                          | 13,192,459 |   |      |   | 13,324,284 |      |  |   | 12,400,167 |   |  |      | 11,039,425 |   |  |   | 10,614,255 |  
|Minority interest held by affiliates                    |  |                          | 130,529    |   |      |   | 124,932    |      |  |   | 114,933    |   |  |      | 98,062     |   |  |   | 88,137     |  
|Minority interest - other                               |  |                          | 296,013    |   |      |   | 296,013    |      |  |   | 296,013    |   |  |      | 249,698    |   |  |   | 218,307    |  
|Total company liabilities                               |  |                          | 14,451,380 |   |      |   | 14,405,448 |      |  |   | 13,487,414 |   |  |      | 12,040,041 |   |  |   | 11,584,075 |  
|Shareholders equity                                    |  |                          | 352,553    |   |      |   | 305,343    |      |  |   | 241,602    |   |  |      | 168,684    |   |  |   | 126,691    |  
|OTHER DATA (1):                                         |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Hotels:                                                 |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Number of hotels                                        |  |                          | 17         |   |      |   | 17         |      |  |   | 18         |   |  |      | 18         |   |  |   | 18         |  
|Number of guest rooms                                   |  |                          | 3,110      |   |      |   | 3,383      |      |  |   | 3,573      |   |  |      | 3,574      |   |  |   | 3,578      |  
|Average occupancy                                       |  |                          | 70         | % |      |   | 68         | %    |  |   | 66         | % |  |      | 61         | % |  |   | 61         | %
|Average room rate                                       |  | $                        | 128.88     |   |      | $ | 106.81     |      |  | $ | 91.67      |   |  | $    | 85.93      |   |  | $ | 86.92      |  
|Office properties:                                      |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Number of properties                                    |  |                          | 14         |   |      |   | 14         |      |  |   | 13         |   |  |      | 13         |   |  |   | 13         |  
|Leasable area (square feet)                             |  |                          | 1,990,147  |   |      |   | 1,990,147  |      |  |   | 1,978,016  |   |  |      | 1,978,016  |   |  |   | 1,978,016  |  
|Leasing percentages                                     |  |                          | 92         | % |      |   | 91         | %    |  |   | 89         | % |  |      | 85         | % |  |   | 86         | %
|Land parcels:                                           |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Number of parcels                                       |  |                          | 11         |   |      |   | 12         |      |  |   | 10         |   |  |      | 10         |   |  |   | 10         |  
|Total acreage                                           |  |                          | 439        |   |      |   | 452        |      |  |   | 381        |   |  |      | 381        |   |  |   | 389        |  



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



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|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

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

CRITICAL ACCOUNTING POLICIES

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

REAL ESTATE

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

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

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

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

Income Recognition: The Real Estate Trust derives room and other revenues from the operations of its hotel portfolio. Hotel revenue is recognized as earned. The Real Estate Trust derives rental income under
noncancelable long-term leases from tenants at its commercial properties. Commercial property rental income is recognized on a straight-line basis. When rental payments due under leases vary from a straight-line basis because of free rent periods or
scheduled rent increases, income is recognized on a straight-line basis throughout the initial term of the lease. Expense recoveries represent a portion of property operating expenses billed to tenants, including common area maintenance, real estate
taxes and other recoverable costs. Expense recoveries are recognized in the period when the expenses are incurred.

BANKING

General:The Banks consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States
(GAAP), which requires the Bank to make certain estimates and assumptions that affect its reported results. See Note 1 to the Consolidated Financial Statements in this report. The Bank has identified four policies that, due to estimates
and assumptions inherent in those policies, involve a relatively high degree of judgment and complexity.

Allowance for Losses:The Bank maintains
allowances for possible losses on its loans at levels it believes to be adequate to absorb estimated probable losses in the loan portfolio at the balance sheet date. Management reviews the adequacy of the allowance for losses using a variety of



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measures and tools appropriate for the asset type, including historical loss performance, delinquent status, current economic conditions, internal risk
ratings, current underwriting policies and practices and market values for similar assets.

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

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

Interest-Only Strips Receivable and Certificates:The Bank sells loans and retains an interest-only strip receivable or receives an interest-only certificate
related to the sold items. The interest-only assets are initially recorded by allocating the previous carrying value of the assets involved in the transactions between the assets sold and the interests retained, including the interest-only strips
receivable. Subsequently, the interest-only assets are carried at their fair values, with changes in fair value reflected in income. Fair value of these interest-only assets is based on discounted expected future cash flows, which are determined
using various assumptions, the most significant of which are discount rates and prepayment speeds. The Bank also engages independent firms with expertise in this area to evaluate these assets and render an opinion on their fair value. If actual
prepayment or default rates significantly exceed the estimates, the actual amount of future cash flow could be less than the expected amount and the value of the interest-only assets, as well as the Banks earnings, could decline.

Mortgage Servicing Rights:The Bank sells mortgage loans and retains the right to service those loans (originated MSR). Originated MSR are
initially recorded by allocating the previous carrying value of the loans between the portion sold and the retained originated MSR. Also, the Bank has purchased the right to service mortgage loans originated by third parties (purchased
MSR and, together with originated MSR, MSR). Purchased MSR are initially recorded at their acquisition cost. Subsequent to origination or purchase, MSR are carried at the lower of their amortized cost or fair value. Fair value of
MSR is based on discounted expected future income, net of related expenses, to be generated by servicing the underlying loans. When determining fair value, the Bank uses several assumptions, the most significant of which are the estimated rate of
repayment of the underlying loans and the discount rate. The Bank also engages independent firms with expertise in this area to evaluate these assets and render an opinion on their fair value. If actual repayment rates significantly exceed the
estimates, the actual amount of future cash flow could be less than the expected amount and the value of the MSR, as well as the Banks earnings, could decline. Effective October 1, 2006, the Bank adopted SFAS 156 and MSRs are now carried
at their fair value. See Note 1 to the Consolidated Financial Statements in this report.

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



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FINANCIAL CONDITION

REAL ESTATE

The Real Estate Trusts investment portfolio at September 30, 2006, consisted primarily of hotels,
office and industrial projects, and land parcels. At September 30, 2006, the Real Estate Trusts hotel portfolio included 17 properties containing 3,110 available rooms. The office property portfolio consisted of 14 properties with a total
gross leasable area of 1,990,000 square feet. See Item 1. Business  Real Estate  Real Estate Investments.

The hotel portfolio,
excluding the two properties acquired and the three properties disposed of during the current and prior fiscal years, (Same hotel properties) experienced an average occupancy of 70.8% and an average room rate of $123.48 during fiscal
2006, compared to an average occupancy of 69.5% and an average room rate of $112.41 during the prior fiscal year. REVPAR (revenue per available room) for the same hotel properties was $87.37 for fiscal 2006, an 11.8% increase over REVPAR for fiscal
2005 of $78.16.

The Real Estate Trusts hotel portfolio has experienced positive growth in occupancy and strong growth in average room rates,
particularly the Northern Virginia and Florida properties, during fiscal year 2006 reflecting continued strength in general business travel.

The Real
Estate Trusts office and industrial property portfolio was 92.0% leased at September 30, 2006, compared to a leasing rate of 91.0% at September 30, 2005. At September 30, 2006, of the total gross leasable area of 1,990,000
square feet, 343,605 square feet (17.3%) and 191,224 square feet (9.6%) were subject to leases expiring in fiscal 2007 and fiscal 2008, respectively. Expiring leases, by property, are detailed in Part I, Item I of this Form 10-K. The Real
Estate Trust is actively marketing all expiring space, both through possible renewals or new tenants.

BANKING

General.The Banks assets decreased by $103.8 million to $14.1 billion during fiscal year 2006. The Bank
recorded operating income of $138.8 million during fiscal year 2006, compared to operating income of $189.7 million during fiscal year 2005. The decrease in operating income for fiscal year 2006 was primarily attributable to reductions in the
carrying value of servicing assets and interest-only assets as a result of continued high prepayment rates on securitized residential mortgage loans, decreased automobile rental income as a result of the Banks prior decision to exit that
business, and increased salaries and employee benefits. Partially offsetting these items were increases in net interest income and a decrease in depreciation and amortization. See Results of Operations.

At September 30, 2006, the Banks tangible, core, tier 1 risk-based and total risk-based regulatory capital ratios were 6.15%, 6.15%, 9.12% and 11.21%,
respectively. The Banks capital ratios exceeded regulatory requirements as well as the standards established for well-capitalized institutions under OTS prompt corrective action regulations. See Capital.

During fiscal year 2006, the Bank declared and paid, out of the retained earnings of the Bank, cash dividends on its Common Stock in the aggregate amount of $4,000 per
share.

The Banks assets are subject to review and classification by the OTS upon examination. The OTS concluded its most recent safety and soundness
examination of the Bank in August 2006.

Asset Quality.Non-Performing Assets. The Banks overall level of non-performing assets
increased during fiscal year 2006 due primarily to increased residential mortgage loans placed on non-accrual status and higher levels of REO due to development expenditures in two projects. The following table sets forth information concerning the
Banks non-performing assets at the dates indicated. The figures shown are after charge-offs and, in the case of real estate acquired in settlement of loans, after all valuation allowances.



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Non-Performing Assets

(Dollars in thousands)



|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|---------------------------------------------------------------------------------------------------------------- |  | ------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------- | -
|                                                                                                                 |  | September 30, |       
|                                                                                                                 |  | 2006          |        |   | 2005 |   |        | 2004 |  |   | 2003   |   |  | 2002 |       
|Non-performing assets:                                                                                           |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Non-accrual loans:                                                                                               |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Residential mortgage                                                                                             |  | $             | 27,352 |   |      | $ | 20,874 |      |  | $ | 8,993  |   |  | $    | 6,567  |   |  | $ | 12,731  |  
|Home equity                                                                                                      |  |               | 1,858  |   |      |   | 1,443  |      |  |   | 1,767  |   |  |      | 1,480  |   |  |   | 949     |  
|Other real estate                                                                                                |  |               | 1,481  |   |      |   |       |      |  |   |       |   |  |      | 1,004  |   |  |   | 653     |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Total non-accrual real estate loans                                                                              |  |               | 30,691 |   |      |   | 22,317 |      |  |   | 10,760 |   |  |      | 9,051  |   |  |   | 14,333  |  
|Commercial                                                                                                       |  |               | 13     |   |      |   | 30     |      |  |   | 242    |   |  |      | 249    |   |  |   | 2,329   |  
|Subprime automobile                                                                                              |  |               | 14     |   |      |   | 375    |      |  |   | 1,164  |   |  |      | 4,372  |   |  |   | 7,755   |  
|Prime automobile                                                                                                 |  |               | 505    |   |      |   | 768    |      |  |   | 1,069  |   |  |      | 1,484  |   |  |   | 1,705   |  
|Other consumer                                                                                                   |  |               | 202    |   |      |   | 216    |      |  |   | 472    |   |  |      | 444    |   |  |   | 431     |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Total non-accrual loans (1)                                                                                      |  |               | 31,425 |   |      |   | 23,706 |      |  |   | 13,707 |   |  |      | 15,600 |   |  |   | 26,553  |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Real estate acquired in settlement of loans                                                                      |  |               | 32,310 |   |      |   | 20,265 |      |  |   | 20,357 |   |  |      | 21,820 |   |  |   | 94,665  |  
|Allowance for losses on real estate acquired in settlement of loans                                              |  |               |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   | (71,293 | )
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Real estate acquired in settlement of loans, net                                                                 |  |               | 32,310 |   |      |   | 20,265 |      |  |   | 20,357 |   |  |      | 21,820 |   |  |   | 23,372  |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Total non-performing assets                                                                                      |  | $             | 63,735 |   |      | $ | 43,971 |      |  | $ | 34,064 |   |  | $    | 37,420 |   |  | $ | 49,925  |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Troubled debt restructurings                                                                                     |  | $             |       |   |      | $ |       |      |  | $ |       |   |  | $    |       |   |  | $ |        |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Allowance for losses on loans                                                                                    |  | $             | 25,000 |   |      | $ | 28,640 |      |  | $ | 37,750 |   |  | $    | 58,397 |   |  | $ | 66,079  |  
|Allowance for losses on real estate held for investment                                                          |  |               |       |   |      |   |       |      |  |   | 202    |   |  |      | 202    |   |  |   | 202     |  
|Allowance for losses on real estate acquired in settlement of loans                                              |  |               |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   | 71,293  |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Total allowances for losses                                                                                      |  | $             | 25,000 |   |      | $ | 28,640 |      |  | $ | 37,952 |   |  | $    | 58,599 |   |  | $ | 137,574 |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Interest income recorded                                                                                         |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Non-accrual assets                                                                                               |  | $             | 1,488  |   |      | $ | 449    |      |  | $ | 180    |   |  | $    | 39     |   |  | $ | 279     |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Restructured loans                                                                                               |  | $             |       |   |      | $ |       |      |  | $ |       |   |  | $    |       |   |  | $ |        |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Interest income that would have been recorded had the loans been current in accordance with their original terms |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Non-accrual assets                                                                                               |  | $             | 1,801  |   |      | $ | 1,034  |      |  | $ | 1,206  |   |  | $    | 2,098  |   |  | $ | 3,141   |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Restructured loans                                                                                               |  | $             |       |   |      | $ |       |      |  | $ |       |   |  | $    |       |   |  | $ |        |  
|                                                                                                                 |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Ratios:                                                                                                          |  |               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Non-performing assets to total assets                                                                            |  |               | 0.45   | % |      |   | 0.31   | %    |  |   | 0.26   | % |  |      | 0.32   | % |  |   | 0.44    | %
|Allowance for losses on real estate loans to non-accrual real estate loans (1)                                   |  |               | 36.33  | % |      |   | 47.48  | %    |  |   | 91.02  | % |  |      | 75.65  | % |  |   | 44.05   | %
|Allowance for losses on loans to non-accrual loans (1)                                                           |  |               | 79.55  | % |      |   | 120.81 | %    |  |   | 275.41 | % |  |      | 374.34 | % |  |   | 248.86  | %
|Allowance for losses on loans to total loans receivable (2)                                                      |  |               | 0.24   | % |      |   | 0.26   | %    |  |   | 0.36   | % |  |      | 0.65   | % |  |   | 0.85    | %



|(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 totaled $63.7 million at September 30, 2006, compared to $44.0 million, at September 30, 2005. The Bank maintained valuation allowances of $25.0 million and $28.6 million on its loan
portfolio at September 30, 2006 and 2005, respectively. The $19.7 million increase in non-performing assets reflected a net increase in non-accrual loans of $7.7 million coupled with an increase in REO of $12.0 million.



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Non-accrual Loans. The Banks non-accrual loans totaled $31.4 million at September 30, 2006, an increase
from $23.7 million at September 30, 2005. At September 30, 2006, non-accrual loans consisted of $30.7 million of non-accrual real estate loans and $0.7 million of non-accrual prime automobile, subprime automobile, commercial and other
consumer loans compared to non-accrual real estate loans of $22.3 million and non-accrual prime automobile, subprime automobile, commercial and other consumer loans of $1.4 million at September 30, 2005. There were 33 non-accrual residential
mortgage loans at September 30, 2006, compared to 28 loans at September 30, 2005. The decrease in non-accrual prime automobile and subprime automobile loans reflects the winding down of those portfolios.

REO. At September 30, 2006, the Banks REO totaled $32.3 million compared to $20.3 million at September 30, 2005. The increase in REO during the
year is a result of development expenditures in two large properties designed to facilitate their eventual sale.

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

Potential Problem Assets. Although not considered non-performing assets, primarily because the loans are not 90 or more days past due and the borrowers have not
abandoned control of the properties, potential problem assets are experiencing problems sufficient to cause management to have serious doubts as to the ability of the borrowers to comply with present repayment terms. Potential problem assets totaled
$4.0 million and $0.4 million, at September 30, 2006 and 2005, respectively. A commercial loan with a balance of $3.6 million was classified as a potential problem loan during the current year. Subsequent to September 30, 2006, the
conditions of this loan improved and it was no longer classified as a potential problem asset.

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

Delinquent Loans. At
September 30, 2006, delinquent loans totaled $42.9 million, or 0.4% of loans, compared to $29.2 million, or 0.3% of loans, at September 30, 2005. The following table sets forth information regarding the Banks delinquent loans at
September 30, 2006.



|                                  |  |                                                               |        |   |            |   |       |       |  |   |        |  
|--------------------------------- |  | ------------------------------------------------------------- | ------ | - | ---------- | - | ----- | ----- |  | - | ------ | -
|                                  |  | Principal Balance (Dollars in thousands) Loans
Delinquent for |       
|                                  |  | 30-59 days                                                    |        |   | 60-89 days |   |       | Total | 
|Residential Mortgage              |  | $                                                             | 18,457 |   |            | $ | 5,309 |       |  | $ | 23,766 |  
|Home Equity                       |  |                                                               | 9,847  |   |            |   | 913   |       |  |   | 10,760 |  
|Other Real Estate                 |  |                                                               | 3,307  |   |            |   |      |       |  |   | 3,307  |  
|Consumer                          |  |                                                               | 3,487  |   |            |   | 1,568 |       |  |   | 5,055  |  
|                                  |  |                                                               |        |   |            |   |       |       |  |   |        |  
|Total                             |  | $                                                             | 35,098 |   |            | $ | 7,790 |       |  | $ | 42,888 |  
|                                  |  |                                                               |        |   |            |   |       |       |  |   |        |  
|Total as a Percentage of Loans(1) |  |                                                               | 0.3    | % |            |   | 0.1   | %     |  |   | 0.4    | %
|                                  |  |                                                               |        |   |            |   |       |       |  |   |        |  

---

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

Total residential mortgage loans delinquent 30-89 days increased to $23.8 million at September 30, 2006 from $10.5 million at
September 30, 2005. Home equity loans delinquent 30-89 days increased to $10.8 million at September 30, 2006 from $5.7 million at September 30, 2005.

Total delinquent consumer loans decreased to $5.1 million at September 30, 2006, from $9.6 million at September 30, 2005, primarily because the Banks portfolio of these loans continues to decline as a
result of the Banks prior decision to discontinue origination of indirect consumer loans.

Troubled Debt Restructurings. A troubled debt
restructuring occurs when the Bank agrees to modify significant terms of a loan in favor of a borrower experiencing financial difficulties. The Bank had no troubled debt restructurings at September 30, 2006 and 2005.

Deferred Interest. Most of the Banks payment option residential mortgage loans have a payment option that could result in interest being added to the
principal of the loan, or negative amortization. See BUSINESSLending and Leasing ActivitiesSingle-Family Residential Real Estate Lending (Excluding Home Equity Lending) in this report. As of September 30,
2006, cumulative net deferred interest, which is included in loans receivable, totaled $32.8 million.

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



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Analysis of Allowance for and Charge-offs of Loans

(Dollars in thousands)



|                                                           |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|---------------------------------------------------------- |  | ------------------------ | ------ | -- | ---- | - | ------- | ---- |  | - | ------- | -- |  | ---- | ------- | - |  | - | ------- | -
|                                                           |  | Year Ended September 30, |       
|                                                           |  | 2006                     |        |    | 2005 |   |         | 2004 |  |   | 2003    |    |  | 2002 |        
|Balance at beginning of year                               |  | $                        | 28,640 |    |      | $ | 37,750  |      |  | $ | 58,397  |    |  | $    | 66,079  |   |  | $ | 57,018  |  
|                                                           |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Provision (credit) for loan losses                         |  |                          | (9,004 | )  |      |   | (11,569 | )    |  |   | (14,522 | )  |  |      | 18,422  |   |  |   | 51,367  |  
|                                                           |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Charge-offs:                                               |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Residential mortgage                                       |  |                          | (880   | )  |      |   | (752    | )    |  |   | (279    | )  |  |      | (273    | ) |  |   | (300    | )
|Home equity                                                |  |                          | (365   | )  |      |   | (818    | )    |  |   | (786    | )  |  |      | (759    | ) |  |   | (832    | )
|Commercial                                                 |  |                          | (26    | )  |      |   | (720    | )    |  |   |        |    |  |      | (382    | ) |  |   | (27     | )
|Automobile                                                 |  |                          | (3,834 | )  |      |   | (9,934  | )    |  |   | (22,292 | )  |  |      | (39,296 | ) |  |   | (51,185 | )
|Other consumer                                             |  |                          | (1,444 | )  |      |   | (2,298  | )    |  |   | (3,201  | )  |  |      | (4,247  | ) |  |   | (3,673  | )
|                                                           |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Total charge-offs                                          |  |                          | (6,549 | )  |      |   | (14,522 | )    |  |   | (26,558 | )  |  |      | (44,957 | ) |  |   | (56,017 | )
|                                                           |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Recoveries:                                                |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Home equity                                                |  |                          | 260    |    |      |   | 321     |      |  |   | 340     |    |  |      | 248     |   |  |   | 76      |  
|Commercial                                                 |  |                          | 192    |    |      |   | 317     |      |  |   |        |    |  |      | 14      |   |  |   | 18      |  
|Automobile                                                 |  |                          | 9,421  |    |      |   | 13,778  |      |  |   | 18,374  |    |  |      | 17,251  |   |  |   | 12,767  |  
|Other consumer                                             |  |                          | 2,040  |    |      |   | 2,565   |      |  |   | 1,719   |    |  |      | 1,340   |   |  |   | 850     |  
|                                                           |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Total recoveries                                           |  |                          | 11,913 |    |      |   | 16,981  |      |  |   | 20,433  |    |  |      | 18,853  |   |  |   | 13,711  |  
|                                                           |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Net (charge-offs), recoveries                              |  |                          | 5,364  |    |      |   | 2,459   |      |  |   | (6,125  | )  |  |      | (26,104 | ) |  |   | (42,306 | )
|                                                           |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Balance at end of year                                     |  | $                        | 25,000 |    |      | $ | 28,640  |      |  | $ | 37,750  |    |  | $    | 58,397  |   |  | $ | 66,079  |  
|                                                           |  |                          |        |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Provision (credit) for loan losses to average loans(1)     |  |                          | (0.08  | %) |      |   | (0.10   | %)   |  |   | (0.14   | %) |  |      | 0.22    | % |  |   | 0.70    | %
|Net loan charge-offs (recoveries) to average loans(1)      |  |                          | (0.05  | %) |      |   | (0.02   | %)   |  |   | 0.06    | %  |  |      | 0.31    | % |  |   | 0.58    | %
|Ending allowance for losses on loans to total loans(1)
(2) |  |                          | 0.24   | %  |      |   | 0.26    | %    |  |   | 0.36    | %  |  |      | 0.65    | % |  |   | 0.85    | %



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Components of Allowance for Losses on Loans by Type

(Dollars in thousands)



|                                     |  |               |        |                               |      |   |        |      |                               |  |      |        |  |                               |        |  |        |   |                               |   |        |        |      |                               |  |   |        |  |      |  
|------------------------------------ |  | ------------- | ------ | ----------------------------- | ---- | - | ------ | ---- | ----------------------------- |  | ---- | ------ |  | ----------------------------- | ------ |  | ------ | - | ----------------------------- | - | ------ | ------ | ---- | ----------------------------- |  | - | ------ |  | ---- | -
|                                     |  | September 30, |       
|                                     |  | 2006          |        |                               | 2005 |   |        | 2004 |                               |  | 2003 |        |  | 2002                          |       
|                                     |  | Amount        |        | Percent ofLoans toTotal Loans |      |   | Amount |      | Percent ofLoans toTotal Loans |  |      | Amount |  | Percent ofLoans toTotal Loans |        |  | Amount |   | Percent ofLoans toTotal Loans |   |        | Amount |      | Percent ofLoans toTotal Loans | 
|Balance at end of year allocated to: |  |               |        |                               |      |   |        |      |                               |  |      |        |  |                               |        |  |        |   |                               |   |        |        |      |                               |  |   |        |  |      |  
|Residential mortgage                 |  | $             | 5,085  |                               | 67.7 | % |        | $    | 5,100                         |  | 68.9 | %      |  | $                             | 4,275  |  | 68.6   | % |                               | $ | 2,161  |        | 64.7 | %                             |  | $ | 1,953  |  | 59.0 | %
|Home equity                          |  |               | 3,095  |                               | 16.1 |   |        |      | 3,570                         |  | 16.4 |        |  |                               | 3,350  |  | 16.5   |   |                               |   | 2,426  |        | 15.0 |                               |  |   | 817    |  | 14.1 |  
|Other real estate                    |  |               | 2,969  |                               | 5.8  |   |        |      | 1,925                         |  | 3.3  |        |  |                               | 2,169  |  | 2.5    |   |                               |   | 2,260  |        | 2.8  |                               |  |   | 3,543  |  | 3.7  |  
|Commercial                           |  |               | 6,371  |                               | 9.4  |   |        |      | 6,775                         |  | 9.5  |        |  |                               | 7,361  |  | 8.8    |   |                               |   | 14,400 |        | 10.0 |                               |  |   | 16,934 |  | 10.4 |  
|Automobile                           |  |               | 2,470  |                               | 0.6  |   |        |      | 3,610                         |  | 1.4  |        |  |                               | 10,320 |  | 2.9    |   |                               |   | 23,013 |        | 6.6  |                               |  |   | 36,150 |  | 11.0 |  
|Other consumer                       |  |               | 1,225  |                               | 0.4  |   |        |      | 2,005                         |  | 0.5  |        |  |                               | 3,415  |  | 0.7    |   |                               |   | 3,069  |        | 0.9  |                               |  |   | 2,786  |  | 1.8  |  
|Unallocated                          |  |               | 3,785  |                               |     |   |        |      | 5,655                         |  |     |        |  |                               | 6,860  |  |       |   |                               |   | 11,068 |        |     |                               |  |   | 3,896  |  |     |  
|                                     |  |               |        |                               |      |   |        |      |                               |  |      |        |  |                               |        |  |        |   |                               |   |        |        |      |                               |  |   |        |  |      |  
|Total                                |  | $             | 25,000 |                               |      |   |        | $    | 28,640                        |  |      |        |  | $                             | 37,750 |  |        |   |                               | $ | 58,397 |        |      |                               |  | $ | 66,079 |  |      |  
|                                     |  |               |        |                               |      |   |        |      |                               |  |      |        |  |                               |        |  |        |   |                               |   |        |        |      |                               |  |   |        |  |      |  

The Banks total allowances for losses on loans decreased to $25.0 million at September 30, 2006, from
$28.6 million at September 30, 2005. Management reviews the delinquent status of loans, current economic conditions, internal risk ratings of loans and current underwriting policies and procedures. Using this analysis, management computes its
estimate of the allowance for losses on loans. Managements prior decisions to discontinue subprime automobile lending and indirect consumer lending, and focus more on residential mortgages, have contributed to the overall improvement in the
credit quality of the Banks loan portfolio. As the balances of automobile loans continue to decline, charge-offs and delinquencies have also declined. The combination of these factors contributed to the Banks decision to reduce the
amount of its allowance for loan losses at September 30, 2006.

The allowance for losses on loans secured by real estate totaled $11.1 million at
September 30, 2006, a $0.5 million increase from the September 30, 2005 level of $10.6 million. The allowance represented 36.3% and 47.5% of the amount of non-performing real estate loans at September 30, 2006 and 2005, respectively.

The allowance for losses on other consumer loans, including automobile, home improvement, overdraft lines of credit and other consumer loans, decreased to
$3.7 million at September 30, 2006 from $5.6 million at September 30, 2005. The decrease in the allowance for prime automobile loans and charge-offs was due to the decline in the Banks portfolio of these loans as a result of the
Banks prior decision to discontinue origination of indirect automobile loans.

The unallocated allowance for losses decreased to $3.8 million at
September 30, 2006 from $5.7 million at September 30, 2005. The unallocated allowance is based upon managements evaluation and judgment of various conditions that are not directly measured in the determination of the allocated and
specific allowances. The conditions evaluated in connection with the unallocated allowance include existing general economic and business conditions affecting key lending areas of the Bank, credit quality trends, collateral values, loan volumes and
concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience in particular segments of the portfolio, natural disasters, regulatory examination results and findings of the
Banks internal credit evaluations. At September 30, 2006 and 2005, most of the unallocated allowance relates to risks inherent in the mortgage loan portfolio, including, for example, geographic concentration and negative amortization
features.

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

The Banks assets and
liabilities are inherently sensitive to changes in interest rates. These movements can result in variations to the overall level of income and market value of equity. Based on the characteristic of a specific asset or liability (including maturity,
repricing frequency and interest rate caps), a change in interest rates can significantly affect the contribution to net income by, and market value of, the instrument. If, in



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the aggregate, the Banks assets mature or reprice more quickly or to a greater extent than its liabilities, the Bank is termed asset
sensitive and will tend to experience an increase in interest income and market value during periods of rising interest rates and declining interest income and market value during periods of falling interest rates. Conversely, if the
Banks liabilities mature or reprice more quickly or to a greater extent than its assets, the Bank is termed liability sensitive and will tend to experience a decrease in interest income and market value during periods of rising
interest rates and increased interest income and market value during periods of falling interest rates.

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

Throughout fiscal year 2006, the Bank continued to originate and hold in its portfolio adjustable-rate loan
products at a greater volume than those with fixed interest rates. At September 30, 2006, adjustable-rate loans accounted for 81.5% of total loans, compared to 82.1% at September 30, 2005.

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

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

The following table presents the Banks interest rate sensitivity gap at September 30, 2006. Balances of interest-earning assets and interest-bearing liabilities are shown in the earlier of the period where
contractual payments are due, interest rates adjust or prepayment is anticipated to occur. Adjustable and floating rate loans are included in the period in which their interest rates are next scheduled to adjust, and prepayment rates are assumed for
all of the Banks loans based on managements estimates. The Banks deposits with no stated maturity, including savings and transaction accounts, have interest rates that may reprice at any time. However, market experience has proven
that these deposits adjust to market prices over a much longer period of time. The Bank considers these deposits to be relatively insensitive to interest rate changes. The table contains information of the Bank only and does not include
consolidation or elimination entries required for the Trusts financial presentation.



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Interest Rate Sensitivity Table (Gap)

(Dollars in thousands)



|                                               |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|---------------------------------------------- |  | ----------------- | --------- | - | ----------------------------------- | - | --------- | ----------------------------------- |  | - | -------------------------------------- | - |  | ------------------- | --------- | - | ----- | - | ---------- | - |  | - | ----------
|                                               |  | Six Monthsor Less |           |   | More thanSix Monthsthrough One Year |   |           | More thanOne YearthroughThree Years |  |   | More thanThree Yearsthrough Five Years |   |  | More thanFive Years |           |   | Total
|As of September 30, 2006                       |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|Real estate loans:                             |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|Adjustable-rate                                |  | $                 | 3,812,888 |   |                                     | $ | 522,672   |                                     |  | $ | 1,856,499                              |   |  | $                   | 909,132   |   |       | $ | 169        |   |  |   | 7,101,360 
|Fixed-rate                                     |  |                   | 25,755    |   |                                     |   | 18,796    |                                     |  |   | 56,302                                 |   |  |                     | 33,806    |   |       |   | 3,908      |   |  |   | 138,567   
|Home equity credit lines and second mortgages  |  |                   | 1,425,670 |   |                                     |   | 43,753    |                                     |  |   | 134,647                                |   |  |                     | 98,818    |   |       |   | 108,065    |   |  |   | 1,810,953 
|Commercial                                     |  |                   | 756,769   |   |                                     |   | 12,658    |                                     |  |   | 44,983                                 |   |  |                     | 30,792    |   |       |   | 141,454    |   |  |   | 986,656   
|Consumer and other                             |  |                   | 56,730    |   |                                     |   | 27,119    |                                     |  |   | 20,191                                 |   |  |                     | 2,802     |   |       |   | 1,443      |   |  |   | 108,285   
|Loans held for securitization and/or sale      |  |                   | 467,574   |   |                                     |   |          |                                     |  |   |                                       |   |  |                     |          |   |       |   |           |   |  |   | 467,574   
|Mortgage-backed securities                     |  |                   | 266,615   |   |                                     |   | 225,966   |                                     |  |   | 387,019                                |   |  |                     | 368,646   |   |       |   | 41,472     |   |  |   | 1,289,718 
|Other investments                              |  |                   | 123,320   |   |                                     |   |          |                                     |  |   | 201,455                                |   |  |                     |          |   |       |   |           |   |  |   | 324,775   
|                                               |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|Total interest-earning assets                  |  |                   | 6,935,321 |   |                                     |   | 850,964   |                                     |  |   | 2,701,096                              |   |  |                     | 1,443,996 |   |       |   | 296,511    |   |  |   | 12,227,888
|Total non-interest earning assets              |  |                   |          |   |                                     |   |          |                                     |  |   |                                       |   |  |                     |          |   |       |   | 1,913,233  |   |  |   | 1,913,233 
|                                               |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|Total assets                                   |  | $                 | 6,935,321 |   |                                     | $ | 850,964   |                                     |  | $ | 2,701,096                              |   |  | $                   | 1,443,996 |   |       | $ | 2,209,744  |   |  | $ | 14,141,121
|                                               |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|Deposits:                                      |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|Fixed maturity deposits                        |  | $                 | 2,331,531 |   |                                     | $ | 877,907   |                                     |  | $ | 212,078                                |   |  | $                   | 37,393    |   |       | $ |           |   |  | $ | 3,458,909 
|NOW, statement and passbook accounts           |  |                   |          |   |                                     |   | 86,238    |                                     |  |   | 172,477                                |   |  |                     | 172,477   |   |       |   | 2,835,623  |   |  |   | 3,266,815 
|Money market deposit accounts                  |  |                   | 2,403,060 |   |                                     |   |          |                                     |  |   |                                       |   |  |                     |          |   |       |   |           |   |  |   | 2,403,060 
|Borrowings:                                    |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|Capital notes - subordinated                   |  |                   |          |   |                                     |   |          |                                     |  |   |                                       |   |  |                     |          |   |       |   | 175,000    |   |  |   | 175,000   
|Other                                          |  |                   | 1,647,314 |   |                                     |   | 159,144   |                                     |  |   | 296,451                                |   |  |                     | 16,058    |   |       |   | 46,984     |   |  |   | 2,165,951 
|                                               |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|Total interest-bearing liabilities             |  |                   | 6,381,905 |   |                                     |   | 1,123,289 |                                     |  |   | 681,006                                |   |  |                     | 225,928   |   |       |   | 3,057,607  |   |  |   | 11,469,735
|Total non-interest bearing liabilities         |  |                   |          |   |                                     |   |          |                                     |  |   |                                       |   |  |                     |          |   |       |   | 1,705,760  |   |  |   | 1,705,760 
|Minority interest                              |  |                   |          |   |                                     |   |          |                                     |  |   |                                       |   |  |                     |          |   |       |   | 175,391    |   |  |   | 175,391   
|Stockholders equity                           |  |                   |          |   |                                     |   |          |                                     |  |   |                                       |   |  |                     |          |   |       |   | 790,235    |   |  |   | 790,235   
|                                               |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|Total liabilities & stockholders equity       |  | $                 | 6,381,905 |   |                                     | $ | 1,123,289 |                                     |  | $ | 681,006                                |   |  | $                   | 225,928   |   |       | $ | 5,728,993  |   |  | $ | 14,141,121
|                                               |  |                   |           |   |                                     |   |           |                                     |  |   |                                        |   |  |                     |           |   |       |   |            |   |  |   |           
|Gap                                            |  | $                 | 553,416   |   |                                     | $ | (272,325  | )                                   |  | $ | 2,020,090                              |   |  | $                   | 1,218,068 |   |       | $ | (2,761,096 | ) |  |   |           
|Cumulative gap                                 |  | $                 | 553,416   |   |                                     | $ | 281,091   |                                     |  | $ | 2,301,181                              |   |  | $                   | 3,519,249 |   |       | $ | 758,153    |   |  |   |           
|Cumulative gap as a percentage of total assets |  |                   | 3.9       | % |                                     |   | 2.0       | %                                   |  |   | 16.3                                   | % |  |                     | 25.0      | % |       |   | 5.4        | % |  |   |           



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The Banks one-year gap, as a percentage of total assets, was 2.0% at September 30, 2006, compared to 13.8% at
September 30, 2005. The change in the gap reflected a decrease in the amount of loans held for securitization and/or sale and an increase in short-term deposits.

In addition to gap measurements, the Bank measures and manages interest-rate risk with the extensive use of computer simulation. This simulation includes calculations of Market Value of Portfolio Equity and Net
Interest Margin. The Bank established limits on the sensitivity of its net interest income and net portfolio value (NPV) to parallel changes in interest rates. Parallel changes in interest rates are defined as instantaneous and sustained
movements of interest rates in 100 basis point increments. The Bank calculates its ratio of NPV to the present value of total assets (NPV Ratio) for each interest rate shock scenario. The following table shows the estimated impact of
parallel shifts in interest rates at September 30, 2006.



|                                        |                                    |                        |    |                                   |   |           |         |  |       |        |  |   |          |   |  |       |  | 
|--------------------------------------- | ---------------------------------- | ---------------------- | -- | --------------------------------- | - | --------- | ------- |  | ----- | ------ |  | - | -------- | - |  | ----- |  | 
|(Basis Points) Change
in Interest Rates |                                    | (Dollars in thousands)
|                                        | Changes in Net Interest Income (1) |                        |    | Change in Net Portfolio Value (2) |   | NPV Ratio
|                                        | Percent                            |                        |    | Amount                            |   |           | Percent |  |       | Amount | 
|+200                                    |                                    | 3.3                    | %  |                                   | $ | 15,274    |         |  | (17.6 | %)     |  | $ | (275,877 | ) |  | 9.0% 
|+100                                    |                                    | 2.0                    | %  |                                   |   | 9,204     |         |  | (9.2  | %)     |  |   | (144,302 | ) |  | 9.8% 
|-100                                    |                                    | (1.6                   | %) |                                   |   | (7,447    | )       |  | 9.1   | %      |  |   | 142,708  |   |  | 11.5%
|-200                                    |                                    | (1.2                   | %) |                                   |   | (5,544    | )       |  | 14.2  | %      |  |   | 223,091  |   |  | 12.0%

---

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



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

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

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

Deferred Taxes.At September 30, 2006, the Bank recorded a net deferred tax
liability of $43.7 million, which generally represents the cumulative excess of the Banks income tax expense for financial reporting purposes over its actual income tax liability. See Note 35 to the Consolidated Financial Statements in this
report.



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Capital.At September 30, 2006, the Bank was in compliance with all of its regulatory capital requirements
under FIRREA, and its capital ratios exceeded the ratios established for well-capitalized institutions under OTS prompt corrective action regulations.

The following table shows the Banks regulatory capital levels at September 30, 2006, in relation to the regulatory requirements in effect at that date. The information below is based upon the Banks understanding of the
regulations and interpretations currently in effect and may be subject to change.

Regulatory Capital

(Dollars in thousands)



|                                                          |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|--------------------------------------------------------- |  | ------ | --------- | - | --------------------------- | ----- | - | -------------- | - | --------------- |  | ---- | ------ |  | --------------- | ------- |  | ---- | -
|                                                          |  | Actual |           |   | Minimum Capital Requirement |       |   | Excess Capital |  
|                                                          |  | Amount |           |   | As a %of Assets             |       |   | Amount         |   | As a %of Assets |  |      | Amount |  | As a %of Assets |        
|Stockholders equity per financial statements             |  | $      | 790,235   |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Minority interest in REIT Subsidiary(1)                   |  |        | 144,000   |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                                          |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                                          |  |        | 934,235   |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Adjustments for tangible and core capital:                |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Intangible assets                                         |  |        | (58,307   | ) |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Non-includable subsidiaries                               |  |        | (3,097    | ) |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Non-qualifying purchased/originated loan servicing rights |  |        | (5,582    | ) |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                                          |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Total tangible capital                                    |  |        | 867,249   |   |                             | 6.15  | % |                | $ | 211,396         |  | 1.50 | %      |  | $               | 655,853 |  | 4.65 | %
|                                                          |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Total core capital(2)                                     |  |        | 867,249   |   |                             | 6.15  | % |                | $ | 563,722         |  | 4.00 | %      |  | $               | 303,527 |  | 2.15 | %
|                                                          |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Tier 1 risk-based capital(2)                              |  |        | 867,249   |   |                             | 9.12  | % |                | $ | 380,911         |  | 4.00 | %      |  | $               | 486,338 |  | 5.12 | %
|                                                          |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Adjustments for total risk-based capital:                 |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Subordinated capital debentures                           |  |        | 175,000   |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Allowance for general loan losses                         |  |        | 25,000    |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                                          |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Total supplementary capital                               |  |        | 200,000   |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                                          |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Total available capital                                   |  |        | 1,067,249 |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Equity investments(3)                                     |  |        | (2,094    | ) |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                                          |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Total risk-based capital(2)                               |  | $      | 1,065,155 |   |                             | 11.21 | % |                | $ | 761,821         |  | 8.00 | %      |  | $               | 303,334 |  | 3.21 | %
|                                                          |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  



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



|(2) | Under the OTS prompt corrective action regulations, the standards for classification as well capitalized are a leverage (or core
capital) ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital ratio of at least 10.0%.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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Under the OTS prompt corrective action regulations, an institution is categorized as well capitalized if it has a
leverage, or core, capital ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0%, a total risk-based capital ratio of at least 10.0% and is not subject to any written agreement, order, capital directive or prompt corrective
action directive to meet and maintain a specific capital level. At September 30, 2006, the Banks leverage, tier 1 risk-based and total risk-based capital ratios were 6.15%, 9.12% and 11.21%, respectively, which exceeded the ratios
established for well-capitalized institutions. The OTS may reclassify an institution from one category to the next lower category, for example from well capitalized to adequately capitalized, if, after notice and an opportunity for a hearing, the
OTS determines that the institution is in an unsafe or unsound condition or has received and has not corrected a less than satisfactory examination rating for asset quality, management, earnings or liquidity. The Bank has not received notice from
the OTS of any potential downgrade.

OTS capital regulations provide a five-year holding period, or such longer period as may be approved by the OTS, for
REO to qualify for an exception from treatment as an equity investment. If an REO property is considered an equity investment, its then-current book value is deducted from total risk-based capital. Accordingly, if the Bank is unable to dispose of
any REO property, whether through bulk sales or otherwise, prior to the end of its applicable five-year holding period and is unable to obtain an extension of the five-year holding period from the OTS, the Bank could be required to deduct the
then-current book value of such REO property from total risk-based capital. In July 2006, the Bank received from the OTS an extension of the holding periods for certain of its REO properties through July 31, 2007. The following table sets forth
the Banks REO at September 30, 2006, by the fiscal year in which the property was acquired through foreclosure.



|            |  |                |        |    
|----------- |  | -------------- | ------ | ---
|Fiscal Year |  | (In thousands) |       
|1990        |  | $              | 2,094  | (1)
|1991        |  |                | 10,263 | (2)
|1995        |  |                | 16,413 | (2)
|2006        |  |                | 3,540  |    
|            |  |                |        |    
|Total REO   |  | $              | 32,310 |    
|            |  |                |        |    

---

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



|(2) | The Bank received an extension of the holding periods for these properties through July 31, 2007.
|--- | -------------------------------------------------------------------------------------------------

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

OTS policies generally require that the Bank occupy at least 25% of an office building in order for it to be considered a permissible investment in office premises and for the Bank to avoid having to deduct its
investment in the building from total capital. OTS also provides a five-year grace period after a building is no longer sufficiently occupied by the Bank before it must either be sold or treated as an equity investment and deducted from total
capital. The Bank owns an office building substantially all of which was occupied by the Bank until completion of the Banks new headquarters building in December 2001. The Bank plans to sell the building to the Real Estate Trust. If the Bank
is unable to complete the sale by December 31, 2006 and does not obtain an extension of the five year grace period from the OTS, the book value of the building, which was $26.9 million at September 30, 2006, would have to be deducted from
the Banks total capital on December 31, 2006. See Managements Discussion and Analysis of Financial Condition and Results of Operations  Financial Condition  Capital.

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

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



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LIQUIDITY AND CAPITAL RESOURCES

REAL ESTATE

The Real Estate Trusts cash flows from operating activities have been historically insufficient to meet all
of its cash flow requirements. The Real Estate Trusts internal source of funds, primarily cash flow generated by its income-producing properties, generally have been sufficient to meet its cash needs other than the repayment of principal on
outstanding debt, including outstanding unsecured notes sold to the public, the payment of interest on its indebtedness, and the payment of capital improvement costs. In the past, the Real Estate Trust funded such shortfalls through a combination of
external funding sources, primarily new financings, the sale of unsecured notes, refinancing of maturing mortgage debt, proceeds from asset sales, and dividends and tax sharing payments from the Bank. The Real Estate Trust receives quarterly
distributions from its investment in Saul Holdings and dividends from its investment in Saul Centers. These amounts totaled $14.8 million in fiscal 2006. Historically these amounts have been reinvested in the paying entities and the Real Estate
Trust has received additional partnership units and common shares in lieu of cash. The Real Estate Trust has the ability, at its own option, to receive these distributions and dividends in cash. The availability and amount of distributions and
dividends in future periods is dependent upon, among other things, Saul Holdings and Saul Centers operating performance and income. Although cash flows from operating activities have improved during the two most recent fiscal years, for
the 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. See also the discussion of potential limitations on the payment of dividends by the Bank contained in Item 1.
BusinessBankingDividends and Other Capital Distributions.

The Real Estate Trust believes that the financial condition and operating
results of the Bank should allow the Real Estate Trust to receive dividend payments from the Bank. During the fiscal year ended September 30, 2006, the Bank made dividend payments totaling $32.0 million and net tax sharing payments totaling
$2.0 million to the Real Estate Trust. Dividend and tax sharing payments received by the Real Estate Trust are presented as cash flows from operating activities in the Consolidated Statements of Cash Flows.

Although operations have shown significant improvement in fiscal 2006 and 2005, in recent years the operations of the Real Estate Trust have generated net operating
losses while the Bank has reported net income. The Trusts consolidation of the Banks operations into the Trusts federal income tax return has resulted in the use of the Real Estate Trusts net operating losses to reduce the
federal income taxes the Bank would otherwise have owed. If in any future year, the Bank has taxable losses or unused credits, the Trust would be obligated to reimburse the Bank for the greater of (1) the tax benefit to the group using such tax
losses or unused tax credits in the groups consolidated federal income tax returns or (2) the amount of the refund which the Bank would otherwise have been able to claim if it were not being included in the consolidated federal income tax
return of the group.

During fiscal 2006, the Real Estate Trust purchased, through dividend reinvestment and direct purchase, approximately 254,000 shares
of common stock of Saul Centers, and as of September 30, 2006, owned approximately 4,721,000 shares representing 27.5% of such companys outstanding common stock. As of September 30, 2006, the market value of these shares was
approximately $212.4 million. Substantially all of these shares have been pledged as collateral with the Real Estate Trusts revolving credit lenders.

As the owner, directly and through two wholly-owned subsidiaries, of a limited partnership interest in Saul Holdings, the Real Estate Trust shares in cash distributions from operations and from capital transactions involving the sale of
properties. The partnership agreement of Saul Holdings provides for quarterly cash distributions to the partners out of net cash flow. See Item 1. Business  Real Estate  Investment in Saul Holdings Limited Partnership and Saul
Centers, Inc. In fiscal 2006, the Real Estate Trust received total cash distributions of $7.2 million from Saul Holdings. Substantially all of the Real Estate Trusts ownership interest in Saul Holdings has been pledged as collateral with
the Real Estate Trusts two revolving credit lenders.

On February 25, 2004, the Real Estate Trust issued, in a private offering, $250.0 million
aggregate principal amount of 7.50% Senior Secured Notes due 2014 (the 2004 Notes). The 2004 Notes are nonrecourse obligations of the Real Estate Trust and are secured by a first priority perfected secured interest in all of the common
stock of the Bank held by the Real Estate Trust. The Real Estate Trust used the net proceeds to redeem all of its outstanding $200.0 million aggregate principal of 9.75% Senior Secured Notes due 2008, including accrued interest and a redemption
premium, for early redemption of the notes, of $6.5 million, to fund renovation and construction activities as well as for general corporate purposes.

The
Real Estate Trust currently has outstanding unsecured notes, with maturities ranging from one to ten years. On June 19, 2006 the Real Estate Trust terminated its public offering of these notes and subsequently withdrew the registration of the
un-issued notes. Consistent with the terms of the notes, as of September 30, 2006, the Real Estate Trust has called $19.1 million of outstanding notes for prepayment, to be prepaid during the first quarter of fiscal 2007. An additional $2.3
million of unsecured notes will mature during the first quarter of fiscal 2007. As of the end of the first quarter of fiscal 2007 the Real Estate Trust anticipates that all unsecured notes outstanding at September 30, 2006 will have been
repaid. The Real Estate Trust intends to repay these notes from cash on hand or other sources of funds.



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The Real Estate Trust has a $60.0 million secured revolving credit line with an unrelated bank that matures on
January 31, 2008, 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 200 basis points over the index. At September 30, 2006, the Real Estate Trust had no outstanding borrowings and unrestricted availability of $60.0 million.

The Real Estate Trust has an additional $60.0 million revolving credit line with an unrelated bank that matures on June 30, 2008, 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 200 basis points over the index. At September 30, 2006, the Real Estate Trust had no outstanding borrowings and unrestricted availability of $54.0 million. The Real Estate Trust was issued a $6.0 million letter of credit for the
benefit of a mortgage lender as part of one of the mortgage financings completed during fiscal 2006. The letter of credit will be reduced quarterly 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, including mortgage notes
payable for real estate held for sale, at September 30, 2006 for fiscal years commencing October 1, 2006 is set forth in the following table:

Debt Maturity Schedule



|            |  |                |         |                         |   |                               |  |       |        |  |   |        
|----------- |  | -------------- | ------- | ----------------------- | - | ----------------------------- |  | ----- | ------ |  | - | -------
|Fiscal Year |  | Mortgage Notes |         | Notes Payable Secured |   | Notes Payable Unsecured (1) |  | Total
|            |  | (In thousands)
|2007        |  | $              | 11,785  |                         | $ |                              |  | $     | 21,398 |  | $ | 33,183 
|2008        |  |                | 6,443   |                         |   |                              |  |       |       |  |   | 6,443  
|2009        |  |                | 20,532  |                         |   |                              |  |       |       |  |   | 20,532 
|2010        |  |                | 12,015  |                         |   |                              |  |       |       |  |   | 12,015 
|2011        |  |                | 22,620  |                         |   |                              |  |       |       |  |   | 22,620 
|Thereafter  |  |                | 414,944 |                         |   | 250,000                       |  |       |       |  |   | 664,944
|            |  |                |         |                         |   |                               |  |       |        |  |   |        
|Total       |  | $              | 488,339 |                         | $ | 250,000                       |  | $     | 21,398 |  | $ | 759,737
|            |  |                |         |                         |   |                               |  |       |        |  |   |        



|(1) | Included in fiscal 2007 are $19.1 million of notes called for early redemption.
|--- | -------------------------------------------------------------------------------

Of the $488.3 million of mortgage notes outstanding at September 30, 2006, $482.5 million are non-recourse to the Real Estate Trust.

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

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

Also on May 26, 2006 the Real Estate Trust closed on a $16.7 million construction loan to be used to finance the construction of the Dulles SpringHill Suites Hotel located in Loudoun County, Virginia. The loan,
which is due on May 26, 2009, with two one-year extension options, currently bears interest at 175 basis points over a floating rate index. Interest only is payable through maturity. $4.0 million has been drawn under this loan as of
September 30, 2006.

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



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

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

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

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

Real Estate Acquisition, Disposition, Development and Capital Expenditures

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

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

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

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

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

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

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

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

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

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

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

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



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On December 9, 2004, the sale of a hotel property, which was placed on the market for sale during fiscal 2004, was
finalized and the Real Estate Trust received proceeds from the sale of approximately $2.2 million, resulting in a loss of $327,000, $310,000 recognized in fiscal 2004 and $17,000 recognized in fiscal 2005.

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

In
February 2004, the Commonwealth of Virginia acquired 7.93 acres of land owned by the Real Estate Trust for use in a highway project. The Commonwealth of Virginia has paid $3.6 million which has resulted in an initial gain of approximately $2.7
million in fiscal 2004.

The Real Estate Trust owns various land parcels with approximately 450 acres of available land. These parcels offer potential
development opportunities for the Trust. During fiscal 2005 the Real Estate Trust commenced the ground-up development of a hotel property on a land parcel owned in Northern Virginia which is scheduled to open in January 2007. In addition, a second
ground up development of a hotel property in Northern Virginia commenced in late fiscal 2006 with a scheduled opening in early fiscal 2008 and the development of for-sale residential townhouses and the related infrastructure commenced in fiscal
2006, with the units scheduled to be ready for sale in early fiscal 2007, on land parcels owned in Atlanta, Georgia. 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 $17.0 to $26.0 million per year for the
next several years.

Liquidity Requirements  Real Estate Trust

The table below specifies the total contractual payment obligations as of September 30, 2006.



|                                   |  |            |         |                  |   |           |  |           |        |               |   |        |  |   |        
|---------------------------------- |  | ---------- | ------- | ---------------- | - | --------- |  | --------- | ------ | ------------- | - | ------ |  | - | -------
|(In thousands)                     |  | Total Cost |         | Less than 1 Year |   | 1-3 Years |  | 4-5 Years |        | After 5 Years
|Contractual Obligations            |  |            |         |                  |   |           |  |           |        |               |   |        |  |   |        
|Mortgage Notes Payable             |  | $          | 488,339 |                  | $ | 11,785    |  | $         | 26,975 |               | $ | 34,635 |  | $ | 414,944
|Notes Payable  Secured            |  |            | 250,000 |                  |   |          |  |           |       |               |   |       |  |   | 250,000
|Notes Payable  Unsecured          |  |            | 21,398  |                  |   | 21,398    |  |           |       |               |   |       |  |   |       
|Advisory Fee                       |  |            | 1,737   |                  |   | 1,737     |  |           |       |               |   |       |  |   |       
|Capital Leases                     |  |            | 815     |                  |   | 451       |  |           | 364    |               |   |       |  |   |       
|Development Obligations            |  |            | 41,686  |                  |   | 41,686    |  |           |       |               |   |       |  |   |       
|Other Obligations                  |  |            | 210     |                  |   | 210       |  |           |       |               |   |       |  |   |       
|                                   |  |            |         |                  |   |           |  |           |        |               |   |        |  |   |        
|Total Contractual Cash Obligations |  | $          | 804,185 |                  | $ | 77,267    |  | $         | 27,339 |               | $ | 34,635 |  | $ | 664,944
|                                   |  |            |         |                  |   |           |  |           |        |               |   |        |  |   |        

As of September 30, 2006, the Real Estate Trusts current contractual obligations, excluding recurring
operating obligations, due within one year total approximately $77.3 million. In addition to these contractual obligations the Real Estate Trust has other short-term liquidity requirements consisting primarily of normal recurring operating expenses,
regular debt service requirements (including debt service relating to additional and replacement debt), recurring corporate expenditures, non-recurring corporate expenditures (such as tenant improvements and hotel improvements) and dividends to
common and preferred shareholders. Overall capital requirements in fiscal year 2007 will depend on any acquisition and development opportunities as well as the level of improvements and redevelopments on existing properties.

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



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BANKING

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

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



| |  |  | principal and interest payments on loans and mortgage-backed securities;
| | - |  | ------------------------------------------------------------------------



| |  |  | savings deposits;
| | - |  | -----------------



| |  |  | sales of loans and trading securities;
| | - |  | --------------------------------------



| |  |  | securitizations and sales of loans; and
| | - |  | ---------------------------------------



| |  |  | borrowed funds, including funds borrowed from the FHLB of Atlanta.
| | - |  | ------------------------------------------------------------------

The
Banks holdings of readily marketable securities and eligible loans constitute another important source of liquidity. Approximately $1.1 billion of these assets are pledged to the Federal Reserve Bank of Richmond, although there were no
outstanding borrowings during fiscal year 2006. As of September 30, 2006, the estimated remaining borrowing capacity, after market value and other adjustments, against that portion of those assets that may be pledged to the FHLB of Atlanta and
various securities dealers totaled $4.7 billion.

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

Since 1988, the Bank has securitized approximately $33.0 billion of loan
receivables. At September 30, 2006, the Bank continues to service $8.5 billion of securitized residential mortgages. Chevy Chase derives fee-based income from servicing these securitized portfolios. However, that fee-based income has been
adversely affected in this and prior periods by increases in prepayments, delinquencies and charge-offs related to the receivables in these securitized pools.

The Bank securitized and sold $4.2 billion and $5.3 billion of loan receivables during fiscal year 2006 and 2005, respectively. At September 30, 2006 and 2005, the Bank had $467.6 million and $1.7 billion, respectively, of loan
receivables held for securitization and/or sale. The proceeds from the securitization and sale of various types of loan receivables will continue to be a significant source of liquidity for the Bank.

The Bank uses its liquidity primarily to meet its commitments to fund maturing savings certificates and deposit withdrawals, fund loan commitments, repay borrowings and
meet operating expenses. During fiscal year 2006, the Bank used the cash provided by operating, investing and financing activities primarily to (i) fund maturing savings certificates and deposit withdrawals of $82.5 billion, (ii) fund loan
commitments, including real estate held for investment or sale, of $1.5 billion, (iii) purchase investments and loans of $1.3 billion, (iv) meet operating expenses, before depreciation and amortization, of $612.5 million and (v) repay
borrowings of $801.7 million, net of proceeds from borrowings. These commitments were funded primarily through (i) proceeds from customer deposits and sales of certificates of deposit of $83.2 billion, (ii) proceeds from sales of loans,
trading securities and real estate of $5.4 billion and (iii) principal and interest collected on investments, loans, and securities of $6.7 billion.

At September 30, 2006, repayments of borrowed money scheduled to occur during the next 12 months were $1.8 billion. Certificates of deposit maturing during the next 12 months amounted to $3.2 billion. The Bank expects that a
significant portion of these maturing certificates of deposit will remain with the Bank, although due to recent increases in market interest rates, the Banks interest expense on those deposits that do remain with the Bank may increase. In the
event that deposit withdrawals are greater than anticipated, the Bank may have to increase deposit interest rates or rely on alternative and potentially higher cost sources of funds in order to meet its liquidity needs.

The Banks liquidity requirements in years subsequent to fiscal year 2006 will continue to be affected both by the asset size of the Bank, the growth of which may
be constrained by capital requirements, and the composition of the asset portfolio. Management believes that the Banks primary sources of funds, described above, will be sufficient to meet the Banks foreseeable liquidity needs. The mix
of funding sources utilized from time to time will be determined by a number of factors, including capital planning objectives, lending and investment strategies and market conditions.

Commitments and Contingencies.The Bank periodically transfers loan receivables to special purpose entities that issue securities to investors. These investors are entitled to a return of cash flows, based on
the principal and interest provided by the loan receivables transferred. This process is referred to as securitization. Since 1988, the Bank has securitized approximately $33.0 billion of loan receivables.

The Bank transfers receivables from time to time to a special purpose entity commonly referred to as a depositor. The depositor then establishes a trust for each
particular securitization, and transfers the related loans to that particular trust. The trust uses proceeds from the sale of the securities to pay the depositor for the loans sold to the trust, and the depositor in turn pays the proceeds over to
the Bank. These securitization



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vehicles are not consolidated within the Banks consolidated financial statements because they satisfy the criteria established by Statement of
Financial Accounting Standards No. 140, Accounting for the Transfers and Servicing of Financial Assets and Extinguishments of Liabilities to be treated as sales. In general, these criteria require the securitization vehicles to be
legally isolated from the transferor (the Bank), be limited to permitted activities, and have defined limits on the assets they can hold and the permitted sales, exchanges or distribution of its assets.

When the Bank sells or securitizes loans, it generally retains the right to service the loans. At September 30, 2006, the Bank continues to service $8.5 billion of
securitized residential mortgages. In addition, when the Bank sells or securitizes loans, the Bank may retain a limited amount of recourse through one or more means, most often the establishment of reserve accounts, overcollateralization of
receivables or retention of subordinated classes. At September 30, 2006 and 2005, total recourse to the Bank related to loan securitization transactions was $2.7 million and $5.7 million, respectively. See Note 6 to the Consolidated Financial
Statements for additional information concerning loan securitization transactions.

The Bank is also obligated under recourse provisions related to the
servicing of certain of its residential mortgage loans. At September 30, 2006 and 2005, the recourse to the Bank under these arrangements totaled $2.9 million and $3.9 million, respectively.

The Banks commitments to extend credit at September 30, 2006 are set forth in the following table.



|                                         |  |                |          
|---------------------------------------- |  | -------------- | ---------
|                                         |  | (In thousands)
|Commitments to originate loans           |  | $              | 364,687  
|                                         |  |                |          
|Loans in process (collateralized loans): |  |                |          
|Home equity                              |  |                | 1,598,438
|Real estate construction and ground      |  |                | 351,110  
|Commercial                               |  |                | 509,245  
|                                         |  |                |          
|Subtotal                                 |  |                | 2,458,793
|                                         |  |                |          
|Loans in process (unsecured loans):      |  |                |          
|Overdraft lines                          |  |                | 151,673  
|Commercial                               |  |                | 504,532  
|                                         |  |                |          
|Subtotal                                 |  |                | 656,205  
|                                         |  |                |          
|Total commitments to extend credit       |  | $              | 3,479,685
|                                         |  |                |          

Based on historical experience, the Bank expects to fund substantially less than the total amount of its
outstanding overdraft line and home equity credit line commitments, which together accounted for 50.3% of commitments to extend credit at September 30, 2006.

In connection with the securitization and sale of certain payment option residential mortgage loans, the Bank is obligated to fund a portion of any negative amortization, resulting from the borrowers electing their option to
make monthly payments that are not sufficient to cover the interest accrued for the payment period. For each dollar of negative amortization funded by the Bank, the balances of certain highly-rated mortgage-backed securities received by the Bank as
part of the securitization transaction increase accordingly. When the borrowers ultimately make the principal payments, the Bank receives its pro rata portion of those payments in cash, and the balances of those securities held by the Bank are
reduced accordingly. During the year ended September 30, 2006, the Bank funded $164.3 million of negative amortization under these obligations, and received $52.0 million in principal payments representing previously funded negative
amortization.



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The following table summarizes certain material contractual cash obligations associated with operating, investing and
financing activities as of September 30, 2006:



|                            |  |                                       |           |                  |   |           |  |           |         |                   |   |        |  |   |        
|--------------------------- |  | ------------------------------------- | --------- | ---------------- | - | --------- |  | --------- | ------- | ----------------- | - | ------ |  | - | -------
|                            |  | Payments due by period (in thousands)
|                            |  | Total                                 |           | Less than 1 year |   | 1-3 years |  | 3-5 years |         | More than 5 years
|Long term debt obligations  |  | $                                     | 2,409,822 |                  | $ | 1,751,164 |  | $         | 383,171 |                   | $ | 53,414 |  | $ | 222,073
|Operating lease obligations |  |                                       | 339,153   |                  |   | 33,800    |  |           | 55,293  |                   |   | 41,961 |  |   | 208,099
|                            |  |                                       |           |                  |   |           |  |           |         |                   |   |        |  |   |        
|Total                       |  | $                                     | 2,748,975 |                  | $ | 1,784,964 |  | $         | 438,464 |                   | $ | 95,375 |  | $ | 430,172
|                            |  |                                       |           |                  |   |           |  |           |         |                   |   |        |  |   |        

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

There were no material commitments for capital expenditures at September 30, 2006.



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RESULTS OF OPERATIONS

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

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

FISCAL 2006 COMPARED TO FISCAL 2005

REAL ESTATE

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

Income after direct operating expenses from hotels, which excludes the two hotels which were sold during fiscal 2006, increased $10.6 million, or 27.4%, in fiscal 2006
from the level achieved in fiscal 2005. Total revenue increased $28.6 million, or 29.0%, as the average room rate, exclusive of the hotel purchased in March 2006, for the hotel properties increased $10.51, or 9.3%, as occupancy levels increased to
70.6% in fiscal 2006 from 69.5% in fiscal 2005. This increase in average room rate while increasing occupancy levels reflects the strong demand at the Real Estate Trusts hotel properties, particularly the Northern Virginia and Florida
properties. Room sales for fiscal 2006 increased $21.7 million, or 26.9%, from fiscal 2005, while food, beverage and other sales increased $6.9 million, or 38.5%. The hotel purchased on November 1, 2005 contributed approximately $3.6 million to
the increase in overall revenue. The hotel purchased on March 24, 2006 contributed approximately $14.0 million to the increase in overall revenue. Because this hotel type is different from the other hotels in the portfolio and accordingly its
operating results are not included in the occupancy or the average room rate statistics above. Exclusive of the two hotels purchased and the two hotels sold during the 2006 period, revenues increased approximately $11.0 million, or 11.2%. Direct
operating expenses increased $18.0 million, or 30.1%, reflecting increased operating costs, such as payroll costs, utility costs, hotel franchise and marketing costs and other operating costs associated with the increased hotel revenue. In addition,
operating costs associated with the hotels purchased on November 1, 2005 and March 24, 2006 are fully integrated into hotel operating results as of the day of purchase.

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

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

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

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



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due to higher mortgage balances, line of credit borrowings and the unsecured bridge loan borrowing which offset lower unsecured note balances. The average
cost of borrowings decreased from 7.85% in fiscal 2005 to 7.44% in fiscal 2006.

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

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

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

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

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

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

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

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

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

BANKING

Overview. The Bank recorded operating income of $138.8 million for the year ended September 30, 2006,
compared to operating income of $189.7 million for the year ended September 30, 2005. The decrease in operating income reflects decreases in servicing, securitization and mortgage banking income and automobile rental income, as well as
increases in salaries and employee benefits, servicing assets amortization and other loan expenses and other operating expenses. An increase in net interest income and a decrease in depreciation and amortization partially offset the decreased
income. During fiscal year 2006, primarily as a result of higher residential mortgage loan prepayments, and anticipation that prepayment levels will remain high in the short-term as a result of the relatively small differential between short- and
long-term interest rates, the Bank increased its prepayment speed assumptions and reduced the carrying value of its interest-only strips receivable and servicing assets which are included on the Condensed Consolidated Statement of Operations in
servicing, securitization and mortgage banking income and servicing assets amortization and other loan expenses, respectively. The Banks operating income in future periods will continue to be affected by increased operating expenses associated
with expansion of the Banks branch network and other areas of business and the fixed payments associated with the REIT preferred stock and 2003 debentures.



68



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##### Table of Contents

Net Interest Income. Net interest income, before the provision for loan losses, increased $51.3 million (or 14.0%)
in fiscal year 2006. The Bank recorded $1.5 million of interest income on non-accrual and restructured loans during fiscal year 2006. The Bank would have recorded additional interest income of $0.3 million during fiscal year 2006 if non-accrual
assets and restructured loans had been current in accordance with their original terms. See Financial Condition  Asset Quality  Non-Performing Assets.



69



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##### Table of Contents

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

Net
Interest Margin Analysis

(Dollars in thousands)



|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|---------------------------------------------------------------------- |  | ------------------------ | ---------- | -------- | ---- | ---------- |  | ------ | --------------- |  | -------- | ---------- | ---------- | - | ------- | --------------- | ------ | -------- |  | ---------- | ---------- |  | - | ------- |  | ------ | -
|                                                                       |  | Year Ended September 30, |           
|                                                                       |  | 2006                     |            |          | 2005 |            |  | 2004   |                
|                                                                       |  | AverageBalances          |            | Interest |      | Yield/Rate |  |        | AverageBalances |  | Interest |            | Yield/Rate |   |         | AverageBalances |        | Interest |  | Yield/Rate |           
|Assets:                                                                |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Interest-earning assets:                                               |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Loans receivable, net (1)                                              |  | $                        | 11,235,149 |          | $    | 669,154    |  | 5.96   | %               |  | $        | 11,047,463 |            | $ | 531,859 |                 | 4.81   | %        |  | $          | 10,081,196 |  | $ | 411,640 |  | 4.08   | %
|Mortgage-backed securities                                             |  |                          | 959,247    |          |      | 43,238     |  | 4.51   |                 |  |          | 575,297    |            |   | 24,915  |                 | 4.33   |          |  |            | 435,313    |  |   | 20,505  |  | 4.71   |  
|Federal funds sold and securities purchased under agreements to resell |  |                          | 73,685     |          |      | 3,465      |  | 4.70   |                 |  |          | 84,134     |            |   | 2,296   |                 | 2.73   |          |  |            | 67,738     |  |   | 748     |  | 1.10   |  
|Trading securities                                                     |  |                          | 6,666      |          |      | 441        |  | 6.62   |                 |  |          | 6,534      |            |   | 364     |                 | 5.57   |          |  |            | 27,079     |  |   | 1,355   |  | 5.00   |  
|Investment securities                                                  |  |                          | 201,572    |          |      | 6,964      |  | 3.45   |                 |  |          | 182,794    |            |   | 4,741   |                 | 2.59   |          |  |            | 58,488     |  |   | 1,163   |  | 1.99   |  
|Other interest-earning assets                                          |  |                          | 204,586    |          |      | 11,741     |  | 5.74   |                 |  |          | 231,111    |            |   | 8,588   |                 | 3.72   |          |  |            | 219,553    |  |   | 5,860   |  | 2.67   |  
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Total                                                                  |  |                          | 12,680,905 |          |      | 735,003    |  | 5.80   |                 |  |          | 12,127,333 |            |   | 572,763 |                 | 4.72   |          |  |            | 10,889,367 |  |   | 441,271 |  | 4.05   |  
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Non-interest earning assets:                                           |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Cash                                                                   |  |                          | 403,645    |          |      |            |  |        |                 |  |          | 347,513    |            |   |         |                 |        |          |  |            | 287,557    |  |   |         |  |        |  
|Real estate held for investment or sale                                |  |                          | 23,597     |          |      |            |  |        |                 |  |          | 22,079     |            |   |         |                 |        |          |  |            | 20,785     |  |   |         |  |        |  
|Property and equipment, net                                            |  |                          | 563,978    |          |      |            |  |        |                 |  |          | 510,716    |            |   |         |                 |        |          |  |            | 482,874    |  |   |         |  |        |  
|Automobiles subject to lease, net                                      |  |                          | 113,557    |          |      |            |  |        |                 |  |          | 294,198    |            |   |         |                 |        |          |  |            | 635,526    |  |   |         |  |        |  
|Goodwill and other intangible assets, net                              |  |                          | 39,004     |          |      |            |  |        |                 |  |          | 25,580     |            |   |         |                 |        |          |  |            | 24,181     |  |   |         |  |        |  
|Other assets                                                           |  |                          | 718,524    |          |      |            |  |        |                 |  |          | 696,546    |            |   |         |                 |        |          |  |            | 480,141    |  |   |         |  |        |  
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Total assets                                                           |  | $                        | 14,543,210 |          |      |            |  |        |                 |  | $        | 14,023,965 |            |   |         |                 |        |          |  | $          | 12,820,431 |  |   |         |  |        |  
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Liabilities and stockholders equity:                                  |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Interest-bearing liabilities:                                          |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Deposit accounts:                                                      |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Demand deposits                                                        |  | $                        | 2,373,370  |          |      | 6,047      |  | 0.25   |                 |  | $        | 2,323,065  |            |   | 5,040   |                 | 0.22   |          |  | $          | 2,094,878  |  |   | 4,351   |  | 0.21   |  
|Savings deposits                                                       |  |                          | 1,069,300  |          |      | 4,423      |  | 0.41   |                 |  |          | 1,209,376  |            |   | 3,407   |                 | 0.28   |          |  |            | 1,200,609  |  |   | 3,294   |  | 0.27   |  
|Time deposits                                                          |  |                          | 2,897,776  |          |      | 114,058    |  | 3.94   |                 |  |          | 2,027,324  |            |   | 52,419  |                 | 2.59   |          |  |            | 1,746,956  |  |   | 33,447  |  | 1.91   |  
|Money market deposits                                                  |  |                          | 2,502,723  |          |      | 55,035     |  | 2.20   |                 |  |          | 2,456,603  |            |   | 34,765  |                 | 1.42   |          |  |            | 2,322,983  |  |   | 17,159  |  | 0.74   |  
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Total deposits                                                         |  |                          | 8,843,169  |          |      | 179,563    |  | 2.03   |                 |  |          | 8,016,368  |            |   | 95,631  |                 | 1.19   |          |  |            | 7,365,426  |  |   | 58,251  |  | 0.79   |  
|Borrowings                                                             |  |                          | 3,102,238  |          |      | 138,608    |  | 4.47   |                 |  |          | 3,443,406  |            |   | 111,562 |                 | 3.24   |          |  |            | 3,173,104  |  |   | 104,771 |  | 3.30   |  
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Total liabilities                                                      |  |                          | 11,945,407 |          |      | 318,171    |  | 2.66   |                 |  |          | 11,459,774 |            |   | 207,193 |                 | 1.81   |          |  |            | 10,538,530 |  |   | 163,022 |  | 1.55   |  
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Noninterest-bearing items:                                             |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Noninterest bearing deposits                                           |  |                          | 1,414,449  |          |      |            |  |        |                 |  |          | 1,373,432  |            |   |         |                 |        |          |  |            | 1,146,484  |  |   |         |  |        |  
|Other liabilities                                                      |  |                          | 246,548    |          |      |            |  |        |                 |  |          | 293,797    |            |   |         |                 |        |          |  |            | 302,171    |  |   |         |  |        |  
|Minority interest                                                      |  |                          | 175,391    |          |      |            |  |        |                 |  |          | 175,391    |            |   |         |                 |        |          |  |            | 175,391    |  |   |         |  |        |  
|Stockholders equity                                                   |  |                          | 761,415    |          |      |            |  |        |                 |  |          | 721,571    |            |   |         |                 |        |          |  |            | 657,855    |  |   |         |  |        |  
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Total liabilities and stockholders equity                             |  | $                        | 14,543,210 |          |      |            |  |        |                 |  | $        | 14,023,965 |            |   |         |                 |        |          |  | $          | 12,820,431 |  |   |         |  |        |  
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Net interest income                                                    |  |                          |            |          | $    | 416,832    |  |        |                 |  |          |            |            | $ | 365,570 |                 |        |          |  |            |            |  | $ | 278,249 |  |        |  
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Net interest spread (2)                                                |  |                          |            |          |      |            |  | 3.14   | %               |  |          |            |            |   |         |                 | 2.91   | %        |  |            |            |  |   |         |  | 2.50   | %
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Net yield on interest-earning assets (3)                               |  |                          |            |          |      |            |  | 3.29   | %               |  |          |            |            |   |         |                 | 3.01   | %        |  |            |            |  |   |         |  | 2.56   | %
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  
|Interest-earning assets to interest-bearing liabilities                |  |                          |            |          |      |            |  | 106.16 | %               |  |          |            |            |   |         |                 | 105.83 | %        |  |            |            |  |   |         |  | 103.33 | %
|                                                                       |  |                          |            |          |      |            |  |        |                 |  |          |            |            |   |         |                 |        |          |  |            |            |  |   |         |  |        |  



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



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



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



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##### Table of Contents

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

Volume and Rate Changes in Net Interest Income

(In thousands)



|                                                                       |  |                                                                                                                  |         |                                                                                                                  |      |   |             |  |        |         |  |      |        |   |             |   |        |   |  |   |         |  
|---------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------- | ------- | ---------------------------------------------------------------------------------------------------------------- | ---- | - | ----------- |  | ------ | ------- |  | ---- | ------ | - | ----------- | - | ------ | - |  | - | ------- | -
|                                                                       |  | Year Ended September 30, 2006 Compared to Year Ended
September 30, 2005 Increase (Decrease) Due to Change in (1) |         | Year Ended September 30, 2005 Compared to Year Ended
September 30, 2004 Increase (Decrease) Due to Change in (1) |     
|                                                                       |  | Volume                                                                                                           |         |                                                                                                                  | Rate |   | TotalChange |  | Volume |         |  | Rate |        |   | TotalChange |  
|Interest income:                                                       |  |                                                                                                                  |         |                                                                                                                  |      |   |             |  |        |         |  |      |        |   |             |   |        |   |  |   |         |  
|Loans (2)                                                              |  | $                                                                                                                | 9,179   |                                                                                                                  |      | $ | 128,116     |  | $      | 137,295 |  | $    | 41,918 |   |             | $ | 78,301 |   |  | $ | 120,219 |  
|Mortgage-backed securities                                             |  |                                                                                                                  | 17,267  |                                                                                                                  |      |   | 1,056       |  |        | 18,323  |  |      | 6,169  |   |             |   | (1,759 | ) |  |   | 4,410   |  
|Federal funds sold and securities purchased under agreements to resell |  |                                                                                                                  | (315    | )                                                                                                                |      |   | 1,484       |  |        | 1,169   |  |      | 219    |   |             |   | 1,329  |   |  |   | 1,548   |  
|Trading securities                                                     |  |                                                                                                                  | 7       |                                                                                                                  |      |   | 70          |  |        | 77      |  |      | (1,129 | ) |             |   | 138    |   |  |   | (991    | )
|Investment securities                                                  |  |                                                                                                                  | 525     |                                                                                                                  |      |   | 1,698       |  |        | 2,223   |  |      | 3,130  |   |             |   | 448    |   |  |   | 3,578   |  
|Other interest-earning assets                                          |  |                                                                                                                  | (1,079  | )                                                                                                                |      |   | 4,232       |  |        | 3,153   |  |      | 323    |   |             |   | 2,405  |   |  |   | 2,728   |  
|                                                                       |  |                                                                                                                  |         |                                                                                                                  |      |   |             |  |        |         |  |      |        |   |             |   |        |   |  |   |         |  
|Total interest income                                                  |  |                                                                                                                  | 25,584  |                                                                                                                  |      |   | 136,656     |  |        | 162,240 |  |      | 50,630 |   |             |   | 80,862 |   |  |   | 131,492 |  
|                                                                       |  |                                                                                                                  |         |                                                                                                                  |      |   |             |  |        |         |  |      |        |   |             |   |        |   |  |   |         |  
|Interest expense:                                                      |  |                                                                                                                  |         |                                                                                                                  |      |   |             |  |        |         |  |      |        |   |             |   |        |   |  |   |         |  
|Deposit accounts                                                       |  |                                                                                                                  | 10,750  |                                                                                                                  |      |   | 73,182      |  |        | 83,932  |  |      | 5,536  |   |             |   | 31,844 |   |  |   | 37,380  |  
|Borrowings                                                             |  |                                                                                                                  | (11,922 | )                                                                                                                |      |   | 38,968      |  |        | 27,046  |  |      | 8,788  |   |             |   | (1,997 | ) |  |   | 6,791   |  
|                                                                       |  |                                                                                                                  |         |                                                                                                                  |      |   |             |  |        |         |  |      |        |   |             |   |        |   |  |   |         |  
|Total interest expense                                                 |  |                                                                                                                  | (1,172  | )                                                                                                                |      |   | 112,150     |  |        | 110,978 |  |      | 14,324 |   |             |   | 29,847 |   |  |   | 44,171  |  
|                                                                       |  |                                                                                                                  |         |                                                                                                                  |      |   |             |  |        |         |  |      |        |   |             |   |        |   |  |   |         |  
|Increase in net interest income                                        |  | $                                                                                                                | 26,756  |                                                                                                                  |      | $ | 24,506      |  | $      | 51,262  |  | $    | 36,306 |   |             | $ | 51,015 |   |  | $ | 87,321  |  
|                                                                       |  |                                                                                                                  |         |                                                                                                                  |      |   |             |  |        |         |  |      |        |   |             |   |        |   |  |   |         |  



|(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.
|--- | ---------------------------------------------------



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Interest income in fiscal year 2006 increased $162.2 million (or 28.3%) from fiscal year 2005 primarily as a result of
higher average yields on loans receivable and higher average balances of mortgage-backed securities.

The Banks net interest spread increased to
3.14% in fiscal year 2006 from 2.91% in fiscal year 2005. The 23 basis point increase was primarily the result of a 108 basis point increase in the average yield on loans which was partially offset by an 84 basis point increase in the cost of both
deposits and borrowings. The ratio of average interest-earning assets to average interest-bearing liabilities increased to 106.2% for fiscal year 2006 compared to 105.8% for fiscal year 2005.

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

Interest income on mortgage-backed securities increased $18.3 million (or 73.5%)
primarily due to an increase in the average balance of those securities.

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

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

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

Other income. Other income decreased to $394.9 million in fiscal year 2006 from $442.6 million in fiscal year 2005 period. The $47.7 million (or 10.8%) decrease
was primarily attributable to decreases in servicing, securitization and mortgage banking income and automobile rental income. Those decreases were partially offset by an increase in deposit servicing fees.

Servicing, securitization and mortgage banking income decreased to $158.8 million in fiscal year 2006, from $171.8 million in fiscal year 2005, a 7.6% decrease. During
fiscal year 2006, the Bank securitized and/or sold $5.4 billion of loans and recognized gains of $118.8 million. During fiscal year 2005 the Bank securitized and/or sold $6.5 billion of loans and recognized gains of $185.5 million. The Bank recorded
a fair value write-down on its interest-only assets of $88.3 million during the current fiscal year compared to $121.0 million in the prior fiscal year.

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

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

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

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

Servicing assets amortization and
other loan expenses increased to $103.7 million in fiscal year 2006 from $96.6 million in fiscal year 2005. The increase resulted primarily from an increase in servicing assets amortization to $83.4 million for fiscal year 2006 compared to $62.9
million for



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fiscal year 2005. Partially offsetting this increase, the mortgage servicing rights valuation allowance provision decreased to $2.7 million in fiscal year
2006 from $19.9 million in fiscal year 2005.

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

Other expenses increased $19.8 million (or 31.4%) in the current period primarily because the Bank settled for $16.1 million a lawsuit related to its former credit card
operations. See Note 23 to the Consolidated Financial Statements.

FISCAL 2005 COMPARED TO FISCAL 2004

REAL ESTATE

The Real Estate Trust recorded an operating loss from continuing operations of $7.4 million for fiscal 2005
compared to an operating loss from continuing operations of $22.6 million for fiscal 2004. The change reflects improved operating results in the hotel portfolio, the office and industrial portfolio and lower interest and amortization of debt expense
offset by a gain associated with a land sale in fiscal 2004, increased depreciation, advisory and management fees and general and administrative expenses. Included in the fiscal 2004 period were a write-off of unamortized debt costs of $2.4 million
and an early redemption premium of $6.5 million associated with the payoff of the Real Estate Trusts $200 million Senior Secured Notes.

Income after
direct operating expenses from hotels, which excludes the two hotel properties that were held for sale as of September 30, 2005, as well as the hotel property sold in December 2004, increased $7.0 million, or 22.3%, in fiscal 2005 from the
level achieved in fiscal 2004. Total revenue increased approximately $14.1 million, or 16.7%, as the average room rate increased $15.86, or 16.4%, from $96.55 in fiscal 2004 to $112.41 in fiscal 2005, reflecting the strong demand at the Real Estate
Trusts hotel properties, particularly the Northern Virginia and Florida properties while the overall occupancy percentage for the hotel properties increased from 69.0% for fiscal 2004 to 69.5% for fiscal 2005, a 0.7% increase. Room sales for
fiscal 2005 increased $11.7 million, or 17.0%, from fiscal 2004, while food, beverage and other sales increased $2.4 million, or 15.4%. Direct operating expenses increased $7.1 million, or 13.4%, reflecting increased operating costs, such as payroll
costs, repairs and maintenance, hotel franchise and marketing costs and other operating costs associated with the increased hotel occupancy and revenue.

Income after direct operating expenses from office and industrial properties increased $989,000, or 3.7%, in fiscal 2005 compared to fiscal 2004. Total revenue increased $1.2 million, or 3.2%, in fiscal 2005. Successful leasing efforts
during the period and the prior fiscal year have increased the office and industrial overall occupancy percentage from 89.0% at September 30, 2004 to 91.0% at September 30, 2005. The revenue generated from the increased occupancy is
slightly offset by lower rental rates as leases turned over. In addition the Real Estate Trust acquired an approximately 12,000 square foot office building on May 25, 2005 which contributed revenue of $200,000 to fiscal 2005. Direct operating
expenses increased $252,000, or 2.1%, as higher property taxes, insurance, and utility costs offset lower bad debt expenses.

Other income, which includes
interest income, income from other real estate properties and other miscellaneous income, increased $473,000, or 50.1%, principally due to higher interest income in the fiscal 2005 period reflecting the Trusts increased invested cash balance
in fiscal 2005 and the collection of a prior period bad debt which had been written off in a prior fiscal year.

Land parcels and other expense increased
$102,000, or 10.5% in fiscal 2005 when compared to fiscal 2004 as a result of increased operating expenses at the Real Estate Trusts other real estate properties.

Interest and amortization of debt expense decreased $12.1 million in fiscal 2005 when compared to fiscal 2004. Included in fiscal 2004 were a write-off of unamortized debt costs of $2.4 million and an early redemption
premium of $6.5 million associated with the payoff of the Real Estate Trusts $200 million Senior Secured Notes. Interest expense in fiscal 2005 includes interest of approximately $18.8 million on the $250 million 7.50% Senior Secured Notes
which were issued on February 25, 2004. Interest expense in fiscal 2004 includes approximately $11.2 million of interest on the $250 million 7.50% Senior Secured Notes, for the period that the Notes were outstanding in the fiscal 2004 period,
as well as approximately $9.8 million on the redeemed $200 million 9.75% Senior Secured Notes. Other interest expense was lower by approximately $1.0 million due to reduced mortgage interest expense, lower mortgage balances, lower line of credit
interest expense and lower unsecured note interest. The average balance of outstanding borrowings decreased to $608.9 million in fiscal 2005 from $638.1 million in fiscal 2004, reflecting the payoff of principal of the $200 million Senior Secured
Note debt, and lower mortgage and line of credit balances. The average cost of borrowings was 7.85% in fiscal 2005 and 9.06% in fiscal 2004. The decreased average cost of borrowings reflects the $6.5 million early redemption premium in the fiscal
2004 period as well as the 225 basis point reduction in the outstanding Senior Secured Note debt.

Depreciation expense increased $1.2 million, or 7.0%,
reflecting capital improvements in both the hotel and office and industrial portfolios that have been placed in service during fiscal 2005 and the prior fiscal year.

Advisory, management and leasing fees paid to related parties increased $1.0 million or 8.1%, in fiscal 2005 when compared to fiscal 2004. The advisory fee in the fiscal 2005 period was $487,000 per month compared to
$472,000 per month for the fiscal 2004 period, an aggregate increase of $180,000. The remainder of the increase, totaling $831,000, was due mainly to higher hotel management fees reflecting the 16.7% increase in hotel revenue.



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General and administrative expense increased $978,000 from $2.4 million in fiscal 2004 to $3.4 million in fiscal 2005.
The Real Estate Trust experienced higher accounting and legal costs in fiscal 2005 which were the major components of the increase.

Equity in earnings of
unconsolidated entities reflected net earnings of $8.2 million in fiscal 2005 as compared to $7.8 million in fiscal 2004, an increase of $458,000, or 5.9%. Earnings from Saul Holdings Limited Partnership and Saul Centers were higher by $424,000 in
fiscal 2005 period primarily due to increases in operating income generated as a result of the acquisition activity of those entities which offset additional general and administrative costs incurred by the organization. Losses from other
investments totaled $582,000 in fiscal 2005 compared to $616,000 in fiscal 2004. These losses are a result of write-downs of a certain non-public investment accounted for under the equity method.

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

In
February 2004, the Commonwealth of Virginia acquired 7.93 acres of land owned by the Real Estate Trust for use in a highway project. The Commonwealth of Virginia has paid $3.6 million which has resulted in an initial gain of approximately $2.7
million. In addition, in June 2004 the Real Estate Trust received a refund of approximately $117,000 for an expenditure relating to a September 2003 land sale. The original gain on the sale of this parcel was recorded in fiscal 2003. This refund has
been recorded as an additional gain on sale of this land parcel in fiscal 2004.

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

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

Loss from operations of discontinued real estate assets totaled $1.7
million for fiscal 2004. Included, are operating losses of $1.0 million for the two hotels which were sold in fiscal 2006 and an operating loss of $1.0 million for a hotel that was sold in December 2004. Also included in the 2005 period net loss is
operating income of approximately $334,000 associated with the other real estate property sold in February 2006 and an operating loss of approximately $32,000 from the other real estate asset sold in January 2005.

BANKING

Overview. The Bank recorded operating income of $189.7 million for the year ended September 30, 2005,
compared to operating income of $231.2 million for the year ended September 30, 2004. The decrease in operating income in fiscal year 2005 was primarily due to decreases in automobile rental income and servicing, securitization and mortgage
banking income, as well as increases in servicing assets amortization and other loan expenses and salaries and employee benefits. An increase in net interest income and a decrease in depreciation and amortization partially offset the decreased
income.

Net Interest Income. Net interest income, before the provision for loan losses, increased $87.3 million (or 31.4%) in fiscal year 2005 from
fiscal year 2004. The Bank recorded $0.4 million of interest income on non-accrual and restructured loans during fiscal year 2005. The Bank would have recorded additional interest income of $0.6 million in fiscal year 2005 if non-accrual assets and
restructured loans had been current in accordance with their original terms. The Banks net interest income in future periods will continue to be adversely affected by the Banks non-performing assets. See Financial Condition 
Asset Quality  Non-Performing Assets.

Interest income in fiscal year 2005 increased $131.5 million (or 29.8%) from fiscal year 2004 primarily
as a result of higher average yields on and higher average balances of loans receivable. Contributing to the increased interest income was an increase in interest income on mortgage-backed securities and other investments caused primarily by higher
average balances.

The Banks net interest spread increased to 2.91% in fiscal year 2005 from 2.50% in fiscal year 2004. The 41 basis point increase
was primarily the result of a 73 basis point increase in the average yield on loans, which was partially offset by a 26 basis point increase in the cost of deposits and borrowings. The ratio of average interest-earning assets to average
interest-bearing liabilities increased to 105.8% for fiscal year 2005 compared to 103.3% for fiscal year 2004.

Interest income on loans, the largest
category of interest-earning assets, increased to $531.9 million for fiscal year 2005 from $411.6 million for fiscal year 2004, an increase of 29.2%, because of higher average yields on and higher average balances of loans receivable. The average
yield on the loan portfolio increased to 4.81% from 4.08% from fiscal year 2004, reflecting increases in the various indices on which interest rates of



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adjustable rate loans are based. Interest income on residential mortgage loans increased $85.0 million due to a $757.5 million increase in average balances
as well as a 72 basis point increase in the average yield (to 4.44% from 3.72%) during fiscal year 2005. Also contributing to the increased interest income on loans were higher average balances of and higher average yields on home equity loans,
which resulted in a $29.1 million (or 46.0%) increase in interest income on those loans. Lower average yields on and lower average balances of automobile loans resulted in a $14.4 million (or 49.2%) decrease in interest income on those loans.

Interest income on mortgage-backed securities increased $4.4 million (or 21.5%) primarily due to increased average balances which was partially offset by
a decrease in the average yields on those securities to 4.33% from 4.71%.

Interest expense on deposits increased $37.4 million (or 64.2%) during fiscal
year 2005. The increase resulted primarily from a 40 basis point increase in the average rate on deposits (to 1.19% from 0.79%) due to increased rates paid by the Bank in response to higher market interest rates and, to a lesser extent, a $650.9
million increase in average deposit balances.

Interest expense on borrowings increased $6.8 million (or 6.5%) in fiscal year 2005 compared to fiscal year
2004. Interest expense on securities sold under repurchase agreements and other borrowings increased $6.3 million and interest expense on advances from the FHLB of Atlanta increased $4.3 million due primarily to higher average balances. The average
balances of subordinated debentures decreased by $34.4 million, and the average rate on those borrowings decreased by 69 basis points, resulting in a decrease of $3.8 million in interest expense. On December 2, 2003, the Bank issued $175.0
million aggregate principal amount of 67/8% subordinated debentures due 2013. On January 2, 2004, the net
proceeds of the offering, along with short-term borrowings, were used to redeem all $250.0 million of the Banks 91/4% subordinated debentures due 2005 and 2008.

Credit for Loan Losses. During fiscal year 2005, the Bank recorded a
negative provision for loan losses of $11.6 million, compared to a negative provision of $14.5 million in fiscal year 2004. Managements prior decisions to discontinue subprime automobile lending and indirect consumer lending, and focus more on
residential mortgages, have improved the overall credit quality of the Banks loan portfolio. As the balances of automobile loans continue to decline, charge-offs and delinquencies also have been declining. The combination of these factors
contributed to the Banks decision to reduce the provision for loan losses. See Financial Condition  Asset Quality  Allowances for Losses.

Other income. Other income decreased to $442.6 million in fiscal year 2005 from $539.5 million in fiscal year 2004. The $96.9 million (or 18.0%) decrease was primarily attributable to decreases in servicing,
securitization and mortgage banking income and automobile rental income, offset partially by an increase in other income.

Servicing, securitization and
mortgage banking income decreased to $171.8 million in fiscal year 2005, from $216.1 million in fiscal year 2004, a 20.5% decrease. The reduction resulted from a $121.0 million decrease in fair value of interest-only strips receivables during the
current period. Also contributing to this decrease was a decrease in gain on sales of loans. During fiscal year 2005, the Bank recognized gains of $185.5 million resulting from the securitization and/or sale of $6.5 billion of loans compared to
gains of $193.6 million resulting from the securitization and/or sale of $6.5 billion of loans during fiscal year 2004. Partially offsetting the decreased income were increases in fees related to the prepayments of certain residential mortgage
loans.

Automobile rental income decreased to $82.0 million during fiscal year 2005 from $157.0 million in the prior year, a 47.8% decrease. The $75.0
million decrease resulted primarily from a $341.3 million (or 53.7%) decrease in average outstanding leases as a result of the Banks prior decision to discontinue origination of automobile leases.

Other income increased to $52.5 million in fiscal year 2005 from $37.3 million in fiscal year 2004, a 40.8% increase. The $15.2 million increase in fiscal year 2005 was
primarily due to earnings of $12.7 million on a joint venture investment.

Operating Expenses. Operating expenses during fiscal year 2005 increased
$29.0 million (or 4.8%) from fiscal year 2004. The increase was largely due to increases in servicing assets amortization and other loan expenses, salaries and employee benefits, property and equipment and marketing, which were partially offset by a
reduction in depreciation and amortization.

Servicing assets amortization and other loan expenses increased to $96.6 million in fiscal year 2005 from
$53.5 million in fiscal year 2004, an 80.5% increase. The increase resulted primarily from an increase in servicing assets amortization to $62.9 million and a $19.9 million increase in the mortgage servicing rights valuation allowance caused by a
decrease in the value of the Banks servicing assets during fiscal year 2005 compared to servicing assets amortization of $44.9 million and a decrease of $2.0 million in the mortgage servicing rights valuation allowance caused by an increase in
the value of the Banks mortgage servicing assets during fiscal year 2004.

Salaries and employee benefits increased $33.5 million (or 14.4%) in
fiscal year 2005 due primarily to increased expenses in the retail branch network.

Property and equipment increased $7.6 million (or 19.4%) in fiscal year
2005 due to increased rent expense due to the addition of new branch offices.

Marketing expenses increased $7.1 million (or 58.2%) in the current period
due to increased efforts to further promote the Banks products and services.



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Depreciation and amortization expense decreased $57.2 million (or 35.6%). Depreciation expense related to automobiles
subject to lease decreased $60.2 million, to $60.7 million in fiscal year 2005, due to lower levels of outstanding leases resulting from the Banks prior decision to discontinue origination of automobile leases.



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|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------

Information required by this Item is included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsFinancial ConditionBankingAsset and Liability Management.



|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------

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



|    |  |                                                                                                                                             |  |       
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------- |  | ------
|(a) |  | Report of Independent Registered Public Accounting Firm.                                                                                    |  | 78    
|    |  |                                                                                                                                            
|(b) |  | Consolidated Balance SheetsAs of September 30, 2006 and 2005.                                                                              |  | 79    
|    |  |                                                                                                                                            
|(c) |  | Consolidated Statements of OperationsFor the years ended September 30, 2006, 2005 and 2004.                                                |  | 80-81 
|    |  |                                                                                                                                            
|(d) |  | Consolidated Statements of Comprehensive Income and Changes in Shareholders Equity For the years ended September 30, 2006, 2005 and 2004. |  | 82    
|    |  |                                                                                                                                            
|(e) |  | Consolidated Statements of Cash FlowsFor the years ended September 30, 2006, 2005 and 2004.                                                |  | 83-84 
|    |  |                                                                                                                                            
|(f) |  | Notes to Consolidated Financial Statements.                                                                                                 |  | 85-139

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



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TRUSTEES AND SHAREHOLDERS

B.F. SAUL REAL ESTATE INVESTMENT TRUST

We have audited the accompanying
consolidated balance sheets of B.F. Saul Real Estate Investment Trust (the Trust) as of September 30, 2006 and 2005, and the related consolidated statements of operations, comprehensive income and changes in shareholders
equity and cash flows for each of the three years in the period ended September 30, 2006. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the
responsibility of the Trusts management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

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

In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial position of B.F. Saul Real Estate Investment Trust as of September 30, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the
three years in the period ended September 30, 2006 in conformity with U. S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements
taken as a whole, present fairly in all material respects the information set forth therein.

/s/ Ernst & Young
LLP

McLean, Virginia

December 5, 2006



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Consolidated Balance Sheets

B. F. SAUL REAL ESTATE INVESTMENT TRUST



|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                                                                                                               |  | September 30, |           
|(In thousands, except share and per share amounts)                                                                                                                             |  | 2006          |            |   | 2005 |  
|ASSETS                                                                                                                                                                         |  |               |            |   |      |   |            |  
|Real Estate                                                                                                                                                                    |  |               |            |   |      |   |            |  
|Income-producing properties                                                                                                                                                    |  |               |            |   |      |   |            |  
|Hotel                                                                                                                                                                          |  | $             | 359,805    |   |      | $ | 246,144    |  
|Office and industrial                                                                                                                                                          |  |               | 210,015    |   |      |   | 194,643    |  
|Other                                                                                                                                                                          |  |               | 1,128      |   |      |   | 1,128      |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|                                                                                                                                                                               |  |               | 570,948    |   |      |   | 441,915    |  
|Accumulated depreciation                                                                                                                                                       |  |               | (197,855   | ) |      |   | (182,255   | )
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|                                                                                                                                                                               |  |               | 373,093    |   |      |   | 259,660    |  
|Land parcels                                                                                                                                                                   |  |               | 44,582     |   |      |   | 48,029     |  
|Construction in progress                                                                                                                                                       |  |               | 34,946     |   |      |   |           |  
|Real estate held for sale                                                                                                                                                      |  |               |           |   |      |   | 11,168     |  
|Investment in Saul Holdings and Saul Centers                                                                                                                                   |  |               | 89,802     |   |      |   | 75,323     |  
|Cash and cash equivalents                                                                                                                                                      |  |               | 46,391     |   |      |   | 13,920     |  
|Note receivable - related party                                                                                                                                                |  |               | 10,300     |   |      |   | 13,100     |  
|Other assets                                                                                                                                                                   |  |               | 63,698     |   |      |   | 44,630     |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Total real estate assets                                                                                                                                                       |  |               | 662,812    |   |      |   | 465,830    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Banking                                                                                                                                                                        |  |               |            |   |      |   |            |  
|Cash and due from banks                                                                                                                                                        |  |               | 394,309    |   |      |   | 438,074    |  
|Interest-bearing deposits                                                                                                                                                      |  |               | 15,879     |   |      |   | 69,425     |  
|Loans held for securitization and/or sale                                                                                                                                      |  |               | 467,574    |   |      |   | 1,718,132  |  
|Investment securities (market value of $200,152 and $198,769, respectively)                                                                                                    |  |               | 201,455    |   |      |   | 200,902    |  
|Mortgage-backed securities (market value of $1,266,970 and $849,764, respectively)                                                                                             |  |               | 1,289,718  |   |      |   | 859,808    |  
|Loans receivable (net of allowance for losses of $25,000 and $28,640, respectively)                                                                                            |  |               | 10,120,821 |   |      |   | 9,303,800  |  
|Federal Home Loan Bank stock                                                                                                                                                   |  |               | 85,449     |   |      |   | 136,093    |  
|Property and equipment, net                                                                                                                                                    |  |               | 601,592    |   |      |   | 534,371    |  
|Automobiles subject to lease, net                                                                                                                                              |  |               | 55,448     |   |      |   | 185,036    |  
|Goodwill and other intangible assets, net                                                                                                                                      |  |               | 39,970     |   |      |   | 30,923     |  
|Interest-only strips receivable                                                                                                                                                |  |               | 344,317    |   |      |   | 348,227    |  
|Servicing assets, net                                                                                                                                                          |  |               | 168,059    |   |      |   | 164,592    |  
|Other assets                                                                                                                                                                   |  |               | 356,530    |   |      |   | 255,578    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Total banking assets                                                                                                                                                           |  |               | 14,141,121 |   |      |   | 14,244,961 |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|TOTAL ASSETS                                                                                                                                                                   |  | $             | 14,803,933 |   |      | $ | 14,710,791 |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|LIABILITIES                                                                                                                                                                    |  |               |            |   |      |   |            |  
|Real Estate                                                                                                                                                                    |  |               |            |   |      |   |            |  
|Mortgage notes payable                                                                                                                                                         |  | $             | 488,339    |   |      | $ | 278,411    |  
|Mortgage notes payable - real estate held for sale                                                                                                                             |  |               |           |   |      |   | 15,917     |  
|Notes payable - secured                                                                                                                                                        |  |               | 250,000    |   |      |   | 250,000    |  
|Notes payable - unsecured                                                                                                                                                      |  |               | 21,398     |   |      |   | 57,760     |  
|Other liabilities and accrued expenses                                                                                                                                         |  |               | 31,361     |   |      |   | 22,180     |  
|Deferred tax liability, net                                                                                                                                                    |  |               | 41,281     |   |      |   | 35,951     |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Total real estate liabilities                                                                                                                                                  |  |               | 832,379    |   |      |   | 660,219    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Banking                                                                                                                                                                        |  |               |            |   |      |   |            |  
|Deposit accounts                                                                                                                                                               |  |               | 10,445,764 |   |      |   | 9,781,768  |  
|Securities sold under repurchase agreements and other short-term borrowings                                                                                                    |  |               | 822,639    |   |      |   | 498,914    |  
|Federal Home Loan Bank advances                                                                                                                                                |  |               | 1,343,312  |   |      |   | 2,468,740  |  
|Custodial accounts                                                                                                                                                             |  |               | 103,903    |   |      |   | 122,670    |  
|Amounts due to banks                                                                                                                                                           |  |               | 64,105     |   |      |   | 85,902     |  
|Other liabilities                                                                                                                                                              |  |               | 237,736    |   |      |   | 191,290    |  
|Capital notes - subordinated                                                                                                                                                   |  |               | 175,000    |   |      |   | 175,000    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Total banking liabilities                                                                                                                                                      |  |               | 13,192,459 |   |      |   | 13,324,284 |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Commitments and contingencies                                                                                                                                                  |  |               |            |   |      |   |            |  
|Minority interest held by affiliates                                                                                                                                           |  |               | 130,529    |   |      |   | 124,932    |  
|Minority interest  other                                                                                                                                                      |  |               | 296,013    |   |      |   | 296,013    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|TOTAL LIABILITIES                                                                                                                                                              |  |               | 14,451,380 |   |      |   | 14,405,448 |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|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                                                                                                                                                              |  |               | 296,293    |   |      |   | 249,083    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|                                                                                                                                                                               |  |               | 396,394    |   |      |   | 349,184    |  
|Less cost of 1,834,088 common shares of beneficial interest in treasury                                                                                                        |  |               | (43,841    | ) |      |   | (43,841    | )
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|TOTAL SHAREHOLDERS EQUITY                                                                                                                                                     |  |               | 352,553    |   |      |   | 305,343    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                     |  | $             | 14,803,933 |   |      | $ | 14,710,791 |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  

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



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##### Table of Contents

Consolidated Statements of Operations

B. F. SAUL REAL ESTATE INVESTMENT TRUST



|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|---------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                                       |  | For the Year Ended September 30, |        
|(In thousands, except per share amounts)                                                                               |  | 2006                             |         |   | 2005 |   |         | 2004 | 
|REAL ESTATE                                                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Income                                                                                                                 |  |                                  |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                                                                 |  | $                                | 127,238 |   |      | $ | 98,621  |      |  | $ | 84,477  |  
|Office and industrial (including $5,792, $5,391 and $5,205 of rental income earned from banking segment, respectively) |  |                                  | 39,984  |   |      |   | 39,466  |      |  |   | 38,225  |  
|Other                                                                                                                  |  |                                  | 2,415   |   |      |   | 1,417   |      |  |   | 944     |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total income                                                                                                           |  |                                  | 169,637 |   |      |   | 139,504 |      |  |   | 123,646 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Expenses                                                                                                               |  |                                  |         |   |      |   |         |      |  |   |         |  
|Direct operating expenses:                                                                                             |  |                                  |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                                                                 |  |                                  | 78,041  |   |      |   | 60,002  |      |  |   | 52,905  |  
|Office and industrial properties                                                                                       |  |                                  | 13,374  |   |      |   | 12,057  |      |  |   | 11,805  |  
|Land parcels and other                                                                                                 |  |                                  | 1,177   |   |      |   | 1,072   |      |  |   | 970     |  
|Interest and amortization of debt expense                                                                              |  |                                  | 50,516  |   |      |   | 46,503  |      |  |   | 58,645  |  
|Depreciation                                                                                                           |  |                                  | 20,390  |   |      |   | 18,878  |      |  |   | 17,646  |  
|Advisory, management and leasing fees - related parties                                                                |  |                                  | 15,480  |   |      |   | 13,448  |      |  |   | 12,437  |  
|General and administrative                                                                                             |  |                                  | 3,156   |   |      |   | 3,421   |      |  |   | 2,443   |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total expenses                                                                                                         |  |                                  | 182,134 |   |      |   | 155,381 |      |  |   | 156,851 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Equity in earnings (losses) of unconsolidated entities:                                                                |  |                                  |         |   |      |   |         |      |  |   |         |  
|Saul Holdings and Saul Centers                                                                                         |  |                                  | 10,554  |   |      |   | 8,828   |      |  |   | 8,404   |  
|Other, including impairment                                                                                            |  |                                  | (503    | ) |      |   | (582    | )    |  |   | (616    | )
|Gain on sales of property                                                                                              |  |                                  | 416     |   |      |   | 263     |      |  |   | 2,769   |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|REAL ESTATE OPERATING LOSS                                                                                             |  | $                                | (2,030  | ) |      | $ | (7,368  | )    |  | $ | (22,648 | )
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|BANKING                                                                                                                |  |                                  |         |   |      |   |         |      |  |   |         |  
|Interest income                                                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Loans                                                                                                                  |  | $                                | 669,154 |   |      | $ | 531,859 |      |  | $ | 411,640 |  
|Mortgage-backed securities                                                                                             |  |                                  | 43,238  |   |      |   | 24,915  |      |  |   | 20,505  |  
|Other                                                                                                                  |  |                                  | 22,611  |   |      |   | 15,989  |      |  |   | 9,126   |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total interest income                                                                                                  |  |                                  | 735,003 |   |      |   | 572,763 |      |  |   | 441,271 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Interest expense                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Deposit accounts                                                                                                       |  |                                  | 179,563 |   |      |   | 95,631  |      |  |   | 58,251  |  
|Short-term borrowings                                                                                                  |  |                                  | 96,913  |   |      |   | 67,275  |      |  |   | 20,012  |  
|Long-term borrowings                                                                                                   |  |                                  | 41,695  |   |      |   | 44,287  |      |  |   | 84,759  |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total interest expense                                                                                                 |  |                                  | 318,171 |   |      |   | 207,193 |      |  |   | 163,022 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net interest income                                                                                                    |  |                                  | 416,832 |   |      |   | 365,570 |      |  |   | 278,249 |  
|Credit for loan losses                                                                                                 |  |                                  | (9,004  | ) |      |   | (11,569 | )    |  |   | (14,522 | )
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net interest income after credit for loan losses                                                                       |  |                                  | 425,836 |   |      |   | 377,139 |      |  |   | 292,771 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Other income                                                                                                           |  |                                  |         |   |      |   |         |      |  |   |         |  
|Deposit servicing fees                                                                                                 |  |                                  | 144,548 |   |      |   | 136,279 |      |  |   | 129,107 |  
|Servicing, securitization and mortgage banking income                                                                  |  |                                  | 158,781 |   |      |   | 171,842 |      |  |   | 216,052 |  
|Automobile rental income, net                                                                                          |  |                                  | 35,196  |   |      |   | 81,963  |      |  |   | 157,034 |  
|Other                                                                                                                  |  |                                  | 56,394  |   |      |   | 52,516  |      |  |   | 37,301  |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total other income                                                                                                     |  |                                  | 394,919 |   |      |   | 442,600 |      |  |   | 539,494 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  

Continued on following page.



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##### Table of Contents

Consolidated Statements of Operations (Continued)

B. F. SAUL REAL ESTATE INVESTMENT TRUST



|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------ |  | -------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                                         |  | For the Year Ended September 30, |        
|(In thousands, except per share amounts)                                                                                 |  | 2006                             |         |   | 2005 |   |         | 2004 | 
|BANKING (Continued)                                                                                                      |  |                                  |         |   |      |   |         |      |  |   |         |  
|Operating expenses                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Salaries and employee benefits                                                                                           |  | $                                | 309,365 |   |      | $ | 266,601 |      |  | $ | 233,093 |  
|Servicing assets amortization and other loan expenses                                                                    |  |                                  | 103,696 |   |      |   | 96,632  |      |  |   | 53,542  |  
|Property and equipment (including $5,792, $5,391 and $5,205 of rental expense paid to real estate segment, respectively) |  |                                  | 55,832  |   |      |   | 46,615  |      |  |   | 39,032  |  
|Marketing                                                                                                                |  |                                  | 22,161  |   |      |   | 19,248  |      |  |   | 12,171  |  
|Data processing                                                                                                          |  |                                  | 38,713  |   |      |   | 34,664  |      |  |   | 35,452  |  
|Depreciation and amortization                                                                                            |  |                                  | 69,465  |   |      |   | 103,319 |      |  |   | 160,509 |  
|Other                                                                                                                    |  |                                  | 82,720  |   |      |   | 62,965  |      |  |   | 67,251  |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total operating expenses                                                                                                 |  |                                  | 681,952 |   |      |   | 630,044 |      |  |   | 601,050 |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|BANKING OPERATING INCOME                                                                                                 |  | $                                | 138,803 |   |      | $ | 189,695 |      |  | $ | 231,215 |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|TOTAL COMPANY                                                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Income from continuing operations before income taxes and minority interest                                              |  | $                                | 136,773 |   |      | $ | 182,327 |      |  | $ | 208,567 |  
|Income tax provision                                                                                                     |  |                                  | 39,663  |   |      |   | 59,141  |      |  |   | 70,480  |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|Income from continuing operations before minority interest                                                               |  |                                  | 97,110  |   |      |   | 123,186 |      |  |   | 138,087 |  
|Minority interest held by affiliates                                                                                     |  |                                  | (13,597 | ) |      |   | (19,516 | )    |  |   | (23,070 | )
|Minority interest - other                                                                                                |  |                                  | (29,141 | ) |      |   | (29,071 | )    |  |   | (37,195 | )
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|INCOME FROM CONTINUING OPERATIONS                                                                                        |  |                                  | 54,372  |   |      |   | 74,599  |      |  |   | 77,822  |  
|Discontinued real estate operations:                                                                                     |  |                                  |         |   |      |   |         |      |  |   |         |  
|Income (loss) from operations of discontinued real estate assets                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|(including net gain (loss) on disposal of $6,286, $882, $(310), respectively)                                            |  |                                  | 4,225   |   |      |   | (1,537  | )    |  |   | (1,724  | )
|Income tax expense (benefit)                                                                                             |  |                                  | 1,635   |   |      |   | (536    | )    |  |   | (602    | )
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|INCOME (LOSS) ON DISCONTINUED REAL ESTATE OPERATIONS                                                                     |  |                                  | 2,590   |   |      |   | (1,001  | )    |  |   | (1,122  | )
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|TOTAL COMPANY NET INCOME                                                                                                 |  | $                                | 56,962  |   |      | $ | 73,598  |      |  | $ | 76,700  |  
|Dividends: Real Estate Trusts preferred shares of beneficial interest                                                   |  |                                  | (5,418  | ) |      |   | (5,418  | )    |  |   | (5,418  | )
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|NET INCOME AVAILABLE TO COMMON SHAREHOLDERS                                                                              |  | $                                | 51,544  |   |      | $ | 68,180  |      |  | $ | 71,282  |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|NET INCOME (LOSS) PER COMMON SHARE                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Income from continuing operations                                                                                        |  | $                                | 10.18   |   |      | $ | 14.39   |      |  | $ | 15.06   |  
|Discontinued operations                                                                                                  |  |                                  | 0.54    |   |      |   | (0.21   | )    |  |   | (0.23   | )
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|NET INCOME PER COMMON SHARE (BASIC AND DILUTED)                                                                          |  | $                                | 10.72   |   |      | $ | 14.18   |      |  | $ | 14.83   |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|DISTRIBUTIONS DECLARED PER COMMON SHARE                                                                                  |  | $                                | 1.37    |   |      | $ | 1.37    |      |  | $ | 0.09    |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  

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



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##### Table of Contents

Consolidated Statements of Comprehensive Income and Changes in Shareholders Equity

B. F. SAUL REAL ESTATE INVESTMENT
TRUST



|                                                                                  |  |                                  |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                  |  | For the Year Ended September 30, |        
|(Dollars in thousands, except share amounts)                                      |  | 2006                             |         |   | 2005 |   |         | 2004 | 
|COMPREHENSIVE INCOME                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net income                                                                        |  | $                                | 56,962  |   |      | $ | 73,598  |      |  | $ | 76,700  |  
|Other comprehensive income                                                        |  |                                  |        |   |      |   |        |      |  |   |        |  
|                                                                                  |  |                                  |         |   |      |   |         |      |  |   |         |  
|TOTAL COMPREHENSIVE INCOME                                                        |  | $                                | 56,962  |   |      | $ | 73,598  |      |  | $ | 76,700  |  
|                                                                                  |  |                                  |         |   |      |   |         |      |  |   |         |  
|CHANGES IN SHAREHOLDERS EQUITY                                                   |  |                                  |         |   |      |   |         |      |  |   |         |  
|PREFERRED SHARES OF BENEFICIAL INTEREST                                           |  |                                  |         |   |      |   |         |      |  |   |         |  
|Beginning and end of year (516,000 shares)                                        |  | $                                | 516     |   |      | $ | 516     |      |  | $ | 516     |  
|                                                                                  |  |                                  |         |   |      |   |         |      |  |   |         |  
|COMMON SHARES OF BENEFICIAL INTEREST                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|Beginning and end of year (6,641,598 shares)                                      |  |                                  | 6,642   |   |      |   | 6,642   |      |  |   | 6,642   |  
|                                                                                  |  |                                  |         |   |      |   |         |      |  |   |         |  
|PAID-IN SURPLUS                                                                   |  |                                  |         |   |      |   |         |      |  |   |         |  
|Beginning and end of year                                                         |  |                                  | 92,943  |   |      |   | 92,943  |      |  |   | 92,943  |  
|                                                                                  |  |                                  |         |   |      |   |         |      |  |   |         |  
|RETAINED EARNINGS                                                                 |  |                                  |         |   |      |   |         |      |  |   |         |  
|Beginning of year                                                                 |  |                                  | 249,083 |   |      |   | 185,342 |      |  |   | 112,424 |  
|Net income                                                                        |  |                                  | 56,962  |   |      |   | 73,598  |      |  |   | 76,700  |  
|Adjustments:                                                                      |  |                                  |         |   |      |   |         |      |  |   |         |  
|Saul Holdings investment, net of taxes of $1,210, $1,309 and $1,120, respectively |  |                                  | 2,248   |   |      |   | 2,427   |      |  |   | 2,080   |  
|Other                                                                             |  |                                  |        |   |      |   | (284    | )    |  |   |        |  
|Dividends:                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Real Estate Trust preferred shares of beneficial interest                         |  |                                  | (5,418  | ) |      |   | (5,418  | )    |  |   | (5,418  | )
|Real Estate Trust common shares of beneficial interest                            |  |                                  | (6,582  | ) |      |   | (6,582  | )    |  |   | (444    | )
|                                                                                  |  |                                  |         |   |      |   |         |      |  |   |         |  
|End of year                                                                       |  |                                  | 296,293 |   |      |   | 249,083 |      |  |   | 185,342 |  
|                                                                                  |  |                                  |         |   |      |   |         |      |  |   |         |  
|TREASURY SHARES                                                                   |  |                                  |         |   |      |   |         |      |  |   |         |  
|Beginning and end of year (1,834,088 shares)                                      |  |                                  | (43,841 | ) |      |   | (43,841 | )    |  |   | (43,841 | )
|                                                                                  |  |                                  |         |   |      |   |         |      |  |   |         |  
|TOTAL SHAREHOLDERS EQUITY                                                        |  | $                                | 352,553 |   |      | $ | 305,343 |      |  | $ | 241,602 |  
|                                                                                  |  |                                  |         |   |      |   |         |      |  |   |         |  

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



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##### Table of Contents

Consolidated Statements of Cash Flows

B. F. SAUL REAL ESTATE INVESTMENT TRUST



|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|---------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                                                                       |  | For the Year Ended September 30, |           
|(In thousands)                                                                                                         |  | 2006                             |            |   | 2005 |   |            | 2004 | 
|CASH FLOWS FROM OPERATING ACTIVITIES                                                                                   |  |                                  |            |   |      |   |            |      |  |   |            |  
|Real Estate                                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|Net income (loss)                                                                                                      |  | $                                | 2,574      |   |      | $ | (4,465     | )    |  | $ | (15,580    | )
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:                     |  |                                  |            |   |      |   |            |      |  |   |            |  
|Net gains on sale of property                                                                                          |  |                                  | (6,702     | ) |      |   | (1,145     | )    |  |   | (2,459     | )
|Depreciation                                                                                                           |  |                                  | 20,390     |   |      |   | 19,857     |      |  |   | 19,053     |  
|Amortization of debt expense                                                                                           |  |                                  | 2,672      |   |      |   | 2,197      |      |  |   | 4,507      |  
|Equity in net earnings of unconsolidated entities, net of net distributions of $5,636, $4,910 and $6,527, respectively |  |                                  | (4,415     | ) |      |   | (3,336     | )    |  |   | (1,262     | )
|Deferred tax expense (benefit)                                                                                         |  |                                  | 4,121      |   |      |   | (922       | )    |  |   | (1,123     | )
|Increase in accounts receivable and accrued income                                                                     |  |                                  | (7,051     | ) |      |   | (4,438     | )    |  |   | (10,766    | )
|Increase (decrease) in accounts payable and accrued expenses                                                           |  |                                  | 550        |   |      |   | (493       | )    |  |   | (6,023     | )
|Dividends and tax sharing payments                                                                                     |  |                                  | 34,031     |   |      |   | 41,320     |      |  |   | 33,611     |  
|Other                                                                                                                  |  |                                  | (5,137     | ) |      |   | 488        |      |  |   | (1,725     | )
|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                                                                       |  |                                  | 41,033     |   |      |   | 49,063     |      |  |   | 18,233     |  
|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|Banking                                                                                                                |  |                                  |            |   |      |   |            |      |  |   |            |  
|Net income                                                                                                             |  |                                  | 54,388     |   |      |   | 78,063     |      |  |   | 92,280     |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities:                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|Amortization of premiums, discounts and net deferred loan fees                                                         |  |                                  | 36,597     |   |      |   | 40,399     |      |  |   | 28,502     |  
|Decrease in income tax payable                                                                                         |  |                                  | (40,900    | ) |      |   | (44,853    | )    |  |   | (49,481    | )
|Depreciation and amortization                                                                                          |  |                                  | 69,465     |   |      |   | 103,319    |      |  |   | 160,509    |  
|Credit for loan losses                                                                                                 |  |                                  | (9,004     | ) |      |   | (11,569    | )    |  |   | (14,522    | )
|Minority interest held by affiliates                                                                                   |  |                                  | 13,597     |   |      |   | 19,516     |      |  |   | 23,070     |  
|Minority interestother                                                                                                |  |                                  | 10,000     |   |      |   | 10,000     |      |  |   | 18,193     |  
|Proceeds from sales of trading securities                                                                              |  |                                  | 224,536    |   |      |   | 192,105    |      |  |   | 668,458    |  
|Purchases and net fundings of loans held for securitization and/or sale                                                |  |                                  | (4,186,104 | ) |      |   | (5,620,487 | )    |  |   | (6,686,606 | )
|Proceeds from sales of loans held for securitization and/or sale                                                       |  |                                  | 5,141,038  |   |      |   | 6,316,045  |      |  |   | 5,810,798  |  
|(Increase) decrease in interest-only strips receivable                                                                 |  |                                  | 3,910      |   |      |   | (60,387    | )    |  |   | (148,059   | )
|Increase in servicing assets                                                                                           |  |                                  | (3,466     | ) |      |   | (16,737    | )    |  |   | (51,588    | )
|Increase in other assets                                                                                               |  |                                  | (88,792    | ) |      |   | (88,963    | )    |  |   | (20,938    | )
|Increase (decrease) in custodial accounts                                                                              |  |                                  | (18,767    | ) |      |   | 4,956      |      |  |   | (56,128    | )
|Increase in other liabilities                                                                                          |  |                                  | 65,549     |   |      |   | 19,255     |      |  |   | 10,267     |  
|Other                                                                                                                  |  |                                  | (890       | ) |      |   | 18,633     |      |  |   | (12,938    | )
|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                                                                       |  |                                  | 1,271,157  |   |      |   | 959,295    |      |  |   | (228,183   | )
|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|Net cash provided by (used in) operating activities                                                                    |  |                                  | 1,312,190  |   |      |   | 1,008,358  |      |  |   | (209,950   | )
|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                                                                   |  |                                  |            |   |      |   |            |      |  |   |            |  
|Real Estate                                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|Property acquisitions                                                                                                  |  |                                  | (108,029   | ) |      |   | (13,532    | )    |  |   |           |  
|Development/redevelopment expenditures                                                                                 |  |                                  | (19,205    | ) |      |   |           |      |  |   |           |  
|Capital expenditures                                                                                                   |  |                                  | (31,835    | ) |      |   | (16,414    | )    |  |   | (17,973    | )
|Property sales, net                                                                                                    |  |                                  | 17,146     |   |      |   | 4,715      |      |  |   | 3,719      |  
|Note receivable and accrued interest  related party (advances)/repayments, net                                        |  |                                  | 2,800      |   |      |   | (5,423     | )    |  |   | (4,690     | )
|Equity investment in Saul Holdings and Saul Centers                                                                    |  |                                  | (6,104     | ) |      |   | (5,901     | )    |  |   | (3,306     | )
|Other investments                                                                                                      |  |                                  | (431       | ) |      |   | (776       | )    |  |   | (800       | )
|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                                                                       |  |                                  | (145,658   | ) |      |   | (37,331    | )    |  |   | (23,050    | )
|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|Banking                                                                                                                |  |                                  |            |   |      |   |            |      |  |   |            |  
|Proceeds from maturities of investment securities                                                                      |  |                                  |           |   |      |   |           |      |  |   | 10,000     |  
|Purchases of investment securities                                                                                     |  |                                  |           |   |      |   | (129,401   | )    |  |   | (34,917    | )
|Proceeds from redemption of Federal Home Loan Bank stock                                                               |  |                                  | 273,074    |   |      |   | 282,492    |      |  |   | 287,599    |  
|Purchases of Federal Home Loan Bank stock                                                                              |  |                                  | (222,430   | ) |      |   | (279,238   | )    |  |   | (319,573   | )
|Net principal collected on loans                                                                                       |  |                                  | 5,505,242  |   |      |   | 5,451,943  |      |  |   | 3,558,267  |  
|Net funding and purchases of loans receivable                                                                          |  |                                  | (6,770,029 | ) |      |   | (7,235,055 | )    |  |   | (5,046,003 | )
|Principal collected on mortgage-backed securities                                                                      |  |                                  | 184,810    |   |      |   | 217,497    |      |  |   | 186,654    |  
|Purchases of mortgage-backed securities                                                                                |  |                                  | (126,788   | ) |      |   | (299,866   | )    |  |   | (9,105     | )
|Proceeds from sales of automobiles subject to lease                                                                    |  |                                  | 106,333    |   |      |   | 189,540    |      |  |   | 299,199    |  
|Net purchases of property and equipment                                                                                |  |                                  | (115,036   | ) |      |   | (84,577    | )    |  |   | (64,197    | )
|Net proceeds from sales of property and equipment                                                                      |  |                                  | 701        |   |      |   |           |      |  |   | 23,320     |  
|Net proceeds from sales of real estate                                                                                 |  |                                  | 4,707      |   |      |   | 12,031     |      |  |   | 9,500      |  
|Disbursements for real estate held for sale                                                                            |  |                                  | (11,793    | ) |      |   | (5,895     | )    |  |   | (3,272     | )
|Purchases of investment management companies                                                                           |  |                                  | (9,552     | ) |      |   | (7,019     | )    |  |   |           |  
|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                                                                       |  |                                  | (1,180,761 | ) |      |   | (1,887,548 | )    |  |   | (1,102,528 | )
|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|Net cash used in investing activities                                                                                  |  |                                  | (1,326,419 | ) |      |   | (1,924,879 | )    |  |   | (1,125,578 | )
|                                                                                                                       |  |                                  |            |   |      |   |            |      |  |   |            |  

Continued on following page.



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Consolidated Statements of Cash Flows (Continued)

B. F. SAUL REAL ESTATE INVESTMENT TRUST



|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                                                        |  | For the Year Ended September 30, |            
|(In thousands)                                                                                          |  | 2006                             |             |   | 2005 |   |             | 2004 | 
|CASH FLOWS FROM FINANCING ACTIVITIES                                                                    |  |                                  |             |   |      |   |             |      |  |   |             |  
|Real Estate                                                                                             |  |                                  |             |   |      |   |             |      |  |   |             |  
|Proceeds from mortgage financing                                                                        |  | $                                | 294,882     |   |      | $ |            |      |  | $ |            |  
|Principal curtailments and repayments of mortgages                                                      |  |                                  | (106,108    | ) |      |   | (15,793     | )    |  |   | (9,923      | )
|Proceeds from secured revolving credit facilities                                                       |  |                                  | 60,000      |   |      |   |            |      |  |   |            |  
|Repayments of secured revolving credit facilities                                                       |  |                                  | (60,000     | ) |      |   |            |      |  |   |            |  
|Proceeds from unsecured bridge loan                                                                     |  |                                  | 86,193      |   |      |   |            |      |  |   |            |  
|Repayments of unsecured bridge loan                                                                     |  |                                  | (86,193     | ) |      |   |            |      |  |   |            |  
|Net secured note financings                                                                             |  |                                  |            |   |      |   |            |      |  |   | 46,200      |  
|Proceeds from sales of unsecured notes                                                                  |  |                                  | 935         |   |      |   | 5,674       |      |  |   | 6,877       |  
|Repayments of unsecured notes                                                                           |  |                                  | (37,297     | ) |      |   | (4,342      | )    |  |   | (5,798      | )
|Costs of obtaining financings                                                                           |  |                                  | (3,316      | ) |      |   | (3,193      | )    |  |   | (7,676      | )
|Cash dividends paid on preferred stock                                                                  |  |                                  | (5,418      | ) |      |   | (5,418      | )    |  |   | (11,556     | )
|Cash dividends paid on common stock                                                                     |  |                                  | (6,582      | ) |      |   | (6,582      | )    |  |   | (444        | )
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|                                                                                                        |  |                                  | 137,096     |   |      |   | (29,654     | )    |  |   | 17,680      |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|Banking                                                                                                 |  |                                  |             |   |      |   |             |      |  |   |             |  
|Proceeds from customer deposits and sales of certificates of deposit                                    |  |                                  | 83,202,385  |   |      |   | 72,320,724  |      |  |   | 53,155,374  |  
|Customer withdrawals of deposits and payments for maturing certificates of deposit                      |  |                                  | (82,538,389 | ) |      |   | (71,394,073 | )    |  |   | (52,400,761 | )
|Capital contribution from parent                                                                        |  |                                  |            |   |      |   | 1,418       |      |  |   |            |  
|Advances from the Federal Home Loan Bank                                                                |  |                                  | 19,764,354  |   |      |   | 23,046,342  |      |  |   | 17,470,676  |  
|Repayments of advances from the Federal Home Loan Bank                                                  |  |                                  | (20,889,782 | ) |      |   | (23,314,541 | )    |  |   | (16,721,207 | )
|Net increase in other borrowings                                                                        |  |                                  | 323,725     |   |      |   | 292,334     |      |  |   | 38,265      |  
|Issuance of 6-7/8% subordinated debentures                                                              |  |                                  |            |   |      |   |            |      |  |   | 171,938     |  
|Issuance of 8% Noncumulative Perpetual Preferred Stock, Series C                                        |  |                                  |            |   |      |   |            |      |  |   | 120,622     |  
|Redemption of 13% Noncumulative Perpetual Preferred Stock, Series A                                     |  |                                  |            |   |      |   |            |      |  |   | (81,750     | )
|Redemption of 9-1/4% Subordinated Debentures                                                            |  |                                  |            |   |      |   |            |      |  |   | (252,775    | )
|Cash dividends paid on preferred stock                                                                  |  |                                  | (10,000     | ) |      |   | (10,000     | )    |  |   | (10,750     | )
|Cash dividends paid on common stock                                                                     |  |                                  | (40,000     | ) |      |   | (49,000     | )    |  |   | (31,000     | )
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|                                                                                                        |  |                                  | (187,707    | ) |      |   | 893,204     |      |  |   | 1,458,632   |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|Net cash (used in) provided by financing activities                                                     |  |                                  | (50,611     | ) |      |   | 863,550     |      |  |   | 1,476,312   |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|Net (decrease) increase in cash and cash equivalents                                                    |  |                                  | (64,840     | ) |      |   | (52,971     | )    |  |   | 140,784     |  
|Cash and cash equivalents at beginning of year                                                          |  |                                  | 521,419     |   |      |   | 574,390     |      |  |   | 433,606     |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|Cash and cash equivalents at end of year                                                                |  | $                                | 456,579     |   |      | $ | 521,419     |      |  | $ | 574,390     |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|Components of cash and cash equivalents at end of year as presented in the consolidated balance sheets: |  |                                  |             |   |      |   |             |      |  |   |             |  
|Real Estate                                                                                             |  |                                  |             |   |      |   |             |      |  |   |             |  
|Cash and cash equivalents                                                                               |  | $                                | 46,391      |   |      | $ | 13,920      |      |  | $ | 31,842      |  
|Banking                                                                                                 |  |                                  |             |   |      |   |             |      |  |   |             |  
|Cash and due from banks                                                                                 |  |                                  | 394,309     |   |      |   | 438,074     |      |  |   | 444,603     |  
|Interest-bearing deposits                                                                               |  |                                  | 15,879      |   |      |   | 69,425      |      |  |   | 97,945      |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|Cash and cash equivalents at end of year                                                                |  | $                                | 456,579     |   |      | $ | 521,419     |      |  | $ | 574,390     |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|Supplemental disclosures of cash flow information:                                                      |  |                                  |             |   |      |   |             |      |  |   |             |  
|Cash paid during the year for:                                                                          |  |                                  |             |   |      |   |             |      |  |   |             |  
|Interest                                                                                                |  | $                                | 352,104     |   |      | $ | 253,831     |      |  | $ | 227,757     |  
|Income taxes paid, net                                                                                  |  |                                  | 82,861      |   |      |   | 140,850     |      |  |   | 107,689     |  
|Shares of Saul Centers, Inc. common stock                                                               |  |                                  | 9,895       |   |      |   | 12,591      |      |  |   | 9,330       |  
|Cash received during the year from:                                                                     |  |                                  |             |   |      |   |             |      |  |   |             |  
|Dividends on shares of Saul Centers, Inc. common stock                                                  |  |                                  | 7,588       |   |      |   | 6,703       |      |  |   | 6,023       |  
|Distributions from Saul Holdings Limited Partnership                                                    |  |                                  | 7,233       |   |      |   | 6,569       |      |  |   | 6,527       |  
|Supplemental disclosures of noncash activities:                                                         |  |                                  |             |   |      |   |             |      |  |   |             |  
|Rollovers of notes payable - unsecured                                                                  |  |                                  | 823         |   |      |   | 7,247       |      |  |   | 6,432       |  
|Loans held for securitization and/or sale exchanged for trading securities                              |  |                                  | 222,742     |   |      |   | 190,578     |      |  |   | 658,587     |  
|Loans receivable transferred to real estate acquired in settlement of loans                             |  |                                  | 4,653       |   |      |   | 4,657       |      |  |   | 3,376       |  
|Loans receivable exchanged for mortgage-backed securities held-to-maturity                              |  |                                  | 486,010     |   |      |   | 364,577     |      |  |   | 108,640     |  
|Loans receivable transferred to loans held for sale and/or securitization                               |  |                                  |            |   |      |   | 693,567     |      |  |   | 339,869     |  
|Assumption of debt not included in cash paid for acquisition of property                                |  |                                  | 5,830       |   |      |   |            |      |  |   |            |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  

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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

GENERAL

B.F. Saul Real Estate Investment Trust
operates as a Maryland real estate investment trust. The principal business activities of B.F. Saul Real Estate Investment Trust and its consolidated subsidiaries (the Trust or Total Company) are the ownership of 80% of the
outstanding common stock of Chevy Chase Bank, F.S.B., whose assets accounted for 96% of the Trusts consolidated assets as of September 30, 2006, and the ownership and development of income-producing properties. The properties are located
predominantly in the Mid-Atlantic and Southeastern regions of the United States and consist principally of hotels, office projects, and undeveloped land parcels. Chevy Chase Bank, F.S.B. is a federally chartered and federally insured stock savings
bank and, as such, is subject to comprehensive regulation, examination and supervision by the Office of Thrift Supervision (OTS) and by the Federal Deposit Insurance Corporation (FDIC). The Bank is principally engaged in the
business of attracting deposits from the public and using such deposits, together with borrowings and other funds, to make loans secured by real estate, primarily residential mortgage loans, and various types of consumer loans and leases and
commercial loans. The Banks principal deposit market is the Washington, DC metropolitan area.

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

PRINCIPLES OF CONSOLIDATION

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

USE OF ESTIMATES

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

ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS

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

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

INCOME TAXES

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

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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



NET INCOME PER COMMON SHARE

Net income per common share is determined by dividing net income, after deducting preferred share dividend requirements, by the weighted average number of common shares outstanding during the year. For fiscal years
2006, 2005 and 2004 weighted average number of shares used in the calculation was 4,807,510. The Trust has no common share equivalents.

RECLASSIFICATIONS

Certain reclassifications of prior periods information have been made to conform with the presentation of the
consolidated financial statements for the year ended September 30, 2006, including the reclassification of certain income and expense amounts to income (loss) from operations of discontinued real estate assets to assure comparability of all
periods presented.

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

CASH EQUIVALENTS

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

REAL ESTATE INVESTMENT
PROPERTIES

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

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

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. At September 30, 2006, indefinite lived intangible assets totaled $9.0 million and are included in Other Assets on the balance sheet. The Real Estate
Trust had no intangible assets as of September 30, 2005.

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

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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



completed portions of a project are accounted for as separate projects. Expenditures for repairs and maintenance are charged to operations as incurred.
Interest expense capitalized during fiscal 2006 totaled $1.1 million. There was no capitalization of interest during fiscal 2005.

CONSTRUCTION IN
PROGRESS

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



|                                        |  |                    |       
|--------------------------------------- |  | ------------------ | ------
|Construction in Progress (In thousands) |  | September 30, 2006
|Dulles SpringHill Suites                |  | $                  | 14,876
|Circle 75 Townhomes                     |  |                    | 9,153 
|Circle 75 Infrastructure                |  |                    | 7,248 
|Dulles Hampton Inn                      |  |                    | 1,864 
|Tysons Park Place II                    |  |                    | 1,805 
|                                        |  |                    |       
|                                        |  | $                  | 34,946
|                                        |  |                    |       

INCOME RECOGNITION

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

ACCOUNTS RECEIVABLE AND ACCRUED INCOME

Accounts receivable and
accrued income of approximately $16.4 million and $13.4 million at September 30, 2006 and 2005, respectively, included in other assets in the financial statements, primarily represents amounts due from commercial property tenants in accordance
with the terms of the respective leases and hotel property accounts based on contractual payment obligations. Receivables are reviewed monthly and reserves established with a charge to current period operations when, in the opinion of management,
collection of the receivable is doubtful. Accounts receivable from commercial property tenants includes minimum rental income accrued on a straight-line basis to be paid by tenants over the remaining term of their respective leases.

INVESTMENT IN SAUL HOLDINGS AND SAUL CENTERS

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

FAIR VALUE OF FINANCIAL INSTRUMENTS

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

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

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

Liabilities

The
fair market value, and the current carrying amount, of notes payablesecured is $250 million, based on managements estimate of current market rates and conditions. The fair value of mortgage notes payable, which includes real estate held
for sale, is based on managements estimate of current market rates for its debt. At September 30, 2006, and 2005, the fair value of mortgage notes payable was $496.1 and $312.0 million, respectively while the carrying amounts of the
mortgage notes payable was $488.3 and $294.3 million, respectively. The fair value of notes payableunsecured is based on the rates currently offered by the Real Estate Trust for similar notes. At September 30, 2006 and 2005, the fair
value of notes payableunsecured was $21.5 and $60.1 million while the carrying amounts was $21.4 and 57.8 million, respectively.



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LEGAL CONTINGENCIES

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

NEW ACCOUNTING STANDARDS

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes (FIN 48). FIN 48 is an interpretation of FASB Statement No. 109, Accounting for Income Taxes, and seeks to reduce the diversity in practice associated with certain aspects of measurement
and recognition in accounting for income taxes. In addition, FIN 48 requires expanded disclosure with respect to the uncertainty in income taxes and is effective as of the beginning of the Trusts 2008 fiscal year. The Trust is currently
evaluating the impact, if any, that FIN 48 will have on the Trusts financial statements.

The Emerging Issues Task Force (EITF) issued
EITF 04-5, last updated on July 15, 2005, Investors Accounting for an Investment in a Limited Partnership when the Investor is the General Partner and the Limited Partners have Certain Rights, (EITF 04-5) which addresses
the General Partner in a limited partnership who is presumed to control the partnership unless the Limited Partners have the ability, through a majority vote, to remove the General Partner without cause or the ability to effectively participate in
significant decisions that would be expected to be made in the ordinary course of business. The EITF is effective as of June 29, 2005 for new limited partnerships and existing limited partnerships where the partnership agreement has been
modified after that date or no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005. The Trust has not entered into any new agreements or made any amendments to existing agreements that are
covered by EITF 04-5. The Trust is evaluating the potential impact of EITF 04-5 with respect to existing agreements and does not anticipate that the adoption of EITF 04-5, if applicable, will have a material impact on its financial condition or
results of operations.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  THE BANK:

Cash and Cash Equivalents:

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

Federal Reserve Board regulations
require the Bank to maintain reserves in the form of cash or deposits in its account at the Federal Reserve Bank of Richmond. The Banks average reserve requirements, before credit for vault cash, were $87.7, $87.8 and $70.5 million during the
years ended September 30, 2006, 2005 and 2004, respectively.

Loans Held for Securitization and/or Sale:

At September 30, 2006, loans held for securitization and/or sale were composed of single-family residential loans of $467.6 million. At September 30, 2005,
loans held for securitization and/or sale were composed of single-family residential and home equity loans of $1,717.8 million and $341,000 respectively. These loans are originated or purchased for sale in the secondary market and are carried at the
lower of aggregate cost or aggregate market value. The Bank periodically securitizes and sells certain pools of loan receivables in the public and private markets in transactions that are recorded as sales. Single-family residential loans held for
sale will either be sold or will be exchanged for mortgage-backed securities and then sold.

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

Investment and Mortgage-Backed Securities:

The Bank classifies its investment and mortgage-backed securities as either held-to-maturity, available-for-sale or trading at the
time such securities are acquired. Investment and mortgage-backed securities classified as held-to-maturity are reported at amortized cost. Investment and mortgage-backed securities classified as available-for-sale are
reported at fair value, with unrealized gains and losses, net of the related tax effect, reported as a separate component of stockholders equity. Investment and mortgage-backed securities classified as trading are reported at fair
value, with unrealized gains and losses included in earnings. All investment securities and mortgage-backed securities are classified as held-to-maturity at September 30, 2006 and 2005. Premiums and discounts on investment securities and
mortgage-backed securities are amortized or accreted using the level-yield method.



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Trading Securities:

As part of its mortgage banking activities, the Bank exchanges certain loans held for sale for mortgage-backed securities and then sells the mortgage-backed securities, which are classified as trading securities, to
third party investors in the month of issuance. Proceeds from sales of trading securities were $224.5, $192.1 and $668.5 million during the years ended September 30, 2006, 2005 and 2004, respectively. The Bank realized net gains of $1.8, $2.3
and $5.4 million on the sales of trading securities for the years ended September 30, 2006, 2005 and 2004, respectively. Gains and losses on sales of trading securities are determined using the specific identification method and are included in
servicing, securitization and mortgage banking income in the Consolidated Statements of Operations. There were no mortgage-backed securities classified as trading securities at September 30, 2006 and 2005.

Loan Origination and Commitment Fees:

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

Impaired Loans:

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

Each impaired real estate or commercial loan is evaluated individually to determine the income recognition policy. Generally, payments received are applied as a
reduction of principal.

At September 30, 2006 and 2005, the Bank had no impaired loans. The Bank did not recognize any interest income on impaired
loans during the years ended September 30, 2006, 2005 and 2004.



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Allowance for Loan Losses:

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

The allocated allowance is assessed on both homogeneous and non-homogeneous loan portfolios. The range is calculated by applying loss and delinquency factors to the outstanding loan balances of these portfolios. Loss
factors are based on analysis of the historical performance of each loan category and an assessment of portfolio trends and conditions, as well as specific risk factors impacting the loan portfolios. Each homogeneous portfolio, such as single-family
residential loans or automobile loans, is evaluated collectively.

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

The unallocated allowance is based upon managements evaluation and judgment of various conditions that are not directly measured in the determination of the
allocated and specific allowances. The conditions evaluated in connection with the unallocated allowance include existing general economic and business conditions affecting the key lending areas of the Bank, credit quality trends, collateral values,
loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience in particular segments of the portfolio, regulatory examination results and findings of the Banks
internal credit evaluations. At September 30, 2006 and 2005, most of the unallocated allowance relates to risks inherent in the mortgage loan portfolio, including, for example, geographic concentration and negative amortization features.

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

Accrued Interest Receivable on Loans:

Loans are reviewed on a monthly basis and are placed on non-accrual status when, in the opinion of management, the full collection of principal or
interest has become unlikely. Uncollectible accrued interest receivable on non-accrual loans is charged against current period interest income.

Real
Estate Held for Sale:

Real estate held for sale, included in other assets on the Consolidated Statements of Financial Condition, consists of real
estate acquired in settlement of loans (REO) and is carried at the lower of cost or fair value (less estimated selling costs). Costs relating to the development and improvement of property, including interest, are capitalized, whereas
costs relating to the holding of property are expensed.



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Property and Equipment:

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

Automobiles Subject to Lease:

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

Goodwill and Other Intangible Assets:

Goodwill is not amortized, but, instead, is periodically tested for impairment. An impairment loss on goodwill is recognized if the fair value is less than the carrying
amount. At September 30, 2006 and 2005, the fair value of the goodwill recorded on the Banks balance sheet exceeded its carrying value. At September 30, 2006 and 2005, goodwill totaled $37.3 and $23.7 million, respectively.

In July 2005, a subsidiary of the Bank purchased an investment management company and recorded goodwill of $5.9 million and an intangible asset of $1.1
million. The intangible asset is being amortized over its expected life. The subsidiary was required to pay an additional $750,000 during fiscal year 2006 and could be required to pay an additional $750,000 in future years if certain contingencies
are satisfied.

In October 2005, another subsidiary of the Bank purchased an investment management company and recorded goodwill of $6.9 million and an
intangible asset of $1.9 million. The intangible asset is being amortized over its expected life. The subsidiary could be required to pay between $14.0 and $17.0 million over the next three years, if certain contingencies are satisfied.

The premium attributable to the value of home equity relationships related to certain home equity loans purchased in fiscal 1999, amounting to $165,000 and $221,000,
net, at September 30, 2006 and 2005, respectively, is included in goodwill and other intangible assets in the Consolidated Statements of Financial Condition. This premium is being amortized over the estimated term of the underlying
relationships. The Bank did not purchase any home equity loans during fiscal years 2006, 2005 and 2004.

Accumulated amortization of other intangible
assets was $11.7 and $11.2 million at September 30, 2006 and 2005, respectively.

Servicing Assets:

Servicing assets are recorded when purchased and in conjunction with loan sale and securitization transactions. Servicing assets, which are stated net of accumulated
amortization, are amortized in proportion to the remaining net servicing revenues estimated to be generated by the underlying loans.



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Servicing Assets (Continued):

The Bank periodically evaluates its servicing assets for impairment based upon fair value. For purposes of evaluating impairment, the Bank stratifies its servicing assets taking into consideration relevant risk
characteristics including loan type and note rate. The fair value of servicing assets is estimated using projected cash flows, adjusted for the effect of anticipated prepayments, and a market discount rate. To the extent the carrying value of
servicing assets exceeds the fair value of such assets, a valuation allowance is recorded. See Note 16.

Interest-Only Strips Receivable:

The Bank accounts for its interest-only certificates and/or interest-only strips receivable (collectively, interest-only assets) as
trading securities and, accordingly, carries them at fair value. The Bank uses certain assumptions to calculate the carrying values of the interest-only assets, mainly estimates of prepayment speeds, credit losses and interest rates, which are
beyond the control of the Bank. To the extent actual results differ from the assumptions, the carrying values are adjusted accordingly. The fair value adjustments for interest-only assets are included in servicing, securitization and mortgage
banking income. Fair value write downs of $88.3, $121.0 and $30.3 million were recorded in the years ended September 30, 2006, 2005 and 2004, respectively.

Interest-only assets capitalized in the years ended September 30, 2006, 2005 and 2004 amounted to $208.1, $275.4 and $235.9 million, respectively, and were related to the securitization and sale of loan receivables. See Note 17.

Derivative Financial Instruments:

The Bank
uses derivative financial instruments to reduce interest-rate risk with respect to its mortgage banking activities. At September 30, 2006 and 2005, all derivatives are recorded on the balance sheet at their fair market value. See Note 29.

Marketing:

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

Recently Issued Accounting Standards:

In September 2006, the Financial Accounting Standards Board (FASB) ratified
Emerging Issues Task Force (EITF) consensus 06-5, Accounting for Purchases of Life Insurance  Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (EITF
06-5). EITF 06-5 eliminates the diversity in policyholder calculations of the amount that would be realized under a life insurance contract if that contract were terminated. Under EITF 06-5, policyholders will be required to recognize
contract-based values at their net present value. EITF 06-5 is effective for fiscal years beginning after December 15, 2006. Management does not expect the adoption of EITF 06-5 to have a material impact on the Banks financial condition
or results of operations.

In September 2006, the FASB issued Statement of Financial Accounting Standards (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 is effective for fiscal years beginning after December 15, 2006. Management does not expect the adoption of FIN 48 to have a material impact on the Banks financial condition or results of operations.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets (SFAS 156). SFAS 156 amends SFAS 140 to require an
entity (i) to initially measure all separately recognized servicing assets and servicing liabilities at fair value, if practicable; (ii) to separately present servicing assets and servicing liabilities subsequently measured at fair value
in the statement of financial position; and (iii) to provide additional disclosures for all separately recognized servicing assets and servicing liabilities. In addition, SFAS 156 permits an entity to



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irrevocably choose either the amortization method or the fair value measurement method for the subsequent measurement of each class of separately recognized
servicing assets and servicing liabilities. SFAS 156 is effective as of the beginning of the first fiscal year that begins after September 15, 2006. As a result of the adoption of SFAS 156 on October 1, 2006, the Bank will identify its
mortgage servicing rights (MSRs) relating primarily to residential mortgage loans as a class of servicing rights and will elect to apply fair value accounting to this class of MSRs. Presently, this class, which also includes servicing
rights related to home equity and home improvement loans, represents all of the Banks MSRs. The impact of the adoption, which represents the difference between the fair value and the carrying amount of the MSRs, net of any related valuation
allowance, is $4.2 million, net of related income taxes, and was recorded as a cumulative-effect adjustment which increased retained earnings on October 1, 2006.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS 155). SFAS 155 amends SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS133) and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140) by eliminating SFAS 133
Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. SFAS 155 permits fair value measurement for any hybrid financial instrument with an embedded derivative that otherwise
would require bifurcation, provided that the whole instrument is accounted for on a fair value basis and eliminates a restriction on the passive derivative instruments that a qualifying special-purpose entity may hold. SFAS 155 applies to all
financial instruments acquired or issued after the beginning of any fiscal year beginning after September 15, 2006, and upon adoption for existing bifurcated hybrid financial instruments not being used in hedging relationships. The adoption of
this statement on October 1, 2006, did not have a material effect on the Banks financial condition or results of operations.



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4. LIQUIDITY AND CAPITAL RESOURCESREAL ESTATE TRUST:

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

During fiscal 2006, 2005 and 2004, the Bank made dividend payments totaling $32.0, $39.2 and $24.8 million to the Real Estate Trust. During fiscal 2006, 2005 and 2004,
the Bank made net tax sharing payments totaling $2.0, $2.1 and $8.8 million to the Real Estate Trust.

Although operations have shown significant
improvement in fiscal 2006 and 2005, in recent years the operations of the Real Estate Trust have generated net operating losses while the Bank has reported net income. The Trusts consolidation of the Banks operations into the
Trusts federal income tax return has resulted in the use of the Real Estate Trusts net operating losses to reduce the federal income taxes the Bank would otherwise have owed. If in any future year, the Bank has taxable losses or unused
credits, the Real Estate Trust would be obligated to reimburse the Bank for the greater of (i) the tax benefit to the group using such tax losses or unused tax credits in the groups consolidated federal income tax returns or (ii) the
amount of the refund which the Bank would otherwise have been able to claim if it were not being included in the consolidated federal income tax return of the group.

5. SAUL HOLDINGS LIMITED PARTNERSHIP AND SAUL CENTERS, INC.REAL ESTATE TRUST:

In fiscal 1993, the Real Estate
Trust entered into a series of transactions undertaken in connection with an initial public offering of common stock of a newly organized corporation, Saul Centers. The Real Estate Trust transferred its 22 shopping centers and one of its office
properties together with the debt associated with such properties to a newly formed partnership, Saul Holdings, in which as of September 30, 2006, the Real Estate Trust owns (directly or through one of its wholly owned subsidiaries) a 19.4%
interest, other entities affiliated with the Real Estate Trust own a 4.6% interest, and Saul Centers owns a 76.0% interest. Certain officers and trustees of the Trust are also officers and/or directors of Saul Centers.

In connection with the transfer of its properties to Saul Holdings, the Real Estate Trust was relieved of approximately $196 million in mortgage debt and deferred
interest. Pursuant to a reimbursement agreement among the partners of Saul Holdings and its subsidiary limited partnerships (collectively, the Partnerships), the Real Estate Trust and its subsidiaries that are partners in the
Partnerships have agreed to reimburse Saul Centers and the other partners in the event the Partnerships fail to make payments with respect to certain portions of the Partnerships debt obligations and Saul Centers or any such other partners
personally make payments with respect to such debt obligations. At September 30, 2006, the maximum potential obligations of the Real Estate Trust and its subsidiaries under this agreement totaled approximately $100 million. The Real Estate
Trust believes that Saul Holdings will be able to make all payments due with respect to its debt obligation.

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

At the date of transfer of the Real Estate Trust properties to Saul Holdings, liabilities exceeded assets transferred by approximately $104.3 million on an historical cost basis. The assets and liabilities were
recorded by Saul Holdings and Saul Centers at their historical cost rather than



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market value because of affiliated ownership and common management and because the assets and liabilities were the subject of the business combination
between Saul Centers and Saul Holdings, newly formed entities with no prior operations.

Immediately subsequent to the business combination and initial
public offering of common stock by Saul Centers, Saul Centers had total owners equity of approximately $16.4 million of which approximately $3.5 million related to the Real Estate Trusts original 21.5% ownership interest. Changes in the
Real Estate Trusts equity investment balance resulting from capital transactions of the investee are recognized directly in the Trusts shareholders equity in the accompanying financial statements.

The management of Saul Centers has adopted a strategy of maintaining a ratio of total debt to total asset value, as estimated by management, of fifty percent or less.
The management of Saul Centers has concluded at September 30, 2006, that the total debt of Saul Centers remains below fifty percent of total asset value. The total asset value is determined by the management of Saul Centers as the aggregate
fair value of the portfolio of properties by reference to the properties aggregate cash flow. As a result, the management of the Real Estate Trust has concluded that fundings under the reimbursement agreement are remote.

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



|                                                |  |                   |         |   |                   |   |         |  
|----------------------------------------------- |  | ----------------- | ------- | - | ----------------- | - | ------- | -
|(In thousands)                                  |  | September 30,2006 |         |   | September 30,2005 |  
|Saul Holdings:                                  |  |                   |         |   |                   |   |         |  
|Investment in partnership units                 |  | $                 | 19,112  |   |                   | $ | 13,718  |  
|Distributions in excess of allocated net income |  |                   | (23,631 | ) |                   |   | (22,425 | )
|Saul Centers:                                   |  |                   |         |   |                   |   |         |  
|Investment in common shares                     |  |                   | 110,521 |   |                   |   | 99,004  |  
|Distributions in excess of allocated net income |  |                   | (16,200 | ) |                   |   | (14,974 | )
|                                                |  |                   |         |   |                   |   |         |  
|Total                                           |  | $                 | 89,802  |   |                   | $ | 75,323  |  
|                                                |  |                   |         |   |                   |   |         |  

The Trusts investments in Saul Centers exceeded the underlying book value of the investment at the time of
the purchases. At September 30, 2006 and 2005, the cumulative excess totaled $101.0 and $91.4 million, respectively. This amount is being amortized over the estimated remaining useful life of the underlying real estate assets. At
September 30, 2006 and 2005, the unamortized balance was $88.2 and $80.7 million, respectively.

As of September 30, 2006, the Real Estate Trust,
through its partnership interest in Saul Holdings of 19.4% and its ownership of common shares of Saul Centers of 27.5% (market value of $212.4 million at September 30, 2006), effectively owns 40.3% of the consolidated entities of Saul Centers.
Substantially all of these shares and/or units have been deposited as collateral for the Trusts revolving lines of credit, see Note 9.

As of
September 30, 2005, the Real Estate Trust, through its partnership interest in Saul Holdings of 19.2% and its ownership of common shares of Saul Centers of 26.6% (market value of $160.7 million at September 30, 2005), effectively owns
39.5% of the consolidated entities of Saul Centers.

The unaudited Condensed Consolidated Balance Sheets as of September 30, 2006 and 2005, and the
unaudited Condensed Consolidated Statements of Operations for the twelve months ended September 30, 2006, 2005 and 2004 of Saul Centers follow.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



SAUL CENTERS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



|                                           |  |               |          |   |      |   |          |  
|------------------------------------------ |  | ------------- | -------- | - | ---- | - | -------- | -
|                                           |  | September 30, |         
|(In thousands)                             |  | 2006          |          |   | 2005 |  
|Assets                                     |  |               |          |   |      |   |          |  
|Real estate investments                    |  | $             | 834,050  |   |      | $ | 717,167  |  
|Accumulated depreciation                   |  |               | (210,025 | ) |      |   | (191,699 | )
|Other assets                               |  |               | 65,714   |   |      |   | 79,794   |  
|                                           |  |               |          |   |      |   |          |  
|Total assets                               |  | $             | 689,739  |   |      | $ | 605,262  |  
|                                           |  |               |          |   |      |   |          |  
|Liabilities and stockholders equity       |  |               |          |   |      |   |          |  
|Mortgage notes payable                     |  | $             | 490,897  |   |      | $ | 461,416  |  
|Other liabilities                          |  |               | 73,800   |   |      |   | 33,659   |  
|                                           |  |               |          |   |      |   |          |  
|Total liabilities                          |  |               | 564,697  |   |      |   | 495,075  |  
|Minority Interests                         |  |               | 5,926    |   |      |   | 1,484    |  
|Total stockholders equity                 |  |               | 119,116  |   |      |   | 108,703  |  
|                                           |  |               |          |   |      |   |          |  
|Total liabilities and stockholders equity |  | $             | 689,739  |   |      | $ | 605,262  |  
|                                           |  |               |          |   |      |   |          |  

SAUL CENTERS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



|                                                  |  |                                          |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------- |  | ---------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                  |  | For the Twelve Months EndedSeptember 30, |        
|(In thousands)                                    |  | 2006                                     |         |   | 2005 |   |         | 2004 | 
|Revenue                                           |  |                                          |         |   |      |   |         |      |  |   |         |  
|Base rent                                         |  | $                                        | 107,579 |   |      | $ | 97,438  |      |  | $ | 87,785  |  
|Other revenue                                     |  |                                          | 27,329  |   |      |   | 26,372  |      |  |   | 21,617  |  
|                                                  |  |                                          |         |   |      |   |         |      |  |   |         |  
|Total revenue                                     |  |                                          | 134,908 |   |      |   | 123,810 |      |  |   | 109,402 |  
|                                                  |  |                                          |         |   |      |   |         |      |  |   |         |  
|Expenses                                          |  |                                          |         |   |      |   |         |      |  |   |         |  
|Operating expenses                                |  |                                          | 28,658  |   |      |   | 24,942  |      |  |   | 21,795  |  
|Interest expense and amortization of debt expense |  |                                          | 31,894  |   |      |   | 29,663  |      |  |   | 26,357  |  
|Depreciation and amortization                     |  |                                          | 25,128  |   |      |   | 24,137  |      |  |   | 20,458  |  
|General and administrative                        |  |                                          | 10,015  |   |      |   | 9,527   |      |  |   | 7,785   |  
|                                                  |  |                                          |         |   |      |   |         |      |  |   |         |  
|Total expenses                                    |  |                                          | 95,695  |   |      |   | 88,269  |      |  |   | 76,395  |  
|                                                  |  |                                          |         |   |      |   |         |      |  |   |         |  
|Operating income                                  |  |                                          | 39,213  |   |      |   | 35,541  |      |  |   | 33,007  |  
|Non-operating item                                |  |                                          |         |   |      |   |         |      |  |   |         |  
|Gain on sale of property                          |  |                                          |        |   |      |   |        |      |  |   | 754     |  
|                                                  |  |                                          |         |   |      |   |         |      |  |   |         |  
|Net income before minority interest               |  |                                          | 39,213  |   |      |   | 35,541  |      |  |   | 33,761  |  
|Minority interest                                 |  |                                          | (7,507  | ) |      |   | (7,976  | )    |  |   | (8,100  | )
|                                                  |  |                                          |         |   |      |   |         |      |  |   |         |  
|Net income                                        |  |                                          | 31,706  |   |      |   | 27,565  |      |  |   | 25,661  |  
|Preferred dividends                               |  |                                          | (8,000  | ) |      |   | (8,000  | )    |  |   | (7,244  | )
|                                                  |  |                                          |         |   |      |   |         |      |  |   |         |  
|Net income available to common shareholders       |  | $                                        | 23,706  |   |      | $ | 19,565  |      |  | $ | 18,417  |  
|                                                  |  |                                          |         |   |      |   |         |      |  |   |         |  



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



6. REAL ESTATE INVESTMENT PROPERTIESREAL ESTATE TRUST:

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





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

---

|(1) | Amount includes $488.3 million of mortgage notes payable and approximately $815,000 of capital leases.
|--- | ------------------------------------------------------------------------------------------------------



|                               |  |     |  |      |        |                           |   |         |  |              |         |  |   |         |    
|------------------------------ |  | --- |  | ---- | ------ | ------------------------- | - | ------- |  | ------------ | ------- |  | - | ------- | ---
|(Dollars in thousands)         |  | No. |  | Land |        | Buildings andImprovements |   | Total   |  | Related Debt |        
|September 30, 2005:            |  |     |  |      |        |                           |   |         |  |              |         |  |   |         |    
|Income-producing properties(2) |  |     |  |      |        |                           |   |         |  |              |         |  |   |         |    
|Hotels                         |  | 15  |  | $    | 17,291 |                           | $ | 228,853 |  | $            | 246,144 |  | $ | 137,214 |    
|Office and industrial          |  | 14  |  |      | 16,678 |                           |   | 177,965 |  |              | 194,643 |  |   | 143,083 |    
|Other                          |  | 2   |  |      | 1,128  |                           |   |        |  |              | 1,128   |  |   |        |    
|                               |  |     |  |      |        |                           |   |         |  |              |         |  |   |         |    
|                               |  | 31  |  | $    | 35,097 |                           | $ | 406,818 |  | $            | 441,915 |  | $ | 280,297 | (3)
|                               |  |     |  |      |        |                           |   |         |  |              |         |  |   |         |    
|Land Parcels                   |  | 12  |  | $    | 48,029 |                           | $ |        |  | $            | 48,029  |  | $ |        |    
|                               |  |     |  |      |        |                           |   |         |  |              |         |  |   |         |    

---

|(2) | Excludes real estate held for sale.
|--- | -----------------------------------



|(3) | Amount includes $278.4 million of mortgage notes payable and $1.9 million of capital leases.
|--- | --------------------------------------------------------------------------------------------

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

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

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

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

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

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

On September 13, 2005, the Real Estate Trust closed on a $6.2 million purchase of a land parcel from the Bank located in
Loudoun County, VA. The purchase was funded from cash on hand, see Note 12.

On July 25, 2005, the Real Estate Trust closed on a $1.9 million purchase
of a land parcel from the Bank located in Loudoun County, VA. The purchase was funded from available cash on hand, see Note 12.

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



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

On May 25, 2005, the Real Estate Trust acquired an approximately 12,000 square foot office building located in Montgomery County, Maryland for approximately $5.3 million, see Note 7.

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

On December 9, 2004, the sale of a hotel property, which was placed on the market for sale during fiscal 2004, was finalized and the Real Estate Trust received
proceeds from the sale of approximately $2.2 million, resulting in a loss of $327,000, $310,000 recognized in fiscal 2004 and $17,000 recognized in fiscal 2005.

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

In February 2004, the Commonwealth of Virginia acquired 7.93 acres of land
owned by the Real Estate Trust for use in a highway project. The Commonwealth of Virginia paid $3.6 million which resulted in an initial gain of approximately $2.7 million in fiscal 2004.

7. REAL ESTATE ACQUIRED  OPERATING PROPERTIES  REAL ESTATE TRUST:

On March 24, 2006, the Real Estate Trust acquired a 145 room historic hotel located in Washington, D.C. for a purchase price of approximately $100.0 million. The Real Estate Trust accounted for the acquisition in accordance with SFAS
No. 141, Business Combinations. The Real Estate Trust allocates the purchase price to various components, such as land, building, personal property and certain marketing related, customer related and franchise related intangibles,
if applicable, as described in Note 2.Of the total cost $9.0 million has been allocated to intangible assets, included in Other Assets on the Consolidated Balance Sheets, $4.1 million has been allocated to personal property and the remainder
allocated to land and building which are included in Hotel Real Estate at September 30, 2006. The results of operations of the acquired hotel are included in the consolidated statements of operations as of the acquisition date.

On November 1, 2005, the Real Estate Trust acquired a 137 room hotel property located in Fairfax County, Virginia for a purchase price of approximately $12.7
million, which included the assumption of a mortgage note of $5.8 million, see Note 10. The Real Estate Trust accounted for the acquisition in accordance with SFAS No. 141, Business Combinations. The Real Estate Trust allocates the
purchase price to various components, such as land, building, personal property and intangibles related to any in-place leases and customer or franchise relationships, if applicable, as described in Note 2. A total of $317,000 of the total cost was
allocated as personal property and is included in hotel real estate assets. The personal property assets are being amortized over their estimated remaining useful life, a weighted average term of 2.0 years. There were no above or below market lease
intangibles or any value assigned to customer or franchise relationships. The results of operations of the acquired hotel are included in the consolidated statements of operations as of the acquisition date.

On May 25, 2005 the Real Estate Trust acquired an approximately 12,000 square foot office building located in Montgomery County, Maryland for approximately $5.3
million. The Real Estate Trust accounted for the acquisition in accordance with SFAS No. 141, Business Combinations. The Real Estate Trust allocates the purchase price to various components, such as land, building and intangibles
related to in-place leases and customer relationships, if applicable, as described in Note 2. The $5.3 million total cost includes both the propertys purchase price and closing costs. A total of $150,000 of the total cost was allocated as
lease intangible assets and included in other assets. The lease intangible assets are being amortized over the remaining periods of the leases acquired, a weighted average term of 2.6 years. The values of below market leases totaled $266,000 and are
being amortized over a weighted average term of 2.1 years and included in other liabilities and accrued expenses. There were no above market lease intangibles.

As of September 30, 2006 and 2005 the gross carrying amount of the lease intangible assets included in lease acquisition costs was $150,000 in each period and accumulated amortization was $101,000 and $25,000, respectively. Total
amortization of this asset was $76,000 and $25,000 for the years ended September 30, 2006 and 2005, respectively. As of September 30, 2006 and 2005 the gross carrying amount of the below market lease intangibles included in other
liabilities and accrued expenses was $266,000 in each period and accumulated amortization was $203,000 and $50,000, respectively. Total amortization of this liability was $153,000 and $50,000 for the years ended September 30, 2006 and 2005,
respectively.



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The following table summarizes the amortization of intangible (assets) liabilities related to in-places leases:



|            |  |                       |     |   |                    |   |       |  |   |    |  
|----------- |  | --------------------- | --- | - | ------------------ | - | ----- |  | - | -- | -
|            |  | (In thousands)        |    
|Fiscal Year |  | Leaseacquisitioncosts |     |   | Belowmarket leases |   | Total | 
|2007        |  | $                     | (34 | ) |                    | $ | 49    |  | $ | 15 |  
|2008        |  |                       | (12 | ) |                    |   | 13    |  |   | 1  |  
|2009        |  |                       | (3  | ) |                    |   | 1     |  |   | (2 | )
|Thereafter  |  |                       |    |   |                    |   |      |  |   |   |  
|            |  |                       |     |   |                    |   |       |  |   |    |  
|Total       |  | $                     | (49 | ) |                    | $ | 63    |  | $ | 14 |  
|            |  |                       |     |   |                    |   |       |  |   |    |  

8. REAL ESTATE SOLD/DISCONTINUED OPERATIONS  REAL ESTATE TRUST:

Land Parcels:

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

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

In June 2004, the Real Estate Trust received a refund of approximately $117,000 for an expenditure relating to the September
2003 land sale. The original gain on the sale of this parcel was recorded in fiscal 2003. This refund has been recorded as an additional gain on sale of this land parcel in fiscal 2004 as Gains on Sales of Property.

In February 2004, the Commonwealth of Virginia acquired 7.93 acres of land owned by the Real Estate Trust for use in a highway project. The Commonwealth of Virginia has
paid $3.6 million which has resulted in an initial gain of approximately $2.7 million recorded as Gains on Sales of Property in fiscal 2004.

Operating
Properties:

During 2006, the Real Estate Trust determined that it would sell one of its other real estate properties located in Metairie, LA. The sale
closed on February 23, 2006 and the Real Estate Trust recorded a gain of $2.9 million. The $2.9 million gain and the related operating income of $47,000 is included in Income (loss) from Operations of Discontinued Real Estate Assets on the
Consolidated Statements of Operations for the year ended September 30, 2006.

During fiscal 2005, the Real Estate Trust determined that it would sell
two of its hotel properties which no longer met its investment criteria. Therefore, in fiscal 2005, the Real Estate Trust determined that the held for sale criteria in accordance with FASB No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets had been met for both properties. Accordingly, the Real Estate Trust compared the carrying value of these assets to their estimated fair value, less cost to sell, to determine if the assets were impaired. The Real
Estate Trust determined that no adjustments to the carrying amounts were required. The sales of the two properties closed on December 16, 2005 and January 19, 2006. Proceeds from the combined sales to the Real Estate Trust totaled
approximately $13.4 million. The January 19, 2006 sale included an additional $500,000 issuance of a note by the purchaser. The note, which bears interest at 9.0%, is due on January 18, 2008. Interest accrues on the note beginning on
July 12, 2006 through maturity. All principal and accrued interest are due at maturity. Included in Income (loss) from Operations of Discontinued Real Estate Assets on the Consolidated Statements of Operations are the gains on the sales of the
hotel assets totaling $3.4 million as well as combined operating losses from the two hotel properties of approximately $2.1 million for the year ended September 30, 2006. Included in the $2.1 operating loss are defeasance charges of $1.8
million as described in Note 10.

The two hotel assets held for sale are classified as Real Estate Held for Sale on the Consolidated Balance Sheets as of
September 30, 2005. Mortgage notes secured by these properties are classified as Mortgage notes payable  real estate held for sale on the Consolidated Balance Sheets. The combined operating loss of $905,000 for the year ended
September 30, 2005 for the two properties is included in Income (loss) from Operations of Discontinued Real Estate Assets on the Consolidated Statements of Operations.

On January 31, 2005, the Real Estate Trust sold one its other real estate properties resulting in a gain of approximately $900,000, which is included in Income (loss) from Operations of Discontinued Real Estate
Assets on the Consolidated Statements of Operations. The Real Estate Trust received proceeds from the sale of approximately $1.4 million. The operating income, $11,000 for the year ended September 30, 2005,



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from this asset is also included in Income (loss) from Operations of Discontinued Real Estate Assets on the Consolidated Statements of Operations.

On December 9, 2004 the sale of a hotel property, which was placed on the market for sale during fiscal 2004, was finalized and the Real Estate Trust
received proceeds from the sale of approximately $2.2 million. Included in the Income (loss) from Operations of Discontinued Real Estate Assets on the Consolidated Statements of Operations for the year ended September 30, 2005 is an additional
loss of $17,000 which reflects the difference between the actual loss on the sale of the property and the estimated loss recorded in Fiscal 2004. Also included in the Income (loss) from Operations of Discontinued Real Estate Assets is an operating
loss of $201,000 from the hotel property through December 9, 2004, the date of sale, and $1.6 million of costs associated with the defeasance of the mortgage loan, including a $1.5 million prepayment premium.

9. DEBTREAL ESTATE TRUST:

Mortgage notes payable:

Mortgage notes payable are secured by various income-producing properties, land parcels, and properties under construction. Almost all mortgage notes
are payable in monthly installments, have maturity dates ranging to 2021 and accrue interest at annual rates from 5.3% to 9.1%. Certain mortgages contain a number of restrictions, including cross default provisions.

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

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

Also on May 26, 2006 the Real Estate Trust closed on a $16.7 million construction loan to be used to finance the
construction of the Dulles SpringHill Suites Hotel located in Loudoun County, Virginia. The loan, which is due on May 26, 2009, with two one-year extension options, currently bears interest at 175 basis points over a floating rate index.
Interest only is payable through maturity. As of September 30, 2006 $4.0 million was drawn under this loan.

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

On April 21, 2006, the Real Estate Trust closed on a $65.0 million mortgage note secured by the 145 room historic hotel located in Washington, D.C., which was
purchased on March 24, 2006. The note, which is due on May 1, 2021, bears interest at 6.199% and requires interest only payments for the initial five years. Beginning in year six, monthly principal and interest payments of $398,000 are
required with a balloon payment of $55.1 million due at maturity. $61.0 million of the proceeds from the financing were used to pay down a portion of the bridge loan.

On March 24, 2006, the Real Estate Trust financed the $100.0 million purchase of the 145 room historic hotel located in Washington, D. C. with an unsecured bridge loan of $86.2 million and cash on hand for the
balance. The loan had a six month term with five six-month extension options. The loan was an interest only loan and bore interest at LIBOR plus 175 basis points. The loan was repaid in full from proceeds of permanent financings on May 24,
2006.

On December 29, 2005, the Real Estate Trust placed a $9.5 million mortgage note on the hotel property that was acquired on November 1,
2005. The note, which is due on January 1, 2016, bears interest at 5.92%. Monthly principal and interest payments, based on a 25 year amortization schedule, of $60,745 are required with a balloon payment of $7.4 million due at maturity.

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



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January 11, 2016, bears interest at 5.3% and requires interest only payments for the initial five years. Beginning in year six, monthly principal and
interest payments of $422,000 are required with a balloon payment of $70.3 million due at maturity.

Notes payable  secured:

On February 25, 2004, the Real Estate Trust issued, in a private offering, $250.0 million aggregate principal amount of 7.50% Senior Secured Notes due 2014 (the
2004 Notes). A substantial portion of the net proceeds of the offering were used to redeem $200.0 million of Senior Secured Notes issued in 1998 (the 1998 Notes), including accrued interest through March 31, 2004, and pay a
redemption premium for early redemption of the notes of $6.5 million. These funds, totaling $216.25 million, which were escrowed at closing, were paid out on April 1, 2004. The Trust received approximately $28.1 million in proceeds from this
offering after the redemption of the 1998 Notes, including accrued interest, the early redemption premium and after deducting costs associated with the offering. In addition, the Real Estate Trust wrote-off unamortized debt costs of $2.4 million,
included in interest and amortization of debt expense on the Consolidated Statements of Operations, relating to the unamortized debt costs of the 1998 Notes. The 2004 Notes are nonrecourse obligations of the Real Estate Trust and are secured by a
first priority perfected security interest in all of the common stock of the Bank held by the Real Estate Trust. The Real Estate Trust used the net proceeds to fund renovation and construction activities as well as for general corporate purposes.

Notes payable  unsecured:

Notes
payableunsecured includes notes which have been sold by the Real Estate Trust directly to investors at varying interest rates with maturities of one to ten years. These notes do not contain any provisions for conversion, sinking fund or
amortization, but are subject to a provision permitting the Real Estate Trust to call them prior to maturity as long as the notes have been outstanding for over one year. On June 19, 2006 the Real Estate Trust terminated its public offering of
these notes and subsequently withdrew the registration of the un-issued notes. Consistent with the terms of the notes, during the year ended September 30, 2006, the Real Estate Trust called $29.6 million of the outstanding notes for prepayment,
of which $19.1 million were outstanding at September 30, 2006 and are scheduled to be prepaid during the first quarter of fiscal 2007. The remaining $2.3 million of uncalled unsecured notes will mature during the first quarter of fiscal 2007.
As of the end of the first quarter of fiscal 2007 the Real Estate Trust anticipates that all of the unsecured notes outstanding as of September 30, 2006 will have been repaid. The weighted average interest rates were 7.6% and 8.1% at
September 30, 2006 and 2005, respectively.

Credit facilities:

On January 31, 2005, the Real Estate Trust executed an extension and expansion of its $55.0 million secured revolving credit facility with an unrelated bank. The credit facility was increased to $60.0 million,
the interest rate spread over the floating index was reduced by 25 basis points to 200 basis points over the floating rate index and the term of the credit facility was extended to January 31, 2008, 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 Limited Partnership and Saul Centers. At September 30, 2006 and 2005, the Real Estate Trust had no outstanding borrowings and
unrestricted availability of $60.0 million.

On June 30, 2005, the Real Estate Trust executed an extension and expansion of its $45.0 million secured
revolving credit facility with an unrelated bank. The credit facility was increased to $60.0 million and the term of the credit facility was extended to June 30, 2008. The interest rate spread remained the same at 200 basis points over the
floating rate index. This facility is secured by a portion of the Real Estate Trusts ownership in Saul Holdings Limited Partnership and Saul Centers. At September 30, 2006, the Real Estate Trust had no outstanding borrowings and
unrestricted availability of $54.0 million. The Real Estate Trust was issued a $6.0 million letter of credit for the benefit of a mortgage lender as part of one of the mortgage financings completed during fiscal 2006. The letter of credit will be
reduced quarterly based on the amount of capital expended at the subject property. The letter of credit reduces the availability under the revolving credit facility. At September 30, 2005, the Real Estate Trust had no outstanding borrowings and
unrestricted availability of $60.0 million.

At September 30, 2006 and 2005 the Real Estate Trust was in compliance with its debt covenants.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The maturity schedule for the Real Estate Trusts outstanding debt, including mortgage notes payable for real
estate held for sale, at September 30, 2006 for the fiscal years commencing October 1, 2006 is set forth in the following table:

Debt Maturity Schedule

(In thousands)



|            |  |                |         |                       |   |                             |  |       |        |  |   |        
|----------- |  | -------------- | ------- | --------------------- | - | --------------------------- |  | ----- | ------ |  | - | -------
|Fiscal Year |  | Mortgage Notes |         | Notes PayableSecured |   | Notes PayableUnsecured (1) |  | Total
|2007        |  | $              | 11,785  |                       | $ |                            |  | $     | 21,398 |  | $ | 33,183 
|2008        |  |                | 6,443   |                       |   |                            |  |       |       |  |   | 6,443  
|2009        |  |                | 20,532  |                       |   |                            |  |       |       |  |   | 20,532 
|2010        |  |                | 12,015  |                       |   |                            |  |       |       |  |   | 12,015 
|2011        |  |                | 22,620  |                       |   |                            |  |       |       |  |   | 22,620 
|Thereafter  |  |                | 414,944 |                       |   | 250,000                     |  |       |       |  |   | 664,944
|            |  |                |         |                       |   |                             |  |       |        |  |   |        
|Total       |  | $              | 488,339 |                       | $ | 250,000                     |  | $     | 21,398 |  | $ | 759,737
|            |  |                |         |                       |   |                             |  |       |        |  |   |        



|(1) | Included in fiscal 2007 are $19.1 million of notes called for early redemption.
|--- | -------------------------------------------------------------------------------

Of the $488.3 million of mortgage notes outstanding at September 30, 2006, $482.5 million was non-recourse to the Real Estate Trust.

10.
EXTINGUISHMENT OF LIABILITIES  REAL ESTATE TRUST:

On January 19, 2006, the Real Estate Trust deposited cash of approximately $7.6 million
into an escrow fund with which United States government securities were purchased to complete a partial defeasance of a mortgage loan made to the Real Estate Trust. The defeased portion of the loan encumbered the hotel property which was sold
January 19, 2006. The defeasance was funded by available cash and line of credit borrowings. The government securities became the replacement collateral for the loan securing the hotel, and became the sole source of payment for the $5.8 million
loan. As a result of the transaction, the principal amount owed by the Real Estate Trust was reduced by $5.8 million, with corresponding reductions in the principal and interest payments to be made to maturity. The Real Estate Trust incurred
defeasance charges of approximately $1.8 million, including a prepayment premium of $1.7 million. The escrow fund is maintained by Wells Fargo Bank, National Association, as Securities Intermediary and Custodian, and the Real Estate Trust is no
longer the primary obligor with respect to the defeased loan.

In connection with the hotel asset acquired on November 1, 2005 (see Note 7) the Real
Estate Trust, on December 21, 2005, defeased the loan that was assumed with the acquisition of the hotel property. The Real Estate Trust paid $6.6 million into an escrow fund with which United States government securities were purchased. The
defeasance was funded by available cash and line of credit borrowings. The government securities became replacement collateral for the loan securing the hotel, and became the sole source of payment of the $5.8 million loan. As a result of the
transaction the Real Estate Trust is no longer the primary obligor with respect to this loan. The escrow fund is maintained by Wells Fargo Bank, National Association, as Securities Intermediary and Custodian. The $5.8 million defeased loan was
accounted for as if it were extinguished in December 2005. The Real Estate Trust incurred defeasance charges of approximately $900,000, including a prepayment premium of $829,000.

On December 9, 2004 the sale of a hotel property, which was placed on the market for sale during fiscal 2004, was finalized and the Real Estate Trust received proceeds from the sale of approximately $2.2 million.
The proceeds from the sale, along with an additional $3.6 million from the Real Estate Trust, were paid into an escrow fund with which United States government securities were purchased. The government securities became replacement collateral for
the loan securing the hotel, and became the sole source of payment for the $4.4 million loan (the Defeased loan). As a result of the transaction, the principal amount owed by the Real Estate Trust was reduced by $4.4 million, with
corresponding reductions in the principal and interest payments to be made to maturity. The escrow fund is maintained by Wells Fargo Bank, National Association, as Securities Intermediary and Custodian, and the Real Estate Trust is no longer the
primary obligor with respect to the Defeased loan and therefore the debt is considered extinguished. The Real Estate Trust incurred defeasance charges of approximately $1.6 million, including a $1.5 million prepayment premium.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



11. INCOME FROM COMMERCIAL PROPERTIESREAL ESTATE TRUST:

Income from commercial properties includes minimum rent arising from non-cancelable commercial leases. Minimum rent for fiscal years 2006, 2005 and 2004 amounted to
$35.2, $34.9 and $33.9 million, respectively. Future minimum rentals as of September 30, 2006 under non-cancelable leases are as follows:



|            |  |                |        
|----------- |  | -------------- | -------
|Fiscal Year |  | (In thousands)
|2007        |  | $              | 31,998 
|2008        |  |                | 28,556 
|2009        |  |                | 23,843 
|2010        |  |                | 16,386 
|2011        |  |                | 10,650 
|Thereafter  |  |                | 34,330 
|            |  |                |        
|Total       |  | $              | 145,763
|            |  |                |        

12. TRANSACTIONS WITH RELATED PARTIESREAL ESTATE TRUST:

TRANSACTIONS WITH B. F. SAUL COMPANY AND ITS SUBSIDIARIES

The Real
Estate Trust has been managed by B. F. Saul Advisory Company, L.L.C., (the Advisor), a wholly-owned subsidiary of B. F. Saul Company (Saul Co.). All of the Real Estate Trust officers and four Trustees of the Trust are also
officers and/or directors of Saul Co. The Advisor is paid a fixed monthly fee which is subject to annual review by the Trustees. The average monthly fee was $560,000 during fiscal 2006, $487,000 during fiscal 2005, and $472,000 during fiscal 2004.
Effective October 1, 2005 the Advisors obligations under the advisory contract were assigned to Saul Co. In addition the agreement was extended until September 30, 2006. The agreement will continue thereafter unless canceled by either
party at the end of any contract year.

Saul Co. and B.F. Saul Property Company (Saul Property Co.), a wholly-owned subsidiary of Saul Co.,
provide services to the Real Estate Trust through commercial property management and leasing, hotel management, development and construction management, and acquisitions, sales and financings of real property agreements. Fees paid to Saul Co. and
Saul Property Co. amounted to $13.0, $9.1 and $8.6 million in fiscal 2006, 2005 and 2004, respectively, related to these services.

The Real Estate Trust
reimburses the Advisor and Saul Property Co. for costs and expenses incurred on behalf of the Real Estate Trust, in-house legal expenses, and for all travel expenses incurred in connection with the affairs of the Real Estate Trust.

The Real Estate Trust currently also pays the Advisor fees equal to 2% of the principal amount of the unsecured notes as they are issued to offset its costs of
administering the program. In October 2005, in conjunction with the Real Estate Trusts decision to discontinue the public sale of unsecured notes, the fee agreement was modified whereas the Advisor fee for any calendar month that the Real
Estate Trust did not issue notes under the program was to be $7,500 for such month. These payments amounted to $111,000, $267,000 and $266,000 in fiscal 2006, 2005 and 2004, respectively. The public sale of these notes was discontinued in fiscal
2006.

A subsidiary of Saul Co. is a general insurance agency which receives commissions and countersignature fees in connection with the Real Estate
Trusts insurance program. Such commissions and fees amounted to approximately $311,000, $316,000 and $288,000 in fiscal 2006, 2005 and 2004, respectively.

Under an existing unsecured note receivable from Saul Co., which was modified and amended on October 1, 2005, not to exceed $30.0 million, the Real Estate Trust received net repayments of $2.8 million during fiscal 2006. During fiscal
2005 net additions totaled $5.4 million. At September 30, 2006 and September 30, 2005, the note balance totaled $10.3 million and $13.1 million, respectively. Interest is computed on the note at 200 basis points over a floating rate index.
Interest earned on the note amounted to $959,000, $616,000 and $108,000 during fiscal 2006, 2005 and 2004, respectively. The note is due and payable on September 30, 2015.

TRANSACTIONS WITH CHEVY CHASE BANK AND ITS SUBSIDIARIES

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

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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The purchase price for the two acquisitions was established using independent appraisals. The Bank realized gains
totaling $2.3 million on the two sales. The gains are eliminated in consolidation and the Real Estate Trust has recorded these land parcels using the Banks carryover basis.

REMUNERATION OF TRUSTEES AND OFFICERS

For fiscal years 2006, 2005, and 2004, the Real Estate Trust paid the Trustees
approximately $94,000, $104,000 and $109,000, respectively, for their services. No compensation was paid to the officers of the Real Estate Trust for acting as such; however, one Trustee was paid by the Bank for his services as Chairman of the Board
and Chief Executive Officer of the Bank, and four others received payments for their services as directors of the Bank. Four of the Trustees and all of the officers of the Real Estate Trust receive compensation from Saul Co. as directors and/or
officers.

SAUL HOLDINGS LIMITED PARTNERSHIP AND SAUL CENTERS, INC.

The Real Estate Trust accounts for these investments under the equity method. The Real Estate Trusts share of earnings for fiscal 2006, 2005 and 2004 was $10.6, $8.8 and $8.4 million, respectively, see Note 5.

OTHER TRANSACTIONS

The Real Estate Trust leases
space to the Bank and Saul Property Co. at several of its income-producing properties. Minimum rents and expense recoveries paid by these affiliates amounted to approximately $5.8, $5.4 and $5.2 million in fiscal 2006, 2005 and 2004, respectively.

13. INVESTMENT AND MORTGAGE-BACKED SECURITIES  THE BANK:

At September 30, 2006 and 2005, investment securities are comprised of U.S. Government and agency debt securities and are classified as held-to-maturity. At September 30, 2006 and 2005, all mortgage-backed securities are also
classified as held-to-maturity. Gross unrealized holding gains and losses on the Banks U.S. Government and mortgage-backed securities are as follows:



|                                                        |  |               |           |                               |   |                                |  |                     |        |  |   |          
|------------------------------------------------------- |  | ------------- | --------- | ----------------------------- | - | ------------------------------ |  | ------------------- | ------ |  | - | ---------
|(In thousands)                                          |  | AmortizedCost |           | Gross UnrealizedHolding Gains |   | Gross UnrealizedHolding Losses |  | AggregateFair Value
|September 30, 2006                                      |  |               |           |                               |   |                                |  |                     |        |  |   |          
|Investment securities:                                  |  |               |           |                               |   |                                |  |                     |        |  |   |          
|Original maturity after one year, but within five years |  | $             | 201,455   |                               | $ |                               |  | $                   | 1,303  |  | $ | 200,152  
|Mortgage-backed securities:                             |  |               |           |                               |   |                                |  |                     |        |  |   |          
|FNMA                                                    |  |               | 233,016   |                               |   | 347                            |  |                     | 2,644  |  |   | 230,719  
|FHLMC                                                   |  |               | 911,004   |                               |   | 1,107                          |  |                     | 21,558 |  |   | 890,553  
|Private label, AAA-rated                                |  |               | 145,698   |                               |   |                               |  |                     |       |  |   | 145,698  
|                                                        |  |               |           |                               |   |                                |  |                     |        |  |   |          
|Total                                                   |  | $             | 1,491,173 |                               | $ | 1,454                          |  | $                   | 25,505 |  | $ | 1,467,122
|                                                        |  |               |           |                               |   |                                |  |                     |        |  |   |          



|                                                        |  |   |           |  |   |       |  |   |        |  |   |          
|------------------------------------------------------- |  | - | --------- |  | - | ----- |  | - | ------ |  | - | ---------
|(In thousands)                                          |  |   |           |  |   |       |  |  
|September 30, 2005                                      |  |   |           |  |   |       |  |   |        |  |   |          
|Investment securities:                                  |  |   |           |  |   |       |  |   |        |  |   |          
|Original maturity after one year, but within five years |  | $ | 200,902   |  | $ |      |  | $ | 2,133  |  | $ | 198,769  
|Mortgage-backed securities:                             |  |   |           |  |   |       |  |   |        |  |   |          
|FNMA                                                    |  |   | 283,709   |  |   | 583   |  |   | 2,805  |  |   | 281,487  
|FHLMC                                                   |  |   | 544,695   |  |   | 1,831 |  |   | 9,653  |  |   | 536,873  
|Private label, AAA-rated                                |  |   | 31,404    |  |   |      |  |   |       |  |   | 31,404   
|                                                        |  |   |           |  |   |       |  |   |        |  |   |          
|Total                                                   |  | $ | 1,060,710 |  | $ | 2,414 |  | $ | 14,591 |  | $ | 1,048,533
|                                                        |  |   |           |  |   |       |  |   |        |  |   |          

There were no sales of investment securities or mortgage-backed securities during the years ended
September 30, 2006, 2005 and 2004.

The table above shows that some of the securities in the held-to-maturity investment portfolio had unrealized
losses, or were temporarily impaired, as of September 30, 2006 and 2005. This temporary impairment represents the amount of loss that would be realized if the securities were sold at the valuation date, and occurs as a result of changes in
overall bond yields between the date the bond was acquired and the valuation date. The unrealized losses associated with the U.S. Government, agency debt and mortgage-backed securities are not considered to be other than temporary because they
relate to changes in interest rates and do not affect the expected cash flows of the securities. Securities which were



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



temporarily impaired at September 30, 2006 and 2005 are shown below, along with the length of the impairment period.



|                                      |  |                     |         |                     |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       
|------------------------------------- |  | ------------------- | ------- | ------------------- | - | ---------- |  | ---------------- | ------- | ---------- | - | ---------------- |  | - | --------- |  | - | ------
|                                      |  | September 30, 2006 
|                                      |  | Less than 12 months |         | 12 months or longer |   | Total     
|(In thousands)                        |  | Fair Value          |         | UnrealizedLosses    |   | Fair Value |  | UnrealizedLosses |         | Fair Value |   | UnrealizedLosses
|U.S. government securities            |  | $                   |        |                     | $ |           |  | $                | 99,339  |            | $ | 363              |  | $ | 99,339    |  | $ | 363   
|Agency debt securities                |  |                     |        |                     |   |           |  |                  | 58,922  |            |   | 940              |  |   | 58,922    |  |   | 940   
|Mortgage-backed securities            |  |                     | 476,714 |                     |   | 10,191     |  |                  | 550,954 |            |   | 14,011           |  |   | 1,027,668 |  |   | 24,202
|                                      |  |                     |         |                     |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       
|Total temporarily impaired Securities |  | $                   | 476,714 |                     | $ | 10,191     |  | $                | 709,215 |            | $ | 15,314           |  | $ | 1,185,929 |  | $ | 25,505
|                                      |  |                     |         |                     |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       
|                                      | 
|                                      |  | September 30, 2005 
|                                      |  | Less than 12 months |         | 12 months or longer |   | Total     
|(In thousands)                        |  | Fair Value          |         | UnrealizedLosses    |   | Fair Value |  | UnrealizedLosses |         | Fair Value |   | UnrealizedLosses
|U.S. government securities            |  | $                   | 68,945  |                     | $ | 892        |  | $                | 69,902  |            | $ | 87               |  | $ | 138,847   |  | $ | 979   
|Agency debt securities                |  |                     | 58,552  |                     |   | 1,155      |  |                  |        |            |   |                 |  |   | 58,552    |  |   | 1,155 
|Mortgage-backed securities            |  |                     | 687,284 |                     |   | 12,247     |  |                  | 8,396   |            |   | 210              |  |   | 695,680   |  |   | 12,457
|                                      |  |                     |         |                     |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       
|Total temporarily impaired Securities |  | $                   | 814,781 |                     | $ | 14,294     |  | $                | 78,298  |            | $ | 297              |  | $ | 893,079   |  | $ | 14,591
|                                      |  |                     |         |                     |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       

Contractual maturities of the Banks mortgage-backed securities at September 30, 2006 are as follows:



|                                           |  |   |          
|------------------------------------------ |  | - | ---------
|(In thousands)                             |  |  
|Due within one year                        |  | $ | 167,589  
|Due after one year, but within five years  |  |   | 83,016   
|Due after five years, but within ten years |  |   | 111,088  
|Due after ten years                        |  |   | 928,025  
|                                           |  |   |          
|Total                                      |  | $ | 1,289,718
|                                           |  |   |          

Accrued interest receivable on investment and mortgage-backed securities totaled $2.1 and $7.7 million at
September 30, 2006, respectively, and $1.0 and $4.8 million at September 30, 2005, respectively, and is included in other assets in the Consolidated Statements of Financial Condition.



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14. LOANS RECEIVABLE  THE BANK:

Loans receivable is composed of the following:



|                                                           |  |               |            |   |      |   |           |  
|---------------------------------------------------------- |  | ------------- | ---------- | - | ---- | - | --------- | -
|                                                           |  | September 30, |           
|(In thousands)                                             |  | 2006          |            |   | 2005 |  
|Single-family residential                                  |  | $             | 6,648,885  |   |      | $ | 5,843,205 |  
|Home equity                                                |  |               | 1,690,421  |   |      |   | 1,796,148 |  
|Other real estate                                          |  |               | 607,451    |   |      |   | 358,937   |  
|Commercial                                                 |  |               | 987,850    |   |      |   | 1,035,972 |  
|Automobile                                                 |  |               | 60,756     |   |      |   | 149,253   |  
|Other consumer                                             |  |               | 46,755     |   |      |   | 53,742    |  
|                                                           |  |               |            |   |      |   |           |  
|                                                           |  |               | 10,042,118 |   |      |   | 9,237,257 |  
|                                                           |  |               |            |   |      |   |           |  
|Unearned discounts and net deferred loan origination costs |  |               | 103,703    |   |      |   | 95,183    |  
|Allowance for losses on loans                              |  |               | (25,000    | ) |      |   | (28,640   | )
|                                                           |  |               |            |   |      |   |           |  
|                                                           |  |               | 78,703     |   |      |   | 66,543    |  
|                                                           |  |               |            |   |      |   |           |  
|Total                                                      |  | $             | 10,120,821 |   |      | $ | 9,303,800 |  
|                                                           |  |               |            |   |      |   |           |  

The Bank serviced loans owned by others amounting to $13,671.4 and $13,480.4 million at September 30, 2006
and 2005, respectively.

Accrued interest receivable on loans totaled $51.9 and $41.3 million at September 30, 2006 and 2005, respectively, and is
included in other assets in the Consolidated Statements of Financial Condition.

15. ALLOWANCE FOR LOSSES  THE BANK:

Activity in the allowance for losses on loans receivable is summarized as follows:



|                  |      |                          |        |      |  |   |         |   |  |   |         |  
|----------------- | ---- | ------------------------ | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|(In thousands)    |      | Year Ended September 30, |       
|                  | 2006 |                          |        | 2005 |  |   | 2004    |  
|Beginning Balance |      | $                        | 28,640 |      |  | $ | 37,750  |   |  | $ | 58,397  |  
|Credit for losses |      |                          | (9,004 | )    |  |   | (11,569 | ) |  |   | (14,522 | )
|Charge-offs       |      |                          | (6,549 | )    |  |   | (14,522 | ) |  |   | (26,558 | )
|Recoveries        |      |                          | 11,913 |      |  |   | 16,981  |   |  |   | 20,433  |  
|                  |      |                          |        |      |  |   |         |   |  |   |         |  
|Ending Balance    |      | $                        | 25,000 |      |  | $ | 28,640  |   |  | $ | 37,750  |  
|                  |      |                          |        |      |  |   |         |   |  |   |         |  



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16. LOAN SERVICING RIGHTS  THE BANK:

Servicing assets are recorded when purchased and in conjunction with loan sales and securitization transactions when servicing rights are retained by the Bank. Activity in servicing assets is summarized as follows:



|                    |  |                          |         |   |      |   |         |      |  |   |         |  
|------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                    |  | Year ended September 30, |        
|(In thousands)      |  | 2006                     |         |   | 2005 |   |         | 2004 | 
|Beginning Balance   |  | $                        | 201,156 |   |      | $ | 164,764 |      |  | $ | 121,594 |  
|Additions           |  |                          | 89,527  |   |      |   | 99,551  |      |  |   | 97,415  |  
|Amortization        |  |                          | (83,428 | ) |      |   | (62,916 | )    |  |   | (44,898 | )
|Sales               |  |                          |        |   |      |   |        |      |  |   | (5,228  | )
|Charge-offs         |  |                          |        |   |      |   | (243    | )    |  |   | (4,119  | )
|                    |  |                          |         |   |      |   |         |      |  |   |         |  
|Ending Balance      |  |                          | 207,255 |   |      |   | 201,156 |      |  |   | 164,764 |  
|Valuation Allowance |  |                          | (39,196 | ) |      |   | (36,564 | )    |  |   | (16,909 | )
|                    |  |                          |         |   |      |   |         |      |  |   |         |  
|Carrying Value      |  | $                        | 168,059 |   |      | $ | 164,592 |      |  | $ | 147,855 |  
|                    |  |                          |         |   |      |   |         |      |  |   |         |  

Accumulated amortization was $356.3 and $272.8 million at September 30, 2006 and 2005, respectively. The
aggregate fair value of servicing assets at September 30, 2006 and 2005 was $174.8 and $177.5 million, respectively.

Activity in the valuation
allowance for servicing assets is summarized as follows:



|                             |      |                          |        |  |   |        |   |  |   |        |  
|---------------------------- | ---- | ------------------------ | ------ |  | - | ------ | - |  | - | ------ | -
|(In thousands)               |      | Year Ended September 30, |       
|                             | 2006 |                          | 2005   |  |   | 2004   |  
|Balance at beginning of year |      | $                        | 36,564 |  | $ | 16,909 |   |  | $ | 25,326 |  
|Additions (reductions)       |      |                          | 2,632  |  |   | 19,898 |   |  |   | (1,962 | )
|Charge-offs                  |      |                          |       |  |   | (243   | ) |  |   | (4,119 | )
|Sales                        |      |                          |       |  |   |       |   |  |   | (2,336 | )
|                             |      |                          |        |  |   |        |   |  |   |        |  
|Balance at end of year       |      | $                        | 39,196 |  | $ | 36,564 |   |  | $ | 16,909 |  
|                             |      |                          |        |  |   |        |   |  |   |        |  

There were no sales of rights to service mortgage loans during fiscal years 2006 and 2005. During fiscal year
2004, the Bank sold $2.99 million of rights to service mortgage loans with principal balances of $214.9 million, which were originated by the Bank in connection with its mortgage banking activities, and recognized a gain of $105,000. Servicing fees
are included in servicing, securitization and mortgage banking income in the Consolidated Statements of Operations.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



At September 30, 2006 and 2005, key assumptions and the sensitivity of the current value of originated servicing
assets to an immediate 10 percent and 20 percent adverse change in those assumptions are as follows:



|                                              |  |                          |         |   |                              |   |      |  
|--------------------------------------------- |  | ------------------------ | ------- | - | ---------------------------- | - | ---- | -
|                                              |  | September 30, 2006       |        
|(Dollars in thousands)                        |  | Single-FamilyResidential |         |   | Home Equity/Home Improvement |  
|Carrying value                                |  | $                        | 167,913 |   |                              | $ | 55   |  
|Weighted average life (in years)              |  |                          | 3.3     |   |                              |   | 2.7  |  
|Prepayment speed assumption (annual rate):(1) |  |                          |         |   |                              |   |      |  
|First twelve months                           |  |                          | 28.7    | % |                              |   | 36.5 | %
|Next twelve months                            |  |                          | 22.0    | % |                              |   | 36.5 | %
|Thereafter                                    |  |                          | 18.1    | % |                              |   | 36.5 | %
|Impact on fair value at 10% adverse change    |  | $                        | (9,950  | ) |                              | $ | (6   | )
|Impact on fair value at 20% adverse change    |  | $                        | (18,203 | ) |                              | $ | (11  | )
|Discount rate (annual)                        |  |                          | 9.6     | % |                              |   | 8.12 | %
|Impact on fair value at 10% adverse change    |  | $                        | (4,190  | ) |                              | $ | (2   | )
|Impact on fair value at 20% adverse change    |  | $                        | (7,497  | ) |                              | $ | (3   | )



|                                              |  |                          |         |   |                              |   |      |  
|--------------------------------------------- |  | ------------------------ | ------- | - | ---------------------------- | - | ---- | -
|                                              |  | September 30, 2005       |        
|(Dollars in thousands)                        |  | Single-FamilyResidential |         |   | Home Equity/Home Improvement |  
|Carrying value                                |  | $                        | 159,178 |   |                              | $ | 89   |  
|Weighted average life (in years)              |  |                          | 3.1     |   |                              |   | 2.9  |  
|Prepayment speed assumption (annual rate):(1) |  |                          |         |   |                              |   |      |  
|First twelve months                           |  |                          | 30.9    | % |                              |   | 34.0 | %
|Next twelve months                            |  |                          | 24.1    | % |                              |   | 34.0 | %
|Thereafter                                    |  |                          | 19.1    | % |                              |   | 34.0 | %
|Impact on fair value at 10% adverse change    |  | $                        | (7,770  | ) |                              | $ | (6   | )
|Impact on fair value at 20% adverse change    |  | $                        | (11,241 | ) |                              | $ | (11  | )
|Discount rate (annual)                        |  |                          | 8.5     | % |                              |   | 8.1  | %
|Impact on fair value at 10% adverse change    |  | $                        | (2,987  | ) |                              | $ | (2   | )
|Impact on fair value at 20% adverse change    |  | $                        | (5,865  | ) |                              | $ | (3   | )

---

|(1) | Represents Constant Prepayment Rate.
|--- | ------------------------------------



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17. LOAN SECURITIZATION TRANSACTIONS  THE BANK:

The Bank periodically sells various loan receivables through asset-backed securitizations, in which receivables are transferred to trusts, and certificates are sold to
investors. The following chart summarizes the Banks securitization activities:



|                                                  |      |                                           |           |  |      |           |  |   |          
|------------------------------------------------- | ---- | ----------------------------------------- | --------- |  | ---- | --------- |  | - | ---------
|(In thousands)                                    |      | As of or for the year ended September 30,
|                                                  | 2006 |                                           | 2005      |  | 2004
|Single-Family Residential                         |      |                                           |           |  |      |           |  |   |          
|Loans sold into new trusts during the year        |      | $                                         | 4,210,911 |  | $    | 5,320,133 |  | $ | 4,853,624
|Outstanding trust certificate balance at year end |      |                                           | 8,710,468 |  |      | 9,446,395 |  |   | 7,246,410
|Gains recognized during the year                  |      |                                           | 112,591   |  |      | 178,580   |  |   | 182,821  
|Automobile                                        |      |                                           |           |  |      |           |  |   |          
|Loans sold into new trusts during the year        |      | $                                         |          |  | $    |          |  | $ |         
|Outstanding trust certificate balance at year end |      |                                           |          |  |      | 27,494    |  |   | 149,345  
|Gains recognized during the year                  |      |                                           |          |  |      |          |  |   |         
|Home Equity                                       |      |                                           |           |  |      |           |  |   |          
|Loans sold into existing trusts during the year   |      | $                                         |          |  | $    |          |  | $ | 3,929    
|Outstanding trust certificate balance at year end |      |                                           |          |  |      |          |  |   |         
|Gains recognized during the year                  |      |                                           |          |  |      |          |  |   | 195      

The Bank continues to service, and receive servicing fees on, the outstanding balance of securitized receivables.
The Bank also retains rights, which may be subordinated, to future cash flows arising from the receivables. The Bank generally estimates the fair value of these retained interests based on the estimated present value of expected future cash flows
from securitized and sold receivables, using managements best estimates of the key assumptions  credit losses, prepayment speeds and discount rates commensurate with the risks involved.

The following table summarizes certain cash flows received from securitization trusts:



|                                                |      |                          |           |  |      |           |  |   |          
|----------------------------------------------- | ---- | ------------------------ | --------- |  | ---- | --------- |  | - | ---------
|(In thousands)                                  |      | Year Ended September 30,
|                                                | 2006 |                          | 2005      |  | 2004
|Proceeds from new securitizations               |      | $                        | 4,135,697 |  | $    | 5,221,409 |  | $ | 4,774,686
|Servicing fees received                         |      |                          | 33,108    |  |      | 31,576    |  |   | 20,290   
|Other cash flows received on retained interests |      |                          | 157,078   |  |      | 145,074   |  |   | 73,891   



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Servicing, securitization and mortgage banking income includes the initial gains on current securitization and sale
transactions and income from interest-only strips receivable recognized in connection with current and prior period securitization and sale transactions. Activity in interest-only assets is summarized as follows:



|                              |      |                          |          |      |  |   |          |   |  |   |         |  
|----------------------------- | ---- | ------------------------ | -------- | ---- |  | - | -------- | - |  | - | ------- | -
|(In thousands)                |      | Year Ended September 30, |         
|                              | 2006 |                          |          | 2005 |  |   | 2004     |  
|Beginning balance             |      | $                        | 348,227  |      |  | $ | 287,840  |   |  | $ | 139,782 |  
|Additions                     |      |                          | 208,133  |      |  |   | 275,405  |   |  |   | 233,177 |  
|Accretion                     |      |                          | 27,644   |      |  |   | 29,333   |   |  |   | 14,683  |  
|Cash received                 |      |                          | (151,403 | )    |  |   | (123,342 | ) |  |   | (75,748 | )
|Fair value adjustments        |      |                          | (88,284  | )    |  |   | (121,009 | ) |  |   | (24,054 | )
|                              |      |                          |          |      |  |   |          |   |  |   |         |  
|Ending balance/Carrying value |      | $                        | 344,317  |      |  | $ | 348,227  |   |  | $ | 287,840 |  
|                              |      |                          |          |      |  |   |          |   |  |   |         |  

At September 30, 2006 and 2005, key assumptions and the sensitivity of the current fair value of the retained
interests to an immediate 10 percent and 20 percent adverse change in those assumptions are as follows:



|                                           |                           |                    |         |  
|------------------------------------------ | ------------------------- | ------------------ | ------- | -
|(Dollars in thousands)                     |                           | September 30, 2006 |        
|                                           | Single-Family Residential |                   
|Carrying value (fair value)(1)             |                           | $                  | 364,817 |  
|Weighted average life (in years)(2)        |                           |                    | 2.4     |  
|Prepayment speed assumption(2)(3):         |                           |                    |         |  
|First twelve months                        |                           |                    | 35.9    | %
|Next twelve months                         |                           |                    | 27.0    | %
|Thereafter                                 |                           |                    | 21.3    | %
|Impact on fair value at 10% adverse change |                           | $                  | (35,701 | )
|Impact on fair value at 20% adverse change |                           | $                  | (66,796 | )
|Residual cash flow discount rate (annual)  |                           |                    | 9.5     | %
|Impact on fair value at 10% adverse change |                           | $                  | (7,804  | )
|Impact on fair value at 20% adverse change |                           | $                  | (15,324 | )



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



|                                           |                           |                    |         |            |  |   |       |  
|------------------------------------------ | ------------------------- | ------------------ | ------- | ---------- |  | - | ----- | -
|(Dollars in thousands)                     |                           | September 30, 2005 |        
|                                           | Single-Family Residential |                    |         | Automobile | 
|Carrying value (fair value)(1)             |                           | $                  | 368,594 |            |  | $ | 3,048 |  
|Weighted average life (in years)(2)        |                           |                    | 2.6     |            |  |   | 0.2   |  
|Prepayment speed assumption(2) (3):        |                           |                    |         |            |  |   |       |  
|First twelve months                        |                           |                    | 37.1    | %          |  |   | 1.5   | %
|Next twelve months                         |                           |                    | 28.7    | %          |  |   | 1.5   | %
|Thereafter                                 |                           |                    | 21.8    | %          |  |   | 1.5   | %
|Impact on fair value at 10% adverse change |                           | $                  | (33,396 | )          |  | $ | (1    | )
|Impact on fair value at 20% adverse change |                           | $                  | (62,407 | )          |  | $ | (10   | )
|Expected credit losses (annual rate)       |                           |                    |        |            |  |   | 4.7   | %
|Impact on fair value at 10% adverse change |                           | $                  |        |            |  | $ | (29   | )
|Impact on fair value at 20% adverse change |                           | $                  |        |            |  | $ | (57   | )
|Discount rate (annual rate)                |                           |                    | 8.5     | %          |  |   | 8.0   | %
|Impact on fair value at 10% adverse change |                           | $                  | (7,755  | )          |  | $ |      |  
|Impact on fair value at 20% adverse change |                           | $                  | (15,228 | )          |  | $ |      |  

---

|(1) | Fiscal year 2006 includes interest-only assets of $344.3 million and reserve accounts of $20.5 million. Fiscal year 2005 includes interest-only assets of $348.2
million and reserve accounts of $23.4 million.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



|(3) | Represents Constant Prepayment Rate for single-family residential loans, and Absolute Pre-payment Speed or ABS for automobile loans. Certain loans may require the
payment of a fee if the borrower prepays the loan during the period up to three years after origination. The Bank uses a lower prepayment assumption during these periods.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Key assumptions used in measuring retained interests at the date of single-family securitizations completed during
fiscal year 2006 and 2005 are as follows:



|                                                     |  |                          |   |  |      |  
|---------------------------------------------------- |  | ------------------------ | - |  | ---- | -
|                                                     |  | Year Ended September 30, |  
|                                                     |  | 2006                     |   |  | 2005 |  
|Prepayment speed assumption(1)(average annual rate): |  |                          |   |  |      |  
|First twelve months                                  |  | 28.5                     | % |  | 21.1 | %
|Next twelve months                                   |  | 27.9                     | % |  | 27.8 | %
|Thereafter                                           |  | 25.5                     | % |  | 24.2 | %
|Expected credit losses (annual rate)                 |  |                         |   |  |     |  
|Discount rate (annual rate)                          |  | 8.9                      | % |  | 8.5  | %

---

|(1) | Expected weighted average life and prepayment speed assumptions are based on life of securitization.
|--- | ----------------------------------------------------------------------------------------------------

These sensitivities are hypothetical and should be used with caution. Changes in fair value based on variations in assumptions generally cannot be extrapolated because
the relationship of the change in assumption to the change in fair value may not be linear. The effects shown in the above tables of a variation in a particular assumption on the fair value of interest-only strips receivable is calculated without
changing any other assumption. In reality, changes in one factor may result in changes in another factor, which might magnify or counteract the sensitivities.

Principal balances, delinquent amounts and net credit losses for securitized loans were as follows:



|                          |                                |                                                |                                                                   |  |                               |        |  |   |       |  
|------------------------- | ------------------------------ | ---------------------------------------------- | ----------------------------------------------------------------- |  | ----------------------------- | ------ |  | - | ----- | -
|(In thousands)            |                                | As of or for the year ended September 30, 2006 |                                                                  
|                          | Total PrincipalAmount of Loans |                                                | Principal Amount ofLoans Past Due 90Days or More orNon-Performing |  | Net Credit Losses(Recoveries) |       
|Single-family residential |                                | $                                              | 8,511,739                                                         |  | $                             | 44,950 |  | $ | 137   |  
|                          |                                |                                                |                                                                   |  |                               |        |  |   |       |  
|                          |                               
|(In thousands)            |                                | As of or for the year ended September 30, 2005 |                                                                  
|                          | Total PrincipalAmount of Loans |                                                | Principal Amount ofLoans Past Due 90Days or More orNon-Performing |  | Net Credit Losses(Recoveries) |       
|Single-family residential |                                | $                                              | 8,989,069                                                         |  | $                             | 22,934 |  | $ | (1    | )
|Automobile                |                                |                                                | 27,494                                                            |  |                               | 268    |  |   | 1,273 |  
|                          |                                |                                                |                                                                   |  |                               |        |  |   |       |  
|Total                     |                                | $                                              | 9,016,563                                                         |  | $                             | 23,202 |  | $ | 1,272 |  
|                          |                                |                                                |                                                                   |  |                               |        |  |   |       |  



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18. PROPERTY AND EQUIPMENT  THE BANK:

Property and equipment is composed of the following:



|                                          |  |                       |  |               |         |  |   |        
|----------------------------------------- |  | --------------------- |  | ------------- | ------- |  | - | -------
|(In thousands)                            |  | EstimatedUseful Lives |  | September 30,
|                                          |  | 2006                  |  | 2005         
|Land                                      |  |                      |  | $             | 130,838 |  | $ | 101,700
|Projects in progress                      |  |                      |  |               | 10,991  |  |   | 13,252 
|Buildings and improvements                |  | 10-65 years           |  |               | 309,555 |  |   | 290,187
|Leasehold and tenant improvements         |  | 7-40 years            |  |               | 202,572 |  |   | 175,275
|Furniture and equipment                   |  | 5-10 years            |  |               | 274,221 |  |   | 266,590
|Automobiles                               |  | 3-5 years             |  |               | 6,222   |  |   | 5,331  
|                                          |  |                       |  |               |         |  |   |        
|                                          |  |                       |  |               | 934,399 |  |   | 852,335
|Less:                                     |  |                       |  |               |         |  |   |        
|Accumulated depreciation and amortization |  |                       |  |               | 332,807 |  |   | 317,964
|                                          |  |                       |  |               |         |  |   |        
|Total                                     |  |                       |  | $             | 601,592 |  | $ | 534,371
|                                          |  |                       |  |               |         |  |   |        

Depreciation and amortization expense related to property and equipment amounted to $45.7, $42.5 and $39.3 million
for the years ended September 30, 2006, 2005 and 2004, respectively.



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19. AUTOMOBILES SUBJECT TO LEASE  THE BANK:

Automobiles subject to lease is composed of the following:



|                         |  |                       |  |               |         |  |   |        
|------------------------ |  | --------------------- |  | ------------- | ------- |  | - | -------
|(Dollars in thousands)   |  | EstimatedUseful Lives |  | September 30,
|                         |  | 2006                  |  | 2005         
|Automobiles              |  | 3-5 years             |  | $             | 110,703 |  | $ | 327,432
|Less:                    |  |                       |  |               |         |  |   |        
|Accumulated depreciation |  |                       |  |               | 55,255  |  |   | 142,396
|                         |  |                       |  |               |         |  |   |        
|Total                    |  |                       |  | $             | 55,448  |  | $ | 185,036
|                         |  |                       |  |               |         |  |   |        

Depreciation expense related to automobile leases amounted to $23.3, $60.7 and $120.9 million for the years ended
September 30, 2006, 2005, and 2004, respectively. Automobile rental income amounted to $35.2, $82.0 and $157.0 million for the years ended September 30, 2006, 2005 and 2004, respectively.

The following is a schedule by years of future minimum automobile rental income at September 30, 2006:

(In thousands)



|                          |  |   |      
|------------------------- |  | - | -----
|Year Ending September 30, |  |  
|2007                      |  | $ | 8,961
|2008                      |  |   | 1,008
|                          |  |   |      
|Total                     |  | $ | 9,969
|                          |  |   |      



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20. LEASES  THE BANK:

The Bank has noncancelable, long-term leases for office premises and retail space which have a variety of terms expiring from fiscal year 2007 to fiscal year 2033 and ground leases which have terms expiring from
fiscal year 2029 to fiscal year 2081. These leases are accounted for as operating leases. Some of the leases are subject to rent adjustments in the future based upon changes in the Consumer Price Index and some also contain renewal options.

The following is a schedule by years of future minimum lease payments required at September 30, 2006:

(In thousands)



|                          |  |   |        
|------------------------- |  | - | -------
|Year Ending September 30, |  |  
|2007                      |  | $ | 33,800 
|2008                      |  |   | 28,811 
|2009                      |  |   | 26,482 
|2010                      |  |   | 21,388 
|2011                      |  |   | 20,573 
|Thereafter                |  |   | 208,099
|                          |  |   |        
|Total                     |  | $ | 339,153
|                          |  |   |        

Rent expense totaled $33.4, $27.4 and $24.0 million for the years ended September 30, 2006, 2005 and 2004,
respectively. For operating leases with fixed escalation amounts, rent expense is recognized on a straight-line basis over the term of the lease.

21.
DEPOSIT ACCOUNTS  THE BANK:

The Banks deposits are insured by the FDIC up to at least $100,000 for each insured depositor. An analysis of
deposit accounts and the related weighted average effective interest rates at year end are as follows:



|                                       |        |               |                     |      |      |        |  |                     |           |  |      |  
|-------------------------------------- | ------ | ------------- | ------------------- | ---- | ---- | ------ |  | ------------------- | --------- |  | ---- | -
|(Dollars in thousands)                 |        | September 30, |                    
|                                       | 2006   |               |                     | 2005 |     
|                                       | Amount |               | WeightedAverageRate |      |      | Amount |  | WeightedAverageRate |          
|Non-interest bearing checking accounts |        | $             | 1,316,980           |      |     |        |  | $                   | 1,346,455 |  |     |  
|Interest bearing checking accounts     |        |               | 2,313,152           |      | 0.28 | %      |  |                     | 2,438,147 |  | 0.22 | %
|Money market deposit accounts          |        |               | 2,403,060           |      | 2.69 | %      |  |                     | 2,521,949 |  | 1.83 | %
|Savings accounts                       |        |               | 953,663             |      | 0.47 | %      |  |                     | 1,153,152 |  | 0.28 | %
|Certificate accounts, less than $100   |        |               | 2,088,368           |      | 4.37 | %      |  |                     | 1,520,829 |  | 3.20 | %
|Certificate accounts, $100 or more     |        |               | 1,370,541           |      | 4.71 | %      |  |                     | 801,236   |  | 3.38 | %
|                                       |        |               |                     |      |      |        |  |                     |           |  |      |  
|Total                                  |        | $             | 10,445,764          |      | 2.21 | %      |  | $                   | 9,781,768 |  | 1.33 | %
|                                       |        |               |                     |      |      |        |  |                     |           |  |      |  



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Interest expense on deposit accounts is composed of the following:



|                              |      |                          |         |  |      |        |  |   |       
|----------------------------- | ---- | ------------------------ | ------- |  | ---- | ------ |  | - | ------
|(In thousands)                |      | Year Ended September 30,
|                              | 2006 |                          | 2005    |  | 2004
|Checking accounts             |      | $                        | 6,021   |  | $    | 5,012  |  | $ | 4,320 
|Money market deposit accounts |      |                          | 55,035  |  |      | 34,765 |  |   | 17,159
|Savings accounts              |      |                          | 4,450   |  |      | 3,435  |  |   | 3,326 
|Certificate accounts          |      |                          | 114,057 |  |      | 52,419 |  |   | 33,446
|                              |      |                          |         |  |      |        |  |   |       
|Total                         |      | $                        | 179,563 |  | $    | 95,631 |  | $ | 58,251
|                              |      |                          |         |  |      |        |  |   |       

Outstanding certificate accounts at September 30, 2006 mature in the years indicated as follows:

(In thousands)



|                          |  |   |          
|------------------------- |  | - | ---------
|Year Ending September 30, |  |  
|2007                      |  | $ | 3,209,438
|2008                      |  |   | 145,378  
|2009                      |  |   | 66,692   
|2010                      |  |   | 28,254   
|2011                      |  |   | 9,147    
|                          |  |   |          
|Total                     |  | $ | 3,458,909
|                          |  |   |          

At September 30, 2006, certificate accounts of $100,000 or more have contractual maturities as indicated
below:

(In thousands)



|                                     |  |   |          
|------------------------------------ |  | - | ---------
|Three months or less                 |  | $ | 640,897  
|Over three months through six months |  |   | 390,643  
|Over six months through 12 months    |  |   | 270,121  
|Over 12 months                       |  |   | 68,880   
|                                     |  |   |          
|Total                                |  | $ | 1,370,541
|                                     |  |   |          



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



22. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS  THE BANK:

Short-term borrowings are summarized as follows:



|                                                    |  |               |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------- |  | ------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|(Dollars in thousands)                              |  | September 30, |        
|                                                    |  | 2006          |         |   | 2005 |   |         | 2004 | 
|Securities sold under repurchase agreements:        |  |               |         |   |      |   |         |      |  |   |         |  
|Balance at year end                                 |  | $             | 458,307 |   |      | $ | 191,034 |      |  | $ | 21,878  |  
|Average amount outstanding during the year          |  |               | 232,824 |   |      |   | 119,791 |      |  |   | 23,994  |  
|Maximum amount outstanding at any month end         |  |               | 458,307 |   |      |   | 191,109 |      |  |   | 87,871  |  
|Amount maturing within 30 days                      |  |               | 458,307 |   |      |   | 191,034 |      |  |   | 18,878  |  
|Weighted average interest rate during the year      |  |               | 4.32    | % |      |   | 2.61    | %    |  |   | 0.87    | %
|Weighted average interest rate on year end balances |  |               | 5.18    | % |      |   | 3.59    | %    |  |   | 0.98    | %
|Other short-term borrowings:                        |  |               |         |   |      |   |         |      |  |   |         |  
|Balance at year end                                 |  | $             | 364,332 |   |      | $ | 307,880 |      |  | $ | 184,701 |  
|Average amount outstanding during the year          |  |               | 335,874 |   |      |   | 221,691 |      |  |   | 178,748 |  
|Maximum amount outstanding at any month end         |  |               | 377,418 |   |      |   | 307,880 |      |  |   | 227,365 |  
|Amount maturing within 30 days                      |  |               | 364,332 |   |      |   | 307,880 |      |  |   | 184,701 |  
|Weighted average interest rate during the year      |  |               | 4.00    | % |      |   | 1.79    | %    |  |   | 0.34    | %
|Weighted average interest rate on year end balances |  |               | 4.41    | % |      |   | 2.88    | %    |  |   | 0.52    | %

The investment and mortgage-backed securities underlying the dealer repurchase agreements were delivered to the
dealers who arranged the transactions. The dealers may have loaned such securities to other parties in the normal course of their operations and agreed to resell to the Bank the identical securities upon the maturities of the agreements.

At September 30, 2006, the Bank had pledged mortgage-backed securities and investment securities with a combined book value of $502.6 and $381.8 million to
secure securities sold under repurchase agreements and certain other short-term borrowings, respectively. Also at September 30, 2006, the Bank had pledged, but did not borrow against, other loans with a total principal balance of $1,080.1
million.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



23. FEDERAL HOME LOAN BANK ADVANCES  THE BANK:

At September 30, 2006 and 2005, advances from the Federal Home Loan Bank of Atlanta (FHLB) totaled $1,343.3 and $2,468.7 million, respectively. The
interest rate on each FHLB advance is fixed for the term of the advance and the weighted average interest rate for all advances was 4.50% at September 30, 2006. The advances mature over varying periods as follows:





|                                         |  |   |          
|---------------------------------------- |  | - | ---------
|(In thousands)                           |  |  
|Six months or less                       |  | $ | 767,180  
|More than six months through one year    |  |   | 145,476  
|More than one year through three years   |  |   | 364,875  
|More than three years through five years |  |   | 14,011   
|More than five years                     |  |   | 51,770   
|                                         |  |   |          
|Total                                    |  | $ | 1,343,312
|                                         |  |   |          

Under a Specific Collateral Agreement with the FHLB, advances are secured by the FHLB stock owned by the Bank and
qualifying first mortgage loans and certain second mortgage loans and/or lines with a total principal balance of $6,073.9 million. The FHLB requires that members maintain qualifying collateral at least equal to 100% of the members outstanding
advances at all times. The collateral held by the FHLB in excess of the amount of the September 30, 2006 advances is available to secure additional advances from the FHLB, subject to its collateralization guidelines.

24. CAPITAL NOTES - SUBORDINATED  THE BANK:

On
December 2, 2003, the Bank issued $175.0 million aggregate principal amount of 6-7/8% subordinated debentures due 2013 (the 2003 Debentures), which are subordinated to the interest of deposit account holders and other senior debt.
The Bank may redeem some or all of the 2003 Debentures at any time on and after December 1, 2008 at the following redemption prices plus accrued and unpaid interest:



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

The Bank received OTS approval to include the principal amount of the 2003 Debentures in the Banks
supplementary capital for regulatory capital purposes.

The indenture pursuant to which the 2003 Debentures were sold (the Indenture) provides
that the Bank may not pay dividends on its capital stock unless, after giving effect to the dividend, no event of default shall have occurred and be continuing and the Bank is in compliance with its regulatory capital requirements. In addition, the
amount of the proposed dividend may not exceed the sum of (i) $50.0 million, (ii) 66 2/3% of the Banks consolidated net income (as defined in the Indenture) accrued on a cumulative basis commencing on October 1, 2002 and
(iii) the aggregate net cash proceeds received by the Bank after October 1, 2002 from the sale of qualified capital stock or certain debt securities, minus the aggregate amount of any restricted payments made by the Bank. Notwithstanding
the above restrictions on dividends, provided no event of default has occurred or is continuing, the Indenture does not restrict the payment of dividends on the Series C Preferred Stock (as defined below).

Deferred debt issuance costs, net of accumulated amortization, amounted to $2.9 and $3.2 million at September 30, 2006 and 2005, respectively, and are included in
other assets in the Consolidated Statements of Financial Condition.



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25. PREFERRED STOCK  THE BANK:

In October 2003, the Bank sold $125.0 million of its 8% Noncumulative Perpetual Preferred Stock, Series C (the Series C Preferred Stock). The Series C Preferred Stock trades on the New York Stock Exchange
under the symbol CCX PrC. Dividends are payable quarterly in arrears at an annual rate of 8% on the Series C Preferred Stock only if the Board of Directors declares them and the OTS does not object. Dividends, once declared, are payable
on or before the fifteenth day of February, May, August and November of each year. Dividends not declared in a quarter will not be paid at any future time, except that upon a liquidation or redemption, accrued dividends for the current period will
be paid.

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

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

26. COMPENSATION PLANS  THE BANK:

The Bank participates in a defined contribution profit sharing retirement
plan (the Plan), which can be modified or discontinued at any time, and which covers those full-time employees who meet the requirements as specified in the Plan.

Corporate contributions, at the discretionary amount of up to six percent of the employees cash compensation, subject to certain limits, were $11.1, $10.2 and $9.2 million for the years ended September 30,
2006, 2005 and 2004, respectively. There are no past service costs associated with the Plan and the Bank has no liability under the Plan other than its current contributions. The Plan owns 4.0% of the Banks common stock.

The Bank provides a supplemental defined contribution profit sharing retirement plan (the SERP), which covers certain highly-compensated full-time employees
who meet the requirements as specified in the SERP. The SERP, which can be modified or discontinued at any time, requires participating employees to contribute 2.0% of their compensation in excess of a specified amount. Corporate contributions,
equal to three times the employees contribution, were $1.4, $1.5 and $1.2 million for the years ended September 30, 2006, 2005 and 2004, respectively.

There are no past service costs associated with the SERP. The Banks liability under the SERP, which includes contributions from employees and is not funded, was $19.2 and $16.3 million at September 30, 2006 and 2005,
respectively, and is included in other liabilities on the Consolidated Statements of Financial Condition.

The Bank has granted awards under a deferred
compensation plan to certain qualified employees. The deferred compensation plan provides that, as of the end of each fiscal year in the ten-year period prior to vesting, the Bank will add to or deduct from the account of each employee who has
received an award, a contribution or deduction, which represents hypothetical interest (which may be positive or negative) earned on the principal contribution, based on the Banks rate of return on average assets as defined in the deferred
compensation plan for the fiscal year then ended. The deferred compensation plan is unfunded. At September 30, 2006, the Bank had recorded a liability totaling $31.0 million reflecting the Banks obligations under the plan, which is
included in other liabilities on the Consolidated Statements of Financial Condition. The Banks expense under the deferred compensation plan totaled $6.7, $7.2 and $7.5 million during the years ended September 30, 2006, 2005 and 2004,
respectively.

Certain officers have entered into agreements with the Bank regarding confidentiality, nonsolicitation, ownership of certain works and
termination upon change of control. Each of those officers has agreed not to compete with, solicit customers of or solicit the employees of the Bank for stated periods following any termination of employment with the Bank. In addition, the Bank has
agreed to pay each such officer a specified amount if the officer is terminated without cause in the three-year period following a change of control of the Bank. The amount payable varies depending upon the officers base compensation and most
recent bonus, the length of the officers employment with the Bank and the per share price at which the triggering change of control has occurred.

Certain executive officers have also entered into Special Retirement Compensation Agreements under which the executive could receive an amount up to three times his base compensation if he retires from the Bank after reaching
age 63. These agreements are unfunded. As of September 30, 2006, the Bank had recorded a liability totaling $3.3 million, which is included in other liabilities on the Consolidated Statements of Financial Condition. The Banks expense
under the special retirement agreements totaled $617,000, $527,000 and $696,000 during the years ended September 30, 2006, 2005 and 2004, respectively.



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27. REGULATORY MATTERS  THE BANK:

The Banks regulatory capital requirements at September 30, 2006 and 2005 were a 1.5% tangible capital requirement, a 4.0% core capital requirement and an 8.0% total risk-based capital requirement. Under the
OTS prompt corrective action regulations, the Bank must maintain minimum leverage, tier 1 risk-based and total risk-based capital ratios of 4.0%, 4.0% and 8.0%, respectively, to meet the ratios established for adequately
capitalized institutions. At September 30, 2006 and 2005, the Bank was in compliance with its regulatory capital requirements and exceeded the capital standards established for well capitalized institutions under the
prompt corrective action regulations. The information below is based upon the Banks understanding of the applicable regulations and related interpretations.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



|                                                     |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|---------------------------------------------------- | ------ | ------------------ | --------- | ---------------- | --------------------------- | ----- | ------ | -------------- | ---------------- | ------- |  | ------ | - | ---------------- | - | ------- |  | ---- | -
|                                                     |        | September 30, 2006 |          
|(Dollars in thousands)                               |        | Actual             |           |                  | Minimum Capital Requirement |       |        | Excess Capital |                 
|                                                     | Amount |                    |           | As a % of Assets |                             |       | Amount |                | As a % of Assets |         |  | Amount |   | As a % of Assets |  
|Stockholders equity per financial statements        |        | $                  | 790,235   |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Minority interest in REIT Subsidiary(1)              |        |                    | 144,000   |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|                                                     |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Adjusted capital                                     |        |                    | 934,235   |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Adjustments for tangible and core capital:           |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Intangible assets                                    |        |                    | (58,307   | )                |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Non-includable subsidiaries                          |        |                    | (3,097    | )                |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Non-qualifying purchased / originated loan servicing |        |                    | (5,582    | )                |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|                                                     |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Total tangible capital                               |        |                    | 867,249   |                  |                             | 6.15  | %      |                | $                | 211,396 |  | 1.50   | % |                  | $ | 655,853 |  | 4.65 | %
|                                                     |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Total core capital(2)                                |        |                    | 867,249   |                  |                             | 6.15  | %      |                | $                | 563,722 |  | 4.00   | % |                  | $ | 303,527 |  | 2.15 | %
|                                                     |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Tier 1 risk-based capital(2)                         |        |                    | 867,249   |                  |                             | 9.12  | %      |                | $                | 380,911 |  | 4.00   | % |                  | $ | 486,338 |  | 5.12 | %
|                                                     |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Adjustments for total risk-based capital:            |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Subordinated capital debentures                      |        |                    | 175,000   |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Allowance for general loan losses                    |        |                    | 25,000    |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|                                                     |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Total supplementary capital                          |        |                    | 200,000   |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|                                                     |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Total available capital                              |        |                    | 1,067,249 |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Equity investments(3)                                |        |                    | (2,094    | )                |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|                                                     |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  
|Total risk-based capital(2)                          |        | $                  | 1,065,155 |                  |                             | 11.21 | %      |                | $                | 761,821 |  | 8.00   | % |                  | $ | 303,334 |  | 3.21 | %
|                                                     |        |                    |           |                  |                             |       |        |                |                  |         |  |        |   |                  |   |         |  |      |  

---

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



|(2) | Under the OTS prompt corrective action regulations, the standards for classification as well capitalized are a leverage (or core
capital) ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital ratio of at least 10.0%.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



|                                                     |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|---------------------------------------------------- | ------ | ------------------ | --------- | --------------- | --------------------------- | ----- | ------ | -------------- | -------------- | ------- |  | ------ | - | -------------- | - | ------- |  | ---- | -
|                                                     |        | September 30, 2005 |          
|(Dollars in thousands)                               |        | Actual             |           |                 | Minimum Capital Requirement |       |        | Excess Capital |               
|                                                     | Amount |                    |           | As a %of Assets |                             |       | Amount |                | As a %ofAssets |         |  | Amount |   | As a %ofAssets |  
|Stockholders equity per financial statements        |        | $                  | 762,056   |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Minority interest in REIT Subsidiary(1)              |        |                    | 144,000   |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|                                                     |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Adjusted capital                                     |        |                    | 906,056   |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Adjustments for tangible and core capital:           |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Intangible assets                                    |        |                    | (49,260   | )               |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Non-includable subsidiaries                          |        |                    | (12,522   | )               |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Non-qualifying purchased / originated loan servicing |        |                    | (3,416    | )               |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|                                                     |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Total tangible capital                               |        |                    | 840,858   |                 |                             | 5.92  | %      |                | $              | 212,982 |  | 1.50   | % |                | $ | 627,876 |  | 4.42 | %
|                                                     |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Total core capital(2)                                |        |                    | 840,858   |                 |                             | 5.92  | %      |                | $              | 567,953 |  | 4.00   | % |                | $ | 272,905 |  | 1.92 | %
|                                                     |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Tier 1 risk-based capital(2)                         |        |                    | 840,858   |                 |                             | 8.82  | %      |                | $              | 381,941 |  | 4.00   | % |                | $ | 458,917 |  | 4.82 | %
|                                                     |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Adjustments for total risk-based capital:            |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Subordinated capital debentures                      |        |                    | 175,000   |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Allowance for general loan losses                    |        |                    | 28,640    |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|                                                     |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Total supplementary capital                          |        |                    | 203,640   |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|                                                     |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Total available capital                              |        |                    | 1,044,498 |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Equity investments(3)                                |        |                    | (2,657    | )               |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|                                                     |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  
|Total risk-based capital(2)                          |        | $                  | 1,041,841 |                 |                             | 10.95 | %      |                | $              | 763,882 |  | 8.00   | % |                | $ | 277,959 |  | 2.95 | %
|                                                     |        |                    |           |                 |                             |       |        |                |                |         |  |        |   |                |   |         |  |      |  

---

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



|(2) | Under the OTS prompt corrective action regulations, the standards for classification as well capitalized are a leverage (or core
capital) ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital ratio of at least 10.0%.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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OTS capital regulations provide a five-year holding period (or such longer period as may be approved by the OTS) for REO
to qualify for an exception from treatment as an equity investment. If an REO property is considered an equity investment, its then current book value is deducted from total risk-based capital. Accordingly, if the Bank is unable to dispose of any
REO property (through bulk sales or otherwise) prior to the end of its applicable five-year holding period and is unable to obtain an extension of such five-year holding period from the OTS, the Bank could be required to deduct the then-current book
value of such REO property from total risk-based capital. In July 2006, the Bank received from the OTS an extension of the holding periods for certain of its REO properties through July 31, 2007.

The following table sets forth the Banks REO at September 30, 2006, by the fiscal year in which the property was acquired through foreclosure.

(In thousands)



|            |  |   |        |    
|----------- |  | - | ------ | ---
|Fiscal Year |  |   |       
|1990        |  | $ | 2,094  | (1)
|1991        |  |   | 10,263 | (2)
|1995        |  |   | 16,413 | (2)
|2006        |  |   | 3,540  |    
|            |  |   |        |    
|Total REO   |  | $ | 32,310 |    
|            |  |   |        |    

---

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



|(2) | The Bank received an extension of the holding periods for these properties through July 31, 2007.
|--- | -------------------------------------------------------------------------------------------------

OTS policies generally require that the Bank occupy at least 25% of an office building in order for it to be considered a permissible investment in office premises and
for the Bank to avoid having to deduct its investment in the building from total capital. OTS also provides a five-year grace period after a building is no longer sufficiently occupied by the Bank before it must either be sold or treated as an
equity investment and deducted from total capital. The Bank is seeking permission from the OTS to continue to treat as permissible office premises an office building it owns substantially all of which was occupied by the Bank until completion of the
Banks new headquarters building in December 2001. If the Bank is unsuccessful in those efforts, and the Bank continues to own the building, the book value of the building, which was $26.9 million at September 30, 2006, would have to
be deducted from the Banks total capital beginning as soon as December 31, 2006.

28. TRANSACTIONS WITH RELATED PARTIES  THE BANK:

Loans Receivable:

From time to time, in the
normal course of business, the Bank may make loans to executive officers and directors, their immediate family members or companies with which they are affiliated. These loans are on substantially the same terms as similar loans with unrelated
parties. An analysis of activity with respect to these loans is as follows:



|                  |      |                          |        |      |  |   |        |   |  |   |        |  
|----------------- | ---- | ------------------------ | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|(In thousands)    |      | Year Ended September 30, |       
|                  | 2006 |                          |        | 2005 |  |   | 2004   |  
|Beginning balance |      | $                        | 14,320 |      |  | $ | 17,604 |   |  | $ | 16,411 |  
|Additions         |      |                          | 3,826  |      |  |   | 5,335  |   |  |   | 2,847  |  
|Reductions        |      |                          | (6,705 | )    |  |   | (8,619 | ) |  |   | (1,654 | )
|                  |      |                          |        |      |  |   |        |   |  |   |        |  
|Ending balance    |      | $                        | 11,441 |      |  | $ | 14,320 |   |  | $ | 17,604 |  
|                  |      |                          |        |      |  |   |        |   |  |   |        |  



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Services:

B.F. Saul Company, which is a shareholder of the Trust, and its subsidiaries provide certain services to the Bank. These services include property management, insurance brokerage and leasing. Fees for these services were $1.6, $1.4 and $2.4
million for the years ended September 30, 2006, 2005 and 2004, respectively.

For each of the years ended September 30, 2006, 2005 and 2004, a
director of the Bank was paid $100,000 for consulting services rendered to the Bank and $5,000 for service on the Boards of Directors for two of the Banks subsidiaries. Another director of the Bank was paid $100,000 for services as Chairman of
the Banks Audit Committee. A third director of the Bank was paid total fees of $100,000 for consulting services rendered to two subsidiaries of the Bank and $5,000 for services as Chairman of the Board of Directors of those subsidiaries.

Tax Sharing Agreement:

The Bank and the other
companies in the Trusts affiliated group are parties to a tax sharing agreement (the Tax Sharing Agreement). The Tax Sharing Agreement provides for payments to be made by members of the Trusts affiliated group to the Trust
based on their separate company tax liabilities. The Tax Sharing Agreement also provides that, to the extent net operating losses or tax credits of a particular member are used to reduce the overall tax liability of the Trusts affiliated
group, such member will be reimbursed by the other members of the affiliated group that have taxable income in an amount equal to such tax reduction. The Bank made net payments of $2.0, $2.1 and $8.8 million to the Trust during fiscal 2006, 2005 and
2004, respectively, under the Tax Sharing Agreement. At September 30, 2006 and 2005, the estimated net tax sharing payment payable to the Real Estate Trust was $4.7 million and $1.8 million, respectively.

Other:

During the year ended September 30, 2005, two
subsidiaries of the Bank each sold a property to the Trust. A gain of $1.4 million, net of taxes, was recorded as a capital contribution because these transfers were between entities under common control.

The Bank paid $10.0, $8.9 and $9.0 million for office space leased from or managed by companies affiliated with the Bank or its directors during the years ended
September 30, 2006, 2005 and 2004, respectively.

The Trust, the B.F. Saul Company, Chevy Chase Lake Corporation and Van Ness Square Corporation,
affiliates of the Bank, from time to time maintain interest-bearing deposit accounts with the Bank. Those accounts had aggregate balances of $91.0 and $49.0 million at September 30, 2006 and 2005, respectively. The Bank paid interest on the
accounts amounting to $1.9 million, $952,000 and $436,000 during fiscal years ended 2006, 2005 and 2004, respectively.



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29. FINANCIAL INSTRUMENTS  THE BANK:

The Bank, in the normal course of business, is a party to financial instruments with off-balance-sheet risk and other derivative financial instruments to meet the financing needs of its customers and to reduce its own
exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit at both fixed and variable rates, letters of credit, interest-rate swap and cap agreements, forward purchase and sale commitments and assets
sold with limited recourse. All such financial instruments are held or issued for purposes other than trading.

These instruments involve, to varying
degrees, elements of credit and interest-rate risk in excess of the amount recognized in the Consolidated Statements of Financial Condition.

The
contractual or notional amount of these instruments reflects the extent of involvement the Bank has in particular classes of financial instruments. For interest-rate swap and cap agreements, assets sold with limited recourse and forward purchase and
sale commitments, the contractual or notional amounts do not represent exposure to credit loss in the event of nonperformance by the other party. The Bank uses the same credit policies in making commitments and conditional obligations as it does for
on-balance sheet instruments.

Commitments to Extend Credit:

The Bank had $3,479.7 million of commitments to extend credit at September 30, 2006. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established
in the agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. These commitments are subject to the Banks normal underwriting and credit evaluation policies and procedures.

Standby Letters of Credit:

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of
a customer to a third party. At September 30, 2006, the Bank had issued standby letters of credit in the amount of $125.9 million to guarantee the performance of and irrevocably assure payment by customers under construction projects. In
accordance with FASB Interpretation No. (FIN) 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, the Bank recorded a liability for the fair
value of its guarantee equal to $375,000.

Of the total, $61.0 million will expire in fiscal 2007 and the remainder will expire over time through fiscal
2012. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan commitments to customers.

Recourse Arrangements:

The Bank is obligated under various recourse provisions (primarily related to credit losses) related to the
securitization and sale of receivables. As a result of these securitization and sale activities, the Bank maintained restricted cash accounts amounting to $20.5 and $23.4 million at September 30, 2006 and 2005, respectively, which are included
in other assets in the Consolidated Statements of Financial Condition. Of these amounts, $2.5 and $4.7 million represented recourse to the Bank at September 30, 2006 and 2005, respectively.

The Bank is also obligated under recourse provisions related to the servicing of certain of its residential mortgage loans. Recourse to the Bank under these agreements
was $2.9 and $3.9 million at September 30, 2006 and 2005, respectively.

Derivative Financial Instruments:

In accordance with SFAS 133, the Bank assigns derivatives to one of these categories at the purchase date: fair value hedge, cash flow hedge or non-designated hedge. SFAS
133 requires an assessment of the expected and ongoing effectiveness of any derivative assigned to a fair value hedge or cash flow hedge relationship.

Fair Value HedgesFor derivatives designated as fair value hedges, the derivative instrument and related hedged item are marked to market through earnings. Derivatives are included in other assets in the Consolidated Statements
of Financial Condition.

During fiscal 2004, the Bank discontinued hedging the change in fair value of its mortgage servicing rights.

At September 30, 2006, the Bank had $75.0 million notional amount of forward sale commitments, which were designated as fair value hedges of loans held for sale. The
net unrealized loss in value of these commitments was $462,000 at September 30, 2006. The net unrealized gain in the value of the related hedged item was $628,000. The net unrealized gains and losses are included in other income in the
Consolidated Statement of Operations.



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Derivative Financial Instruments (Continued):

At September 30, 2005, the Bank had $127.5 million notional amount of forward sale commitments, which were designated as fair value hedges of loans held for sale. The net unrealized gain in value of these
commitments was $468,000 at September 30, 2005. The net unrealized loss in the value of the related hedged item was $528,000. The net unrealized gains and losses are included in other income in the Consolidated Statement of Operations. There
was no ineffectiveness during the year ended September 30, 2005.

Cash Flow Hedges For derivatives designated as cash flow hedges, mark
to market adjustments are recorded as a component of equity. At September 30, 2006 and 2005, the Bank did not have any derivatives designated as cash flow hedges.

Non-Designated Hedges Certain economic hedges are not designated as cash flow hedges or as fair value hedges for accounting purposes. As a result, changes in their fair value are recorded in other income
in the Consolidated Statements of Operations. The fair value of these derivatives is included in other assets in the Consolidated Statements of Financial Condition and are discussed below.

At September 30, 2006, the Bank had $73.0 million in forward sale commitments. The net unrealized loss in the value of these commitments was $236,000 at
September 30, 2006. In addition, at September 30, 2006, the Bank had interest rate locks (IRLs) with a notional amount of $89.1 million. The net unrealized gain in the value of the IRLs was $175,000.

At September 30, 2005, the Bank had $110.8 million in forward sale commitments. The net unrealized gain in the value of these commitments was $403,000 at
September 30, 2005. In addition, at September 30, 2005, the Bank had interest rate locks (IRLs) with a notional amount of $145.5 million. The net unrealized loss in the value of the IRLs was $393,000.

At September 30, 2006 and 2005, the Banks exposure for interest-rate swap and cap agreements was equal to their carrying amount of $9.0 and $14.6 million,
respectively.

Liquidity Facility:

In
connection with the securitization and sale of certain payment option residential mortgage loans, the Bank is obligated to fund a portion of any negative amortization resulting from the borrowers electing their option to make monthly
payments that are not sufficient to cover the interest accrued for the payment period. For each dollar of negative amortization funded by the Bank, the balances of certain highly-rated mortgage-backed securities received by the Bank as part of the
securitization transaction increase accordingly. When the borrowers ultimately make the principal payments, the Bank receives its pro rata portion of those payments in cash, and the balances of those securities held by the Bank are reduced
accordingly. During the year ended September 30, 2006, the Bank funded $164.3 million of negative amortization under these obligations, and received $52.0 million in principal payments representing previously funded negative amortization.

Concentrations of Credit:

The Banks
principal market is the metropolitan Washington, DC area. In addition, a significant portion of the Banks residential mortgage loans are secured by properties in California. Service industries and federal, state and local governments employ a
significant portion of the Washington, DC area labor force. Adverse changes in economic conditions in these areas could have a direct impact on the timing and amount of payments by borrowers.

30. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS  THE BANK:

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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The estimated fair values of the Banks financial instruments are as follows:



|                                                                                                                |                |               |            |      |                |  |            |            |  |           |  |  |  | 
|--------------------------------------------------------------------------------------------------------------- | -------------- | ------------- | ---------- | ---- | -------------- |  | ---------- | ---------- |  | --------- |  |  |  | 
|                                                                                                                |                | September 30,
|(In thousands)                                                                                                  |                | 2006          |            | 2005
|                                                                                                                | CarryingAmount |               | Fair Value |      | CarryingAmount |  | Fair Value
|Financial assets:                                                                                               |                |               |            |      |                |  |            |            |  |          
|Cash, due from banks and interest-bearing deposits                                                              |                | $             | 410,188    |      | $410,188       |  | $          | 507,499    |  | $507,499 
|Loans held for securitization and/or sale                                                                       |                |               | 467,574    |      | 476,801        |  |            | 1,718,132  |  | 1,804,230
|U.S. Government securities                                                                                      |                |               | 201,455    |      | 200,152        |  |            | 200,902    |  | 198,769  
|Mortgage-backed securities                                                                                      |                |               | 1,289,718  |      | 1,266,970      |  |            | 859,808    |  | 849,764  
|Loans receivable, net                                                                                           |                |               | 10,120,821 |      | 10,063,355     |  |            | 9,303,800  |  | 9,312,435
|Interest-only strips receivable                                                                                 |                |               | 344,317    |      | 344,317        |  |            | 348,227    |  | 348,227  
|Servicing assets, net                                                                                           |                |               | 168,059    |      | 174,781        |  |            | 164,592    |  | 177,492  
|Other financial assets                                                                                          |                |               | 144,479    |      | 144,479        |  |            | 182,803    |  | 182,803  
|Financial liabilities:                                                                                          |                |               |            |      |                |  |            |            |  |          
|Deposit accounts with no stated maturities                                                                      |                |               | 6,986,855  |      | 6,986,855      |  |            | 7,459,703  |  | 7,459,703
|Deposit accounts with stated maturities                                                                         |                |               | 3,458,909  |      | 3,469,791      |  |            | 2,322,065  |  | 2,328,642
|Securities sold under repurchase agreements and other short-term borrowings and Federal Home Loan Bank advances |                |               | 2,165,951  |      | 2,166,114      |  |            | 2,967,654  |  | 2,969,599
|Capital notes-subordinated                                                                                      |                |               | 172,072(1) |      | 172,947        |  |            | 171,770(1) |  | 176,583  
|Other financial liabilities                                                                                     |                |               | 247,879    |      | 247,879        |  |            | 262,731    |  | 262,731  

---

|(1) | Net of deferred debt issuance costs which are included in other assets in the Consolidated Statements of Financial Condition.
|--- | -----------------------------------------------------------------------------------------------------------------------------

The following methods and assumptions were used to estimate the fair value amounts at September 30, 2006 and 2005:

Cash, due from banks and, interest-bearing deposits,: Carrying amount approximates fair value.

Loans held for securitization and/or sale:The fair value of loans held for securitization and/or sale is determined using discounted cash flow analysis,
using quoted prices for loans or securities backed by loans with similar characteristics, or outstanding commitment prices from investors.

U.S.
Government securities:Fair value is based on quoted market prices.

Mortgage-backed securities: Fair value is based on quoted market
prices, dealer quotes or estimates using dealer quoted market prices for similar securities.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Loans receivable, net: Fair value of certain homogeneous groups of loans (e.g., single-family
residential, automobile loans, home improvement loans and fixed-rate commercial and multifamily loans) is estimated using discounted cash flow analyses based on contractual repayment schedules and managements estimate of future prepayment
rates. The discount rates used in these analyses are based on either the interest rates paid on U.S.

Treasury securities of comparable maturities adjusted
for credit risk and non-interest operating costs, or the interest rates currently offered by the Bank for loans with similar terms to borrowers of similar credit quality. For loans, which reprice frequently at market rates (e.g., home equity,
variable-rate commercial and multifamily, real estate construction and ground loans), the carrying amount approximates fair value. The fair value of the Banks loan portfolio as presented above does not include the value of established credit
line customer relationships, or the value relating to estimated cash flows from future receivables and the associated fees generated from existing customers.

Interest-only strips receivable:Interest-only strips receivable are carried at fair value.

Servicing assets, net:Fair value of servicing assets is estimated using discounted cash flow analyses based on contractual repayment schedules and managements estimate of future prepayment rates.

Other financial assets: The carrying amount of Federal Home Loan Bank stock, accrued interest receivable, interest-bearing deposits maintained pursuant to
various asset securitizations and other short-term receivables approximate fair value. Derivative financial instruments are carried at fair value.

Deposit accounts with no stated maturities: Deposit liabilities payable on demand, consisting of NOW accounts, money market deposits, statement savings and other deposit accounts, are assumed to have an estimated fair value
equal to carrying value. The indicated fair value does not consider the value of the Banks established deposit customer relationships.

Deposit
accounts with stated maturities:Fair value of fixed-rate certificates of deposit is estimated based on the remaining maturity of the underlying accounts and interest rates currently offered on certificates of deposits with similar
maturities.

Securities sold under repurchase agreements and other short-term borrowings and Federal Home Loan Bank advances:For these
borrowings, which either reprice frequently to market interest rates or are short-term in duration, the carrying amount approximates fair value. Fair value of the remaining amounts borrowed is estimated based on discounted cash flow analyses using
interest rates currently charged by the lender for comparable borrowings with similar remaining maturities.

Capital notes-subordinated: Fair
value of the Banks subordinated debentures is based on quoted market prices.

Other financial liabilities: The carrying amount of
custodial accounts, amounts due to banks, accrued interest payable and other short-term payables approximates fair value.

31. BUSINESS SEGMENTS 
THE BANK:

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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Selected segment information is as follows:



|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|----------------------------- |  | ------------- | ---------- | - | ----------------- | - | --------- | ----------- |  | - | ------ | - |  | - | ---------- | -
|(In thousands)                |  | RetailBanking |            |   | CommercialBanking |   |           | Non-banking |  |   | Total  |  
|Year ended September 30, 2006 |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Core Operating income         |  | $             | 731,625    |   |                   | $ | 53,483    |             |  | $ | 33,342 |   |  | $ | 818,450    |  
|Core Operating expense        |  |               | 612,957    |   |                   |   | 27,783    |             |  |   | 33,531 |   |  |   | 674,271    |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Core earnings (loss)          |  |               | 118,668    |   |                   |   | 25,700    |             |  |   | (189   | ) |  |   | 144,179    |  
|Non-core items                |  |               | (4,000     | ) |                   |   | (437      | )           |  |   | (939   | ) |  |   | (5,376     | )
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Operating income (loss)       |  | $             | 114,668    |   |                   | $ | 25,263    |             |  |   | (1,128 | ) |  | $ | 138,803    |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Average assets                |  | $             | 13,101,110 |   |                   | $ | 1,389,027 |             |  | $ | 53,073 |   |  | $ | 14,543,210 |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Year ended September 30, 2005 |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Core Operating income         |  | $             | 736,977    |   |                   | $ | 44,836    |             |  | $ | 18,827 |   |  | $ | 800,640    |  
|Core Operating expense        |  |               | 589,953    |   |                   |   | 25,809    |             |  |   | 24,739 |   |  |   | 640,501    |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Core earnings (loss)          |  |               | 147,024    |   |                   |   | 19,027    |             |  |   | (5,912 | ) |  |   | 160,139    |  
|Non-core items                |  |               | 28,711     |   |                   |   | 877       |             |  |   | (32    | ) |  |   | 29,556     |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Operating income (loss)       |  | $             | 175,735    |   |                   | $ | 19,904    |             |  | $ | (5,944 | ) |  | $ | 189,695    |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Average assets                |  | $             | 12,723,216 |   |                   | $ | 1,262,957 |             |  | $ | 37,783 |   |  | $ | 14,023,965 |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Year ended September 30, 2004 |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Core Operating income         |  | $             | 762,495    |   |                   | $ | 36,738    |             |  | $ | 14,847 |   |  | $ | 814,080    |  
|Core Operating expense        |  |               | 557,697    |   |                   |   | 23,375    |             |  |   | 20,606 |   |  |   | 601,678    |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Core earnings (loss)          |  |               | 204,798    |   |                   |   | 13,363    |             |  |   | (5,759 | ) |  |   | 212,402    |  
|Non-core items                |  |               | 11,680     |   |                   |   | 7,133     |             |  |   |       |   |  |   | 18,813     |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Operating income (loss)       |  | $             | 216,478    |   |                   | $ | 20,496    |             |  | $ | (5,759 | ) |  | $ | 231,215    |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  
|Average assets                |  | $             | 11,625,320 |   |                   | $ | 1,159,089 |             |  | $ | 36,021 |   |  | $ | 12,820,431 |  
|                              |  |               |            |   |                   |   |           |             |  |   |        |   |  |   |            |  

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

At September 30, 2006, goodwill of $18.3 million related to the retail banking segment and $37.3 million related to two reporting units within the asset management
segment and is included in the non-banking segment.



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32. 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.

During the fiscal year ended September 30, 2006, the Bank settled for $16.1 million a seven year old class action lawsuit related to its prior credit card business which the Bank sold in 1998. The settlement completely resolves the
case and the settlement amount includes plaintiffs counsels legal fees, the administrative costs of the claims and notification process as well as payment of alleged damages.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



33. QUARTERLY FINANCIAL DATA  THE BANK (Unaudited):

The quarterly financial data of the Bank herein has been derived from the unaudited quarterly financial statements of the Company. The data should be read in conjunction
with Managements Discussion and Analysis of Financial Condition and Results of Operations and the financial statements included elsewhere herein. The quarterly data contains information of the Bank only and does not include
consolidation or elimination entries required for the Trusts financial presentation.

Chevy Chase Bank, F.S.B.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(Unaudited)



|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|----------------------------------------------------- |  | --------------------- | ------- | - | ---------- | - | ------- | --------- |  | - | -------------- | - |  | - | ------- | -
|                                                      |  | For the quarter ended |        
|(In thousands)                                        |  | December 2005         |         |   | March 2006 |   |         | June 2006 |  |   | September 2006 |  
|OPERATING DATA:                                       |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Interest income                                       |  | $                     | 169,396 |   |            | $ | 184,952 |           |  | $ | 187,766        |   |  | $ | 192,889 |  
|Interest expense                                      |  |                       | 69,221  |   |            |   | 78,029  |           |  |   | 82,133         |   |  |   | 88,788  |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Net interest income                                   |  |                       | 100,175 |   |            |   | 106,923 |           |  |   | 105,633        |   |  |   | 104,101 |  
|Credit for loan losses                                |  |                       | (557    | ) |            |   | (1,222  | )         |  |   | (5,837         | ) |  |   | (1,388  | )
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Net interest income after credit for loan losses      |  |                       | 100,732 |   |            |   | 108,145 |           |  |   | 111,470        |   |  |   | 105,489 |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Other income                                          |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Deposit servicing fees                                |  |                       | 35,519  |   |            |   | 33,610  |           |  |   | 37,308         |   |  |   | 38,111  |  
|Servicing, securitization and mortgage banking income |  |                       | 51,672  |   |            |   | 9,527   |           |  |   | 57,217         |   |  |   | 40,365  |  
|Automobile rental income, net                         |  |                       | 12,526  |   |            |   | 10,051  |           |  |   | 7,410          |   |  |   | 5,209   |  
|Other                                                 |  |                       | 12,841  |   |            |   | 16,709  |           |  |   | 13,301         |   |  |   | 13,543  |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Total other income                                    |  |                       | 112,558 |   |            |   | 69,897  |           |  |   | 115,236        |   |  |   | 97,228  |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Operating expenses                                    |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Salaries and employee benefits                        |  |                       | 71,888  |   |            |   | 79,746  |           |  |   | 79,408         |   |  |   | 78,323  |  
|Servicing assets amortization and other loan expenses |  |                       | 22,178  |   |            |   | 25,576  |           |  |   | 25,380         |   |  |   | 30,562  |  
|Property and equipment                                |  |                       | 13,258  |   |            |   | 13,551  |           |  |   | 14,293         |   |  |   | 14,730  |  
|Marketing                                             |  |                       | 5,677   |   |            |   | 4,037   |           |  |   | 7,778          |   |  |   | 4,669   |  
|Data processing                                       |  |                       | 9,997   |   |            |   | 9,672   |           |  |   | 9,486          |   |  |   | 9,558   |  
|Depreciation and amortization                         |  |                       | 19,895  |   |            |   | 18,539  |           |  |   | 15,935         |   |  |   | 15,096  |  
|Other                                                 |  |                       | 14,813  |   |            |   | 18,951  |           |  |   | 32,347         |   |  |   | 16,609  |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Total operating expenses                              |  |                       | 157,706 |   |            |   | 170,072 |           |  |   | 184,627        |   |  |   | 169,547 |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Total Banking Operating Income                        |  | $                     | 55,584  |   |            | $ | 7,970   |           |  | $ | 42,079         |   |  | $ | 33,170  |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|----------------------------------------------------- |  | --------------------- | ------- | - | ---------- | - | ------- | --------- |  | - | -------------- | - |  | - | ------- | -
|                                                      |  | For the quarter ended |        
|(In thousands)                                        |  | December 2004         |         |   | March 2005 |   |         | June 2005 |  |   | September 2005 |  
|OPERATING DATA:                                       |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Interest income                                       |  | $                     | 126,007 |   |            | $ | 134,702 |           |  | $ | 148,709        |   |  | $ | 163,345 |  
|Interest expense                                      |  |                       | 42,217  |   |            |   | 45,294  |           |  |   | 54,472         |   |  |   | 65,210  |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Net interest income                                   |  |                       | 83,790  |   |            |   | 89,408  |           |  |   | 94,237         |   |  |   | 98,135  |  
|Credit for loan losses                                |  |                       | (383    | ) |            |   | (4,093  | )         |  |   | (4,236         | ) |  |   | (2,857  | )
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Net interest income after credit for loan losses      |  |                       | 84,173  |   |            |   | 93,501  |           |  |   | 98,473         |   |  |   | 100,992 |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Other income                                          |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Deposit servicing fees                                |  |                       | 34,091  |   |            |   | 31,788  |           |  |   | 34,529         |   |  |   | 35,871  |  
|Servicing, securitization and mortgage banking income |  |                       | 65,028  |   |            |   | 58,791  |           |  |   | 23,396         |   |  |   | 24,627  |  
|Automobile rental income, net                         |  |                       | 25,249  |   |            |   | 22,309  |           |  |   | 19,083         |   |  |   | 15,322  |  
|Other                                                 |  |                       | 9,275   |   |            |   | 12,484  |           |  |   | 16,493         |   |  |   | 14,264  |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Total other income                                    |  |                       | 133,643 |   |            |   | 125,372 |           |  |   | 93,501         |   |  |   | 90,084  |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Operating expenses                                    |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Salaries and employee benefits                        |  |                       | 63,995  |   |            |   | 65,432  |           |  |   | 66,625         |   |  |   | 70,549  |  
|Servicing assets amortization and other loan expenses |  |                       | 15,490  |   |            |   | 14,742  |           |  |   | 35,919         |   |  |   | 30,481  |  
|Property and equipment                                |  |                       | 10,715  |   |            |   | 11,450  |           |  |   | 11,390         |   |  |   | 13,060  |  
|Marketing                                             |  |                       | 3,285   |   |            |   | 3,994   |           |  |   | 6,176          |   |  |   | 5,793   |  
|Data processing                                       |  |                       | 8,268   |   |            |   | 8,938   |           |  |   | 8,583          |   |  |   | 8,875   |  
|Depreciation and amortization                         |  |                       | 30,098  |   |            |   | 27,814  |           |  |   | 24,006         |   |  |   | 21,401  |  
|Other                                                 |  |                       | 16,150  |   |            |   | 15,704  |           |  |   | 15,477         |   |  |   | 15,634  |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Total operating expenses                              |  |                       | 148,001 |   |            |   | 148,074 |           |  |   | 168,176        |   |  |   | 165,793 |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  
|Total Banking Operating Income                        |  | $                     | 69,815  |   |            | $ | 70,799  |           |  | $ | 23,798         |   |  | $ | 25,283  |  
|                                                      |  |                       |         |   |            |   |         |           |  |   |                |   |  |   |         |  



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



34. MINORITY INTERESTTHE TRUST:

At September 30, 2006 and 2005, minority interest held by affiliates of $130.5 and $124.9 million represent the 20% minority interest in the Banks common shares.

Minority interest  other consists of the following:



|                                                 |  |               |         |      |   |        
|------------------------------------------------ |  | ------------- | ------- | ---- | - | -------
|                                                 |  | September 30,
|(In thousands)                                   |  | 2006          |         | 2005
|Preferred Stock of Chevy Chases REIT subsidiary |  | $             | 144,000 |      | $ | 144,000
|Chevy Chases Preferred Stock (See Note 25)      |  |               | 120,622 |      |   | 120,622
|Chevy Chases ground lease (See below)           |  |               | 31,391  |      |   | 31,391 
|                                                 |  |               |         |      |   |        
|Total minority interestother                    |  | $             | 296,013 |      | $ | 296,013
|                                                 |  |               |         |      |   |        

At September 30, 2006, the Bank is the primary beneficiary of one variable interest entity which holds the
ground lease under the Banks executive offices. In April 1998, the Bank entered into a ground lease agreement with a single purpose LLC. The LLCs only significant asset is the land on which the Banks executive office building was
constructed. Lease payments made to the LLC are presented as minority interest in the Consolidated Statements of Operations beginning July 1, 2003. The following is a schedule by years of the future lease payments under the agreement as of
September 30, 2006:



|                          |  |                |        
|------------------------- |  | -------------- | -------
|Year Ending September 30, |  | (In thousands)
|2007                      |  | $              | 3,650  
|2008                      |  |                | 3,723  
|2009                      |  |                | 3,798  
|2010                      |  |                | 3,874  
|2011                      |  |                | 3,951  
|Thereafter                |  |                | 266,357
|                          |  |                |        
|Total                     |  | $              | 285,353
|                          |  |                |        

The lease, which expires in year 2062, is subject to fixed rent adjustments. At the end of the lease term, the
Bank has the option to purchase the land for $84.1 million from the LLC. The lease also allows the owners of the LLC to put their equity interests in the LLC to the Bank, subject to certain limitations.

The Bank consolidated the assets and liabilities of the LLC. As a result, property and equipment and minority interest on the Consolidated Balance Sheets each include
$31.4 million at September 30, 2006 and 2005 related to the Banks involvement with the LLC.

Minority interest also includes the net cash
proceeds received by a subsidiary of the Bank (the REIT Subsidiary) from the sale of $150.0 million of its Noncumulative Exchangeable Preferred Stock, Series A, par value $5 per share (the REIT Preferred Stock). Cash
dividends on the REIT Preferred Stock are payable quarterly in arrears at an annual rate of 10-3/8%. The
liquidation value of each share of REIT Preferred Stock is $50 plus accrued and unpaid dividends. Except under certain limited circumstances, the holders of the REIT Preferred Stockholders have no voting rights. The REIT Preferred Stock is
automatically exchangeable for a new series of Preferred Stock of the Bank upon the occurrence of certain events.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Preferred Stockholders have no voting rights. The REIT Preferred Stock is automatically exchangeable for a new series
of Preferred Stock of the Bank upon the occurrence of certain events.

The REIT Preferred Stock is redeemable at the option of the REIT subsidiary at any
time on or after January 15, 2007, in whole or in part, at the following per share redemption prices plus accrued and unpaid dividends:



|                                                             |  |                  |       
|------------------------------------------------------------ |  | ---------------- | ------
|If redeemed during the 12-month period beginning January 15, |  | Redemption Price
|2007                                                         |  | $                | 52.594
|2008                                                         |  | $                | 52.075
|2009                                                         |  | $                | 51.556
|2010                                                         |  | $                | 51.038
|2011                                                         |  | $                | 50.519
|2012 and thereafter                                          |  | $                | 50.000

The Bank received OTS approval to include the net proceeds from the sale of the REIT Preferred Stock in the core
capital of the Bank for regulatory capital purposes in an amount up to 25% of the Banks core capital. Dividends on the REIT Preferred Stock are presented as minority interest in the Consolidated Statements of Operations.

35. INCOME TAXESTHE TRUST:

The Trust voluntarily terminated
its qualification as a real estate investment trust under the Internal Revenue Code during fiscal 1978.

The provisions for income taxes for the years
ended September 30, 2006, 2005 and 2004, consist of the following:



|                                        |  |                          |        |   |      |   |         |      |  |   |         |  
|--------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                        |  | Year Ended September 30, |       
|(In thousands)                          |  | 2006                     |        |   | 2005 |   |         | 2004 | 
|Current provision (benefit):            |  |                          |        |   |      |   |         |      |  |   |         |  
|Federal                                 |  | $                        | 43,224 |   |      | $ | 88,146  |      |  | $ | 114,214 |  
|State                                   |  |                          | 2,869  |   |      |   | 5,513   |      |  |   | 6,389   |  
|                                        |  |                          |        |   |      |   |         |      |  |   |         |  
|                                        |  |                          | 46,093 |   |      |   | 93,659  |      |  |   | 120,603 |  
|                                        |  |                          |        |   |      |   |         |      |  |   |         |  
|Deferred provision (benefit):           |  |                          |        |   |      |   |         |      |  |   |         |  
|Federal                                 |  |                          | (5,277 | ) |      |   | (37,567 | )    |  |   | (55,982 | )
|State                                   |  |                          | 482    |   |      |   | 2,513   |      |  |   | 5,258   |  
|                                        |  |                          |        |   |      |   |         |      |  |   |         |  
|                                        |  |                          | (4,795 | ) |      |   | (35,054 | )    |  |   | (50,724 | )
|                                        |  |                          |        |   |      |   |         |      |  |   |         |  
|Total                                   |  | $                        | 41,298 |   |      | $ | 58,605  |      |  | $ | 69,879  |  
|                                        |  |                          |        |   |      |   |         |      |  |   |         |  
|Tax effect of other equity transactions |  | $                        | 1,210  |   |      | $ | 1,309   |      |  | $ | 1,120   |  
|                                        |  |                          |        |   |      |   |         |      |  |   |         |  

The Trusts effective income tax rate varies from the statutory Federal income tax rate as a result of the
following factors:



|                                                                                     |  |                          |        |   |      |   |        |      |  |   |        |  
|------------------------------------------------------------------------------------ |  | ------------------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                     |  | Year Ended September 30, |       
|(In thousands)                                                                       |  | 2006                     |        |   | 2005 |   |        | 2004 | 
|Computed tax at statutory Federal income tax rate                                    |  | $                        | 49,325 |   |      | $ | 63,276 |      |  | $ | 72,396 |  
|Increase (reduction) in taxes resulting from:                                        |  |                          |        |   |      |   |        |      |  |   |        |  
|Minority interest                                                                    |  |                          | (6,675 | ) |      |   | (6,675 | )    |  |   | (6,651 | )
|Change in valuation allowance for deferred tax asset allocated to income tax expense |  |                          | (1,317 | ) |      |   | (1,414 | )    |  |   | (707   | )
|State income taxes                                                                   |  |                          | 3,086  |   |      |   | 7,241  |      |  |   | 7,573  |  
|Tax credits                                                                          |  |                          | (1,097 | ) |      |   | (2,374 | )    |  |   | (1,316 | )
|Other                                                                                |  |                          | (2,024 | ) |      |   | (1,449 | )    |  |   | (1,416 | )
|                                                                                     |  |                          |        |   |      |   |        |      |  |   |        |  
|Total                                                                                |  | $                        | 41,298 |   |      | $ | 58,605 |      |  | $ | 69,879 |  
|                                                                                     |  |                          |        |   |      |   |        |      |  |   |        |  



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The components of the net deferred tax asset (liability) were as follows:



|                                               |  |               |         |   |      |   |         |  
|---------------------------------------------- |  | ------------- | ------- | - | ---- | - | ------- | -
|                                               |  | September 30, |        
|(In thousands)                                 |  | 2006          |         |   | 2005 |  
|Deferred tax assets:                           |  |               |         |   |      |   |         |  
|Unrealized gains on loans and investments, net |  | $             | 1,202   |   |      | $ | 22,147  |  
|State net operating loss carry forwards        |  |               | 15,930  |   |      |   | 20,187  |  
|Asset securitizations, net                     |  |               | 25,221  |   |      |   | 20,532  |  
|Allowance for loan and real estate losses      |  |               | 16,891  |   |      |   | 18,400  |  
|Deferred compensation                          |  |               | 20,982  |   |      |   | 19,169  |  
|Other                                          |  |               | 7,475   |   |      |   | 5,893   |  
|                                               |  |               |         |   |      |   |         |  
|Gross deferred tax assets                      |  |               | 87,701  |   |      |   | 106,328 |  
|                                               |  |               |         |   |      |   |         |  
|Deferred tax liabilities:                      |  |               |         |   |      |   |         |  
|Automobile leasing                             |  |               | 11,704  |   |      |   | 44,000  |  
|Saul Holdings and Saul Centers                 |  |               | 47,472  |   |      |   | 47,530  |  
|Originated servicing rights                    |  |               | 47,017  |   |      |   | 44,634  |  
|Property and depreciation                      |  |               | 15,321  |   |      |   | 16,383  |  
|Deferred expenses and other                    |  |               | 43,764  |   |      |   | 33,687  |  
|                                               |  |               |         |   |      |   |         |  
|Gross deferred tax liabilities                 |  |               | 165,278 |   |      |   | 186,234 |  
|                                               |  |               |         |   |      |   |         |  
|                                               |  |               | (77,577 | ) |      |   | (79,906 | )
|Valuation allowance                            |  |               | (8,149  | ) |      |   | (9,404  | )
|                                               |  |               |         |   |      |   |         |  
|Net deferred tax liability                     |  | $             | (85,726 | ) |      | $ | (89,310 | )
|                                               |  |               |         |   |      |   |         |  

At September 30, 2006, the Real Estate Trust and the Bank had state net operating loss carryovers totaling
approximately $202.4 and $109.2 million, respectively. The state net operating loss carryovers will expire in the years 2007 through 2026.

The Trust
establishes a valuation allowance against the gross deferred tax asset to the extent the Trust cannot determine that it is more likely than not such assets will be realized through taxes available in carryback years, future reversals of existing
taxable temporary differences or projected future taxable income. Such a valuation allowance has been established to reduce the gross deferred asset for state net operating loss carryforwards to an amount that is considered more likely than not to
be realized. In fiscal years 2006 and 2005, the Real Estate Trust determined it will be able to utilize currently some of its state net operating loss carryforwards and, as a result, decreased the valuation allowance by $1.3 and $1.4 million,
respectively. In addition, at the Real Estate Trust, state net operating loss carryforwards in excess of state deferred tax liabilities are fully reserved due to expected future state tax losses.

Management believes the existing net deductible temporary differences will reverse during periods in which the Bank generates taxable income in excess of Real Estate
Trust taxable losses. Management believes that the positive consolidated earnings will continue as a result of the Banks earnings.

TAX SHARING
AGREEMENT

The Trusts affiliated group, including the Bank, entered into a tax sharing agreement dated June 28, 1990, as amended. This
agreement provides that payments be made by members of the affiliated group to the Trust based on their respective allocable shares of the overall federal income tax liability of the affiliated group for taxable years and partial taxable years
beginning on or after that date. In addition, the agreement also applies if some or all of the members file a consolidated return in any state.

Allocable
shares of the overall tax liability are prorated among the members with taxable income calculated on a separate return basis. The agreement also provides that, to the extent net operating losses or tax credits of a particular member are used to
reduce overall tax liability of the Trusts affiliated group, such member will be reimbursed on a dollar-for-dollar basis by the other members of the affiliated group that have taxable income in an amount equal to such tax reduction. Under the
tax sharing agreement, the Bank paid $2.0, $2.1 and $8.8 million, to the Real Estate Trust during fiscal 2006, 2005 and 2004. At September 30, 2006, the Real Estate Trust was due $4.7 million from the Bank under the tax sharing agreement.

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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



36. SHAREHOLDERS EQUITYTHE TRUST:

In June 1990, the Trust acquired from affiliated companies an additional equity interest in the Bank, which raised the Trusts ownership share of the Bank to 80%. In exchange for the interest acquired, the Trust
issued 450,000 shares of a new class of $10.50 cumulative preferred shares of beneficial interest with a par value of $1 (the preferred shares). The transaction has been accounted for at historical cost in a manner similar to the pooling
of interests method because the entities are considered to be under common control. In addition, the Trust acquired two real estate properties from an affiliate in exchange for 66,000 preferred shares.

The Trust paid preferred dividends of $5.4, $5.4 and $11.6 million per year in fiscal 2006, 2005 and 2004, respectively. At September 30, 2006 and 2005, there were
no dividends in arrears on the preferred shares.

37. INDUSTRY SEGMENT INFORMATIONREAL ESTATE TRUST:

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



|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                            |  | Year Ended September 30 |        
|(In thousands)                                                              |  | 2006                    |         |   | 2005 |   |         | 2004 | 
|INCOME (from continuing operations)                                         |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 127,238 |   |      | $ | 98,621  |      |  | $ | 84,477  |  
|Office and industrial properties                                            |  |                         | 39,984  |   |      |   | 39,466  |      |  |   | 38,225  |  
|Other                                                                       |  |                         | 2,415   |   |      |   | 1,417   |      |  |   | 944     |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  | $                       | 169,637 |   |      | $ | 139,504 |      |  | $ | 123,646 |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|OPERATING PROFIT (LOSS) (from continuing operations) (1)                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 37,137  |   |      | $ | 27,316  |      |  | $ | 20,811  |  
|Office and industrial properties                                            |  |                         | 18,303  |   |      |   | 19,857  |      |  |   | 19,558  |  
|Other                                                                       |  |                         | 1,215   |   |      |   | 322     |      |  |   | (49     | )
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  |                         | 56,655  |   |      |   | 47,495  |      |  |   | 40,320  |  
|Equity earnings of unconsolidated entities                                  |  |                         | 10,051  |   |      |   | 8,246   |      |  |   | 7,788   |  
|Impairment loss on investments                                              |  |                         |        |   |      |   |        |      |  |   |        |  
|Gain on sales of property                                                   |  |                         | 416     |   |      |   | 263     |      |  |   | 2,769   |  
|Interest and amortization of debt expense                                   |  |                         | (50,516 | ) |      |   | (46,503 | )    |  |   | (58,645 | )
|Advisory fee, management and leasing feesrelated parties                   |  |                         | (15,480 | ) |      |   | (13,448 | )    |  |   | (12,437 | )
|General and administrative                                                  |  |                         | (3,156  | ) |      |   | (3,421  | )    |  |   | (2,443  | )
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Operating loss from continuing operations                                   |  | $                       | (2,030  | ) |      | $ | (7,368  | )    |  | $ | (22,648 | )
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|IDENTIFIABLE ASSETS (AT YEAR END)                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 299,452 |   |      | $ | 186,484 |      |  | $ | 184,697 |  
|Office and industrial properties                                            |  |                         | 140,709 |   |      |   | 130,268 |      |  |   | 124,966 |  
|Other                                                                       |  |                         | 222,651 |   |      |   | 149,078 |      |  |   | 148,506 |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  | $                       | 662,812 |   |      | $ | 465,830 |      |  | $ | 458,169 |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|INTEREST AND AMORTIZATION OF DEBT EXPENSE (from continuing operations)      |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 14,262  |   |      | $ | 10,538  |      |  | $ | 11,000  |  
|Office and industrial properties                                            |  |                         | 12,456  |   |      |   | 11,616  |      |  |   | 12,000  |  
|Other                                                                       |  |                         | 23,798  |   |      |   | 24,349  |      |  |   | 35,645  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  | $                       | 50,516  |   |      | $ | 46,503  |      |  | $ | 58,645  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|DEPRECIATION (from continuing operations)                                   |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 12,060  |   |      | $ | 11,303  |      |  | $ | 10,761  |  
|Office and industrial properties                                            |  |                         | 8,307   |   |      |   | 7,552   |      |  |   | 6,862   |  
|Other                                                                       |  |                         | 23      |   |      |   | 23      |      |  |   | 23      |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  | $                       | 20,390  |   |      | $ | 18,878  |      |  | $ | 17,646  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|CAPITAL EXPENDITURES AND PROPERTY ACQUISITIONS (from continuing operations) |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 117,066 |   |      | $ | 8,174   |      |  | $ | 11,421  |  
|Office and industrial properties                                            |  |                         | 17,777  |   |      |   | 11,070  |      |  |   | 4,782   |  
|Other                                                                       |  |                         | 31,000  |   |      |   | 9,980   |      |  |   | 247     |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  | $                       | 165,843 |   |      | $ | 29,224  |      |  | $ | 16,450  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  



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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



38. CONDENSED FINANCIAL STATEMENTS  THE TRUST:

These condensed financial statements reflect the Real Estate Trust and all its consolidated subsidiaries except for the Bank which has been reflected on the equity
method.

CONDENSED BALANCE SHEETS



|                                                     |  |              |           |   |      |   |          |  
|---------------------------------------------------- |  | ------------ | --------- | - | ---- | - | -------- | -
|                                                     |  | September 30 |          
|(In thousands)                                       |  | 2006         |           |   | 2005 |  
|ASSETS                                               |  |              |           |   |      |   |          |  
|Income-producing properties                          |  | $            | 570,948   |   |      | $ | 441,915  |  
|Accumulated depreciation                             |  |              | (197,855  | ) |      |   | (182,255 | )
|                                                     |  |              |           |   |      |   |          |  
|                                                     |  |              | 373,093   |   |      |   | 259,660  |  
|Land parcels                                         |  |              | 44,582    |   |      |   | 48,029   |  
|Construction in progress                             |  |              | 34,946    |   |      |   |         |  
|Real estate held for sale - net of depreciation      |  |              |          |   |      |   | 11,168   |  
|Equity investment in bank                            |  |              | 522,283   |   |      |   | 499,895  |  
|Equity investment in Saul Holdings and Saul Centers  |  |              | 89,802    |   |      |   | 75,323   |  
|Cash and cash equivalents                            |  |              | 46,391    |   |      |   | 13,920   |  
|Note receivable and accrued interest - related party |  |              | 10,300    |   |      |   | 13,100   |  
|Other assets                                         |  |              | 63,535    |   |      |   | 44,467   |  
|                                                     |  |              |           |   |      |   |          |  
|TOTAL ASSETS                                         |  | $            | 1,184,932 |   |      | $ | 965,562  |  
|                                                     |  |              |           |   |      |   |          |  
|LIABILITIES                                          |  |              |           |   |      |   |          |  
|Mortgage notes payable                               |  | $            | 488,339   |   |      | $ | 278,411  |  
|Mortgage notes payable - real estate held for sale   |  |              |          |   |      |   | 15,917   |  
|Notes payable  secured                              |  |              | 250,000   |   |      |   | 250,000  |  
|Notes payable  unsecured                            |  |              | 21,398    |   |      |   | 57,760   |  
|Other liabilities and accrued expenses               |  |              | 72,642    |   |      |   | 58,131   |  
|                                                     |  |              |           |   |      |   |          |  
|Total liabilities                                    |  |              | 832,379   |   |      |   | 660,219  |  
|                                                     |  |              |           |   |      |   |          |  
|TOTAL SHAREHOLDERS EQUITY                           |  |              | 352,553   |   |      |   | 305,343  |  
|                                                     |  |              |           |   |      |   |          |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY           |  | $            | 1,184,932 |   |      | $ | 965,562  |  
|                                                     |  |              |           |   |      |   |          |  

---

|* | See Consolidated Statements of Shareholders Equity
|- | ---------------------------------------------------

CONDENSED
STATEMENTS OF OPERATIONS



|                                                      |  |                                 |          |   |      |   |          |      |  |   |          |  
|----------------------------------------------------- |  | ------------------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                      |  | For the Year Ended September 30 |         
|(In thousands)                                        |  | 2006                            |          |   | 2005 |   |          | 2004 | 
|Total income                                          |  | $                               | 169,637  |   |      | $ | 139,504  |      |  | $ | 123,646  |  
|Total expenses                                        |  |                                 | (182,134 | ) |      |   | (155,381 | )    |  |   | (156,851 | )
|Equity in earnings of unconsolidated entities, net    |  |                                 | 10,051   |   |      |   | 8,246    |      |  |   | 7,788    |  
|Gain on sales of property                             |  |                                 | 416      |   |      |   | 263      |      |  |   | 2,769    |  
|Impairment loss on investments                        |  |                                 |         |   |      |   |         |      |  |   |         |  
|                                                      |  |                                 |          |   |      |   |          |      |  |   |          |  
|Real estate operating loss from continuing operations |  |                                 | (2,030   | ) |      |   | (7,368   | )    |  |   | (22,648  | )
|Equity in earnings of Bank                            |  |                                 | 54,388   |   |      |   | 78,063   |      |  |   | 92,280   |  
|                                                      |  |                                 |          |   |      |   |          |      |  |   |          |  
|Total company operating income                        |  |                                 | 52,358   |   |      |   | 70,695   |      |  |   | 69,632   |  
|Income tax benefit                                    |  |                                 | 2,014    |   |      |   | 3,904    |      |  |   | 8,190    |  
|Discontinued operations-net of income tax benefit     |  |                                 | 2,590    |   |      |   | (1,001   | )    |  |   | (1,122   | )
|                                                      |  |                                 |          |   |      |   |          |      |  |   |          |  
|TOTAL COMPANY NET INCOME                              |  | $                               | 56,962   |   |      | $ | 73,598   |      |  | $ | 76,700   |  
|                                                      |  |                                 |          |   |      |   |          |      |  |   |          |  



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



CONDENSED STATEMENTS OF CASH FLOWS



|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------------- | -------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                  |  | For the Year Ended September 30 |         
|(In thousands)                                                                    |  | 2006                            |          |   | 2005 |   |         | 2004 | 
|CASH FLOWS FROM OPERATING ACTIVITIES                                              |  |                                 |          |   |      |   |         |      |  |   |         |  
|Net income                                                                        |  | $                               | 56,962   |   |      | $ | 73,598  |      |  | $ | 76,700  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                 |          |   |      |   |         |      |  |   |         |  
|Depreciation                                                                      |  |                                 | 20,390   |   |      |   | 19,857  |      |  |   | 19,053  |  
|Amortization of debt expense                                                      |  |                                 | 2,672    |   |      |   | 2,197   |      |  |   | 4,507   |  
|Equity in earnings of Bank, net of distributions                                  |  |                                 | (22,388  | ) |      |   | (38,863 | )    |  |   | (67,480 | )
|Equity in earnings of unconsolidated entities, net of distributions               |  |                                 | (4,415   | ) |      |   | (3,336  | )    |  |   | (1,262  | )
|Gain on sale of property                                                          |  |                                 | (6,702   | ) |      |   | (1,146  | )    |  |   | (2,459  | )
|Deferred tax benefit (expense)                                                    |  |                                 | 4,121    |   |      |   | (922    | )    |  |   | (1,123  | )
|Increase (decrease) in accounts receivable and accrued income                     |  |                                 | (5,020   | ) |      |   | (2,318  | )    |  |   | (1,955  | )
|Decrease in accounts payable and accrued expenses                                 |  |                                 | 550      |   |      |   | (493    | )    |  |   | (6,023  | )
|Other                                                                             |  |                                 | (5,137   | ) |      |   | 489     |      |  |   | (1,725  | )
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|Net cash provided by operating activities                                         |  |                                 | 41,033   |   |      |   | 49,063  |      |  |   | 18,233  |  
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                              |  |                                 |          |   |      |   |         |      |  |   |         |  
|Capital expenditures and acquisitions  properties                                |  |                                 | (159,069 | ) |      |   | (29,946 | )    |  |   | (17,973 | )
|Property sales                                                                    |  |                                 | 17,146   |   |      |   | 4,715   |      |  |   | 3,719   |  
|Note receivable and accrued interest  (advances)/repayments, net                 |  |                                 | 2,800    |   |      |   | (5,423  | )    |  |   | (4,690  | )
|Equity investment in Saul Holdings and Saul Centers                               |  |                                 | (6,104   | ) |      |   | (5,901  | )    |  |   | (3,306  | )
|Other investments                                                                 |  |                                 | (431     | ) |      |   | (776    | )    |  |   | (800    | )
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|Net cash used in investing activities                                             |  |                                 | (145,658 | ) |      |   | (37,331 | )    |  |   | (23,050 | )
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                              |  |                                 |          |   |      |   |         |      |  |   |         |  
|Proceeds from mortgage financing                                                  |  |                                 | 294,882  |   |      |   |        |      |  |   |        |  
|Principal curtailments and repayments of mortgages                                |  |                                 | (12,678  | ) |      |   | (15,793 | )    |  |   | (9,923  | )
|Net secured note financings (repayments)                                          |  |                                 | (93,430  | ) |      |   |        |      |  |   | 46,200  |  
|Proceeds from sales of unsecured notes                                            |  |                                 | 935      |   |      |   | 5,674   |      |  |   | 6,877   |  
|Repayments of unsecured notes                                                     |  |                                 | (37,297  | ) |      |   | (4,342  | )    |  |   | (5,798  | )
|Costs of obtaining financings                                                     |  |                                 | (3,316   | ) |      |   | (3,193  | )    |  |   | (7,676  | )
|Purchase of treasury stock                                                        |  |                                 |         |   |      |   |        |      |  |   |        |  
|Dividends paidpreferred shares of beneficial interest                            |  |                                 | (12,000  | ) |      |   | (12,000 | )    |  |   | (12,000 | )
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|Net cash (used in) provided by financing activities                               |  |                                 | 137,096  |   |      |   | (29,654 | )    |  |   | 17,680  |  
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |                                 | 32,471   |   |      |   | (17,922 | )    |  |   | 12,863  |  
|Cash and cash equivalents at beginning of year                                    |  |                                 | 13,920   |   |      |   | 31,842  |      |  |   | 18,979  |  
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of year                                          |  | $                               | 46,391   |   |      | $ | 13,920  |      |  | $ | 31,842  |  
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



39. SUBSEQUENT EVENTS  THE REAL ESTATE TRUST:

On October 19, 2006, amendments were executed for two of the Real Estate Trusts mortgage notes, both of which were held by the same lender and both closed in
fiscal 2006. The balance of the mortgage note secured by the 145 room historic hotel was increased by $10.0 million to $75.0 million with the interest rate remaining at 6.199%. A corresponding $10.0 million reduction to the mortgage note secured by
a hotel property in Loudoun County, Virginia was made to reduce this note to $34.8 million. The rate on this loan was reduced by approximately 3 basis points from 6.101% to 6.0714% which maintains the Real Estate Trusts annual interest expense
on the two loans.

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 expects to record the final
gain in the first quarter of fiscal 2007 of approximately $1.2 million, net of approximately $400,000 of related expenses. The initial gain on this condemnation of $2.7 million was recorded in fiscal 2004.



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|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------

None.



|ITEM 9A. | CONTROLS AND PROCEDURES
|-------- | -----------------------

The Trust maintains disclosure controls
and procedures that are designed to ensure that information required to be disclosed in the Trusts reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods
specified in the SECs rules and forms, and that such information is accumulated and communicated to the Trusts management, including its Chairman and its Vice President and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosures based closely on the definition of disclosure controls and procedures in Rule 13a-15(e) promulgated under the Exchange Act. In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.

The Trust carried out an evaluation, under the supervision and with the
participation of the Trusts management, including its Chairman and its Vice President and Chief Financial Officer of the effectiveness of the design and operation of the Trusts disclosure controls and procedures as of September 30,
2006. Based on the foregoing, the Companys Chairman and its Vice President and Chief Financial Officer concluded that the Trusts disclosure controls and procedures were effective at the reasonable assurance level as of September 30,
2006.

During the three months ended September 30, 2006, there were no changes in the Trusts internal control over financial reporting that
materially affected, or are reasonably likely to materially affect, the Trusts internal control over financial reporting.



|ITEM 9B. | OTHER ITEMS
|-------- | -----------

None



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PART III



|ITEM 10. | TRUSTEES AND EXECUTIVE OFFICERS OF THE TRUST
|-------- | --------------------------------------------

The Declaration of
Trust provides that there shall be no fewer than three nor more than twelve trustees, as determined from time to time by the trustees in office. The Board of Trustees has fixed its permanent membership at seven trustees divided into three classes
with overlapping three-year terms. The term of each class expires at the Annual Meeting of Shareholders, which is usually held on the last Friday of January.

The following list sets forth the name, age, position with the Trust, present principal occupation or employment and material occupations, positions, offices or employments during the past five years of each trustee and executive officer of
the Trust. Unless otherwise indicated, each individual has held an office with the Trust for at least the past five years.

Class One
TrusteesTerms End at the 2009 Annual Meeting

Philip D. Caraci, age 68, was elected a Trustee in 2003. For the previous six years he served
as Senior Vice President and Secretary of the Trust, Executive Vice President of Saul Company, Senior Vice President of the Advisor, Chairman of the Board of Saul Property Co., and a Director and President of Saul Centers. Mr. Caraci is also a
member of the ASB Real Estate Advisory Committee, a subsidiary of Chevy Chase.

Gilbert M. Grosvenor, age 75, has served as a Trustee since 1971.
Mr. Grosvenor also serves as Chairman of the Board of the National Geographic Society and as a Director of Chevy Chase Bank and Saul Centers.

Class Two TrusteesTerms End at the 2007 Annual Meeting

George M. Rogers, Jr., age 73, has served as a Trustee since 1969.
Mr. Rogers is a Senior Counsel in the law firm of Pillsbury Winthrop Shaw Pittman LLP, Washington, DC, which serves as counsel to the Trust and Chevy Chase. Mr. Rogers serves as a Director of Chevy Chase, Saul Company, Chevy Chase Property
Company, Westminster Investing Corporation, and Chevy Chase Lake Corporation.

B. Francis Saul III, age 44, is Senior Vice President of the Trust
and has served as a Trustee since 1997. Mr. Saul also serves as a Director and Vice Chairman of Chevy Chase and as a Director and/or Officer of Saul Company, Saul Property Co., Chevy Chase Property Company and Westminster Investing Corporation.
He is President and Director of Saul Centers. He is also Chairman Emeritus of the Boys & Girls Clubs of Greater Washington, Vice Chairman of Childrens National Medical Center, and a Director of The Conservation Fund and The Economic
Club of Washington. Mr. Saul is the son of B. Francis Saul II.

Class Three TrusteeTerm Ends at the 2008 Annual Meeting

B. Francis Saul II, age 74, has served as Chairman and Chief Executive Officer of the Trust since 1969 and as a Trustee since 1964. Mr. Saul also serves as
Chief Executive Officer and Chairman of the Board of Directors of B.F. Saul Company, Chevy Chase and Saul Centers, as President and Chairman of the Board of Directors of Chevy Chase Property Company, Westminster Investing Company, and Chevy Chase
Lake Corporation, and as a Trustee of the National Geographic and the John Hopkins Medicine Board. Mr. Saul is the father of B. Francis Saul III.

John R. Whitmore, age 73, has served as a Trustee since 1984. He is a Financial Advisor who served as Senior Advisor to The Bessemer Group, Incorporated (a financial management and banking firm) and its Bessemer Trust Company
subsidiaries from 1999 to 2003. Mr. Whitmore is a director of Chevy Chase, Chevy Chase Property Company, Saul Company and Saul Centers. During the period 1975-1998, Mr. Whitmore was President and Chief Executive Officer of Bessemer Group,
Incorporated and its Bessemer Trust Company subsidiaries and a director of Bessemer Securities Corporation.

Executive Officers of the Trust Who Are Not Directors

Stephen R. Halpin, Jr., age 51, serves as Vice President and
Chief Financial Officer of the Trust, and Senior Vice President and Chief Financial Officer of Saul Company. He also serves as Executive Vice President and Chief Financial Officer of Chevy Chase.

Thomas H. McCormick, age 56, joined the Trust in February 2005 and serves as General Counsel of the Trust, Executive Vice President and General Counsel of Chevy
Chase, Senior Vice President and General Counsel and a Director of B.F. Saul Company and Senior Vice President and General Counsel of Saul Centers. Prior to joining the Trust, Mr. McCormick was a senior partner with the law firm Shaw Pittman
LLP, now know as Pillsbury Winthrop Shaw Pittman LLP. He also served as the Chair of Shaw Pittmans Board of Directors and its Corporate and Securities group.

Patrick T. Connors, age 44, has served as a Vice President of the Trust and Senior Vice President of Saul Company since January 2000. For the previous four years, he was an attorney with the law firm of Shaw Pittman LLP, Washington,
DC.

Kenneth D. Shoop,age 47, joined the Trust in September 2003 and serves as Vice President, Chief Accounting Officer and Treasurer, of the
Trust, Treasurer and Vice President of Saul Company, the Advisor, Saul Property Company and Chief Accounting Officer and Vice President of Saul Centers. Prior to joining the Trust, Mr. Shoop was Vice President and Controller of Federal Realty
Investment Trust.



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Ross E. Heasley, age 67, serves as Vice President of the Trust, Saul Company, the Advisor, Saul Property Co. and
Saul Centers.

Henry Ravenel, Jr., age 72, serves as Vice President of the Trust, Saul Company and the Advisor.

John A. Spain, age 43, serves as Vice President of the Trust and Saul Company.

Committees of the Board of Trustees

The Board of Trustees met four times during fiscal 2006. Each member of the Board attended
at least 75% of the aggregate number of meetings of the Board and of the committees of the Board on which he served.

The Board of Trustees has two
standing committees: the Audit Committee and the Executive Committee.

The Audit Committee is composed of Messrs. Caraci and Grosvenor. The Audit
Committees duties include nominating the Trusts independent registered public accounting firm, discussing with them the scope of their examination of the Trust, reviewing with them the Trusts financial statements and accompanying
report, and reviewing their recommendations regarding internal controls and related matters. This committee met four times during fiscal 2006.

None of the
members of the Audit Committee qualify as an audit committee financial expert as such term is defined in the Exchange Act and the rules and regulations thereunder. A substantial portion of the Trusts consolidated assets are held,
and operations are performed, at the Bank level. As of September 30, 2006, the Bank accounted for 96% of the Trusts assets on a consolidated basis and, for the year ended September 30, 2006, the Bank accounted for 87% of the
Trusts revenue on a consolidated basis. Because the Bank operates in a highly regulated industry and has audited financial statements that are reviewed and approved by its own audit committee, which includes two persons who are deemed audit
committee financial experts, the Board of Trustees has determined that it is not necessary for the Audit Committee of the Trust to include an audit committee financial expert at this time. In addition, the Board of Trustees has noted that
Mr. Caraci, in his previous position as President of Saul Centers, gained substantial experience regarding accounting issues of the breadth and complexity that typically arise in connection with the Real Estate Trusts business.

The Executive Committee is composed of Messrs. Rogers, Saul II and Whitmore. It is empowered to oversee day-to-day actions of the Advisor and Saul
Property Co. in connection with the operations of the Trust, including the acquisition, administration, sale or disposition of investments. No meetings of this committee were held during fiscal 2006.

Trustees of the Trust are currently paid an annual retainer of $12,500 and a fee of $600 for each board or committee meeting attended. Trustees from outside the
Washington, D.C. area are also reimbursed for out-of-pocket expenses in connection with their attendance at meetings. Mr. Saul II is not paid for attending Executive Committee meetings. For the fiscal year ended September 30, 2006, the
Real Estate Trust paid total fees of $94,000 to the Trustees, including $15,000 to Mr. Saul II.

Code of Ethics

The Trusts officers and trustees are governed by a code of ethics. The code of ethics will be made available free of charge to any person upon request. Requests
shall be made in writing to Mr. Kenneth Shoop, Vice President and Chief Accounting Officer, B.F. Saul Real Estate Investment Trust, 7501 Wisconsin Avenue, Bethesda, Maryland 20814.



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------

The Real Estate Trust pays no compensation
to its executive officers for their services in such capacity. Messrs. Saul II, Halpin, Saul III and McCormick receive compensation from Chevy Chase for their services as Officers of Chevy Chase. No other executive officers of the Real Estate Trust
received any compensation from the Real Estate Trust or its subsidiaries with respect to any of the fiscal years ended September 30, 2006, 2005 and 2004.

The following table sets forth the cash compensation paid by Chevy Chase to Mr. Saul II, Mr. Halpin, Mr. Saul III and Mr. McCormick for or with respect to the fiscal years ended September 30, 2006, 2005 and 2004 for
all capacities in which they served during such fiscal years.



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SUMMARY COMPENSATION TABLE

Annual Compensation



|                                           |  |      |  |        |           |       |   |                              |  |                       |         |  |   |           |    
|------------------------------------------ |  | ---- |  | ------ | --------- | ----- | - | ---------------------------- |  | --------------------- | ------- |  | - | --------- | ---
|Name and Principal Position                |  | Year |  | Salary |           | Bonus |   | Long-TermCompensationPayouts |  | All OtherCompensation |        
|B. Francis Saul II,                        |  | 2006 |  | $      | 1,903,846 |       | $ | 2,500,000                    |  | $                     | 956,024 |  | $ | 828,770   | (1)
|Chairman and Chief                         |  | 2005 |  |        | 1,865,385 |       |   | 2,500,000                    |  |                       | 836,521 |  |   | 1,254,225 | (2)
|Executive Officer of Chevy Chase           |  | 2004 |  |        | 1,678,078 |       |   | 2,000,000                    |  |                       | 655,206 |  |   | 1,399,311 | (3)
|                                           |  |      |  |        |          
|Stephen R. Halpin, Jr.,                    |  | 2006 |  | $      | 619,231   |       | $ | 190,000                      |  | $                     | 215,105 |  | $ | 227,846   | (1)
|Executive Vice President                   |  | 2005 |  |        | 590,385   |       |   | 182,500                      |  |                       | 191,205 |  |   | 307,480   | (2)
|and Chief Financial Officer of Chevy Chase |  | 2004 |  |        | 517,311   |       |   | 75,000                       |  |                       | 163,801 |  |   | 521,964   | (3)
|                                           |  |      |  |        |          
|B. Francis Saul III,                       |  | 2006 |  | $      | 284,615   |       | $ | 41,250                       |  | $                     |        |  | $ | 44,315    | (1)
|Vice Chairman of Chevy Chase               |  | 2005 |  |        | 269,231   |       |   | 37,500                       |  |                       |        |  |   | 44,724    | (2)
|                                           |  | 2004 |  |        | 240,199   |       |   | 35,250                       |  |                       |        |  |   | 42,676    | (3)
|                                           |  |      |  |        |          
|Thomas H. McCormick                        |  | 2006 |  | $      | 569,231   |       | $ | 82,500                       |  | $                     |        |  | $ | 41,436    | (1)
|Executive Vice President                   |  | 2005 |  |        |          |       |   |                             |  |                       |        |  |   |          |    
|and General Counsel of Chevy Chase         |  | 2004 |  |        |          |       |   |                             |  |                       |        |  |   |          |    

---

|(1) | The total amounts shown in the All Other Compensation column for fiscal year 2006 consist of the following: (i) contributions made by Chevy Chase to its
Supplemental Executive Retirement Plan on behalf of Mr. Saul II ($321,592), Mr. Halpin ($48,260), Mr. Saul III ($19,552) and Mr. McCormick ($13,223); (ii) the taxable benefit of premiums paid for group term insurance on
behalf of Mr. Saul II ($11,112), Mr. Halpin ($2,610), Mr. Saul III ($1,100) and Mr. McCormick ($4,890); (iii) contributions to the B.F. Saul Company Employees Profit Sharing Retirement Plan (the Retirement Plan), a defined
contribution plan, on behalf of Mr. Halpin ($13,200) and Mr. McCormick ($8,123); (iv) accrued earnings on awards previously made under Chevy Chases Deferred Compensation Plan on behalf of Mr. Saul II ($496,066),
Mr. Halpin ($105,742), Mr. Saul III ($23,663) and Mr. McCormick ($15,200); and (v) accrued compensation on behalf of Mr. Halpin ($58,034) for the Special Retirement Compensation Agreements under which the
executive could receive an amount of up to three times his base compensation if he retires from the bank after reaching age 63.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | The total amounts shown in the All Other Compensation column for fiscal year 2005 consist of the following: (i) contributions made by Chevy Chase to its
Supplemental Executive Retirement Plan on behalf of Mr. Saul II ($312,114), Mr. Halpin ($45,245) and Mr. Saul III ($18,404); (ii) the taxable benefit of premiums paid for group term insurance on behalf of Mr. Saul II
($11,539), Mr. Halpin ($2,465) and Mr. Saul III ($1,056); (iii) contributions to the B.F. Saul Company Employees Profit Sharing Retirement Plan (the Retirement Plan), a defined contribution plan, on behalf of Mr. Halpin
($12,600); (iv) accrued earnings on awards previously made under Chevy Chases Deferred Compensation Plan on behalf of Mr. Saul II ($930,572), Mr. Halpin ($201,269), and Mr. Saul III ($25,264); and (v) accrued
compensation on behalf of Mr. Halpin ($45,901) for the Special Retirement Compensation Agreements under which the executive could receive an amount of up to three times his base compensation if he retires from the bank after
reaching age 63.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | The total amounts shown in the All Other Compensation column for fiscal year 2004 consist of the following: (i) contributions made by Chevy Chase to its
Supplemental Executive Retirement Plan on behalf of Mr. Saul II ($259,997), Mr. Halpin ($33,067) and Mr. Saul III ($16,527); (ii) the taxable benefit of premiums paid for group term insurance on behalf of Mr. Saul II
($16,341), Mr. Halpin ($1,698) and Mr. Saul III ($899); (iii) contributions to the B.F. Saul Company Employees Profit Sharing Retirement Plan (the Retirement Plan), a defined contribution plan, on behalf of Mr. Halpin ($12,300);
(iv) accrued earnings on awards previously made under Chevy Chases Deferred Compensation Plan on behalf of Mr. Saul II ($1,122,973), Mr. Halpin ($244,804), and Mr. Saul III ($25,250); and (v) accrued compensation on
behalf of Mr. Halpin ($230,095) for the Special Retirement Compensation Agreements under which the executive could receive an amount of up to three times his base compensation if he retires from the bank after reaching age 63
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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LONG-TERM INCENTIVE PLAN AWARDS. The following table sets forth certain information concerning the principal
contributions (the Principal Contributions) credited by the Bank to the accounts (the Accounts) of the executive officers named above for fiscal year 2006 under the Banks Deferred Compensation Plan (the
Plan).

LONG-TERM INCENTIVE PROGRAMAWARDS IN LAST FISCAL YEAR



|                       |  |                                                     |           |                                                               |           |  |         |           |  |   |          
|---------------------- |  | --------------------------------------------------- | --------- | ------------------------------------------------------------- | --------- |  | ------- | --------- |  | - | ---------
|                       |  | Performance orOther PeriodUntil Maturationor Payout |           | Estimated Future Payouts (1)Under Non-Stock Price-Based Plans
|Name                   |  |                                                     | Threshold |                                                               | Target(2) |  | Maximum
|B. Francis Saul II(3)  |  | 2006                                                |           | $                                                             | 900,000   |  | $       | 1,943,033 |  | $ | 5,572,563
|Stephen R. Halpin, Jr. |  | 2015                                                |           | $                                                             | 190,000   |  | $       | 410,196   |  | $ | 1,176,430

---

|(1) | The estimated future payouts shown in the table are based on assumed performance rates for the Bank during each year in the ten-year performance period. The actual
payouts under the Plan may vary substantially from the payouts shown in the table, depending upon the Banks actual rate of return on average assets for each fiscal year in the ten-year performance period ending September 30, 2015.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | The Plan does not establish any target performance levels. The payout amounts shown in this column have been calculated assuming that the Banks rate of return
on average assets during each of the years in the performance period are the same as the Banks rate of return during the fiscal year ended September 30, 2006.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | The payout amounts shown for all participants are the estimated amounts that would be payable
to such participants if their employment continued with the Bank for the entire ten-year performance period of the Plan. Mr. Saul attained the age of 72 in 2004, at which time he became fully vested in the Account maintained for his benefit
under the Plan. As of September 30, 2006, the vested account balance maintained for Mr. Sauls benefit under the Plan was $9,674,618. Under the Plan, if Mr. Saul were to retire after that date, he could elect to have the Bank pay
out the net contribution (as defined) in the Account prior to the year 2015.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As of September 30, 2006, the following individuals have
vested amounts that are payable within 120 days after September 30, 2006: Mr. Saul ($733,918) and Mr. Halpin ($163,093).

The Plan provides
that, as of the end of each fiscal year in the ten-year period ending September 30, 2015 (or the executive officers earlier termination of employment with the Bank), the Bank will add to or deduct from each executive officers
Account a contribution or deduction, as the case may be, which represents the hypothetical interest (which may be positive or negative) earned on the Principal Contribution, based on the Banks rate of return on average assets (as computed
under the Plan) for the fiscal year then ended. (The Principal Contribution, plus or minus any interest credited or deducted, is referred to as the Net Contribution.)

Executive officers are entitled to receive the Net Contribution in their respective Account only upon full or partial vesting. Plan participants become fully vested in their Account under the Plan, provided that they
remain continuously employed by the Bank during the vesting period, upon the earliest to occur of any of the following:



| |  |  | September 30, 2015;
| | - |  | -------------------



| |  |  | attainment of age 65;
| | - |  | ---------------------



| |  |  | death;
| | - |  | ------



| |  |  | total and permanent disability; or
| | - |  | ----------------------------------



| |  |  | a change in control of the Bank (as defined in the Plan).
| | - |  | ---------------------------------------------------------

Plan
participants become partially vested, to the extent of 50% of the Net Contribution in the Account, upon the termination of their employment by the Bank without cause (as defined in the Plan) after September 30, 2010.

Payouts are made under the Plan within 120 days after September 30, 2015, or the earlier termination of the executive officers employment with the Bank,
provided that vesting or partial vesting has occurred under the Plan.

OTHER COMPENSATION AGREEMENTS. Mr. Halpin has entered into an agreement with
the Bank entitled Agreement For Executive Level Officers Governing Confidentiality, Nonsolicitation, Ownership of Certain Works and Termination Upon Change in Control under which the executive officer has agreed not to compete with,
solicit customers of or solicit the employees of the Bank for stated periods following any termination of employment with the Bank. In addition, the Bank agrees to pay the executive a specified amount if the executive is terminated without cause in
the three-year period following a change of control of the Bank. The amount payable varies depending upon the executives base compensation and most recent bonus, the length of the executives employment with the Bank and the per share
price at which the triggering change of control has occurred.

Mr. Halpin also has entered into Special Retirement Compensation Agreements
under which the executive could receive an amount up to three times his base compensation if he retires from Chevy Chase after reaching age 63. As of September 30, 2006, accrued compensation on behalf of Mr. Halpin totaled $334,030.



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Report of the Banks Compensation Committee

The Compensation Committee of the Bank reviews compensation of the Banks senior officers, which include Messrs. Saul II, Saul III, Halpin and McCormick. The
components of compensation reviewed by the Committee include salary, bonuses and deferred compensation. Because the Banks common stock is privately held, the Bank does not offer stock options as part of its compensation program. As part of its
review of compensation, the Committee considers a variety of factors, including each individuals tenure, level of responsibility and performance, as well as factors relating to the overall performance of the Bank, the results of regulatory
examinations, and the Banks overall compliance status.

The Committee also informs itself generally of executive level compensation of banks of
comparable size to the Bank. In determining compensation of the Banks senior officers, the Committee seeks to maintain a competitive position in the marketplace, taking into account that the Bank does not offer equity based compensation
programs.

With respect to officers other than Mr. Saul II, the Committee takes into account the recommendations of Mr. Saul II. The Committee is
aware that Mr. Saul II is, indirectly, a significant shareholder of the Bank and thus has a strong incentive to act in the best interest of the shareholders. Mr. Saul II does not participate in the discussion of his own compensation and
similarly abstains from voting on his own compensation.

The Committee has not adopted any specific policies concerning the relationship of corporate
performance to executive compensation. Instead, the Committee follows a more flexible approach which it believes to be better suited to the specific circumstances of the Bank.

Members of the Banks Compensation Committee

Garland P. Moore, Jr., Chair

George M. Rogers, Jr.

B. Francis Saul II



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|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------

The following
table sets forth certain information, as of December 15, 2006, concerning beneficial ownership of Common Shares and preferred shares of beneficial interest, referred to in this report as the Preferred Shares, by (a) each person
known by the Trust to be the beneficial owner of more than 5% of the Common Shares and the Preferred Shares, (b) each member of the Board of Trustees, (c) each executive officer of the Trust named in the Summary Compensation Table under
Item 11. Executive Compensation and (d) all trustees and executive officers of the Trust as a group.



|                                                           |  |                                                  |  |                     |  
|---------------------------------------------------------- |  | ------------------------------------------------ |  | ------------------- | -
|Name ofBeneficial Owner                                    |  | Aggregate Number of SharesBeneficially Owned
(1) |  | Percent ofClass (1) |  
|B. Francis Saul II                                         |  | Preferred: 516,000 (2)                           |  | 100.00              | %
|                                                           |  | Common: 4,807,510 (3)                            |  | 100.00              | %
|All Trustees and executive officers as a group (9 persons) |  | Preferred: 516,000 (2)                           |  | 100.00              | %
|                                                           |  | Common: 4,807,510 (3)                            |  | 100.00              | %

---

|(1) | Beneficial owner and percent of class are calculated pursuant to rule 13d-3 under the
Securities Exchange Act of 1934.
|--- | ----------------------------------------------------------------------------------------------------------------------



|(2) | Consists of Preferred Shares owned of record by Saul Company and other companies of which Mr. Saul is an officer, director and/or more than 10% shareholder,
comprising 270,000 Preferred Shares owned by Saul Company, 90,000 Preferred Shares owned by Franklin Development Company, Inc., 90,000 Preferred Shares owned by The Klingle Corporation, and 66,000 Preferred Shares owned by Westminster Investing
Corporation. The address of each person listed in this footnote is 7501 Wisconsin Avenue, Bethesda, Maryland 20814. Pursuant to Rule 13d-3, the Preferred Shares described above are considered to be beneficially owned by Mr. Saul because he has
or may be deemed to have sole or shared voting and/or investment power in respect thereof.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Consists of Common Shares owned of record by Saul Company and other companies of which
Mr. Saul is an officer and director and/or more than 10% shareholder, comprising 1,125,739 Common Shares owned by Westminster Investing Corporation, 43,673 Common Shares owned by Derwood Investment Corporation, a subsidiary of Westminster
Investing Corporation, 34,400 Common Shares owned by Somerset Investment Company, Inc., a subsidiary of Westminster Investing Corporation, 2,751,662 Common Shares owned by Saul Company, 283,400 Common Shares owned by Columbia Securities Company of
Washington, D.C., 172,918 Common Shares owned by Franklin Development Company, Inc., and 395,718 Common Shares owned by The Klingle Corporation. The address of each person listed in this footnote is 7501 Wisconsin Avenue, Bethesda, Maryland 20814.
Pursuant to Rule 13d-3, the Common Shares described above are considered to be beneficially owned by Mr. Saul because he has or may be deemed to have sole or shared voting and/or investment power in respect thereof.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Preferred Shares were issued in June 1990 in connection with the transaction in which the Trust increased its equity interest in Chevy Chase from 60% to 80%. The
dividend rate on the Preferred Shares is $10.50 per share per annum. Dividends are cumulative and are payable annually or at such other times as the Trustees may determine, as and when declared by the Trustees out of any assets legally available
therefor. The Preferred Shares have a liquidation preference of $100 per share. Subject to limits in certain of the Trusts loan agreements, the Preferred Shares are subject to redemption at the option of the Trust at a redemption price equal
to their liquidation preference. Except as otherwise required by applicable law, the holders of Preferred Shares are entitled to vote only in certain limited situations, such as the merger of the Trust or a sale of all or substantially all of the
assets of the Trust.



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
|-------- | ----------------------------------------------

Management Personnel

All of the officers of the Trust and Messrs. Saul II, Saul III, Rogers and Whitmore, each of whom is a trustee of the Trust, are also officers and/or directors of Saul
Company and/or its subsidiaries. In addition, Messrs. Saul II, Saul III, Whitmore, Grosvenor, Caraci, McCormick, Heasley and Shoop are also officers and/or directors of Saul Centers and/or its subsidiaries.

Transactions with Saul Company and its Subsidiaries

The Real Estate
Trust has been managed by B. F. Saul Advisory Company, L.L.C., (the Advisor), a wholly-owned subsidiary of B. F. Saul Company (Saul Co.). All of the Real Estate Trust officers and four Trustees of the Trust are also officers
and/or directors of Saul Co. The Advisor is paid a fixed monthly fee which is subject to annual review by the Trustees. The average monthly fee was $560,000 during fiscal 2006, $487,000 during fiscal 2005, and $472,000 during fiscal 2004. Effective
October 1, 2005 the Advisors obligations under the advisory contract were assigned to Saul Co. In addition the agreement was extended until September 30, 2006. The agreement will continue thereafter unless canceled by either party at the
end of any contract year. Certain loan agreements prohibit termination of this contract.

Saul Company and Saul Property Co., a wholly owned subsidiary of
Saul Company, provide services to the Real Estate Trust in the areas of commercial property management and leasing, hotel management, development and construction management, and acquisitions, sales and financings of real property. Fees to the two
companies amounted to $13.0 million in fiscal 2006.



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The Real Estate Trust reimburses the Advisor and Saul Property Co. for costs and expenses incurred in connection with the
acquisition and development of real property on behalf of the Real Estate Trust, in-house legal expenses, and all travel expenses incurred in connection with the affairs of the Real Estate Trust.

The Real Estate Trust pays the Advisor fees equal to 2% of the principal amount of publicly offered unsecured notes as they are issued to offset the Advisors costs
of administering the program. In October 2006, in conjunction with the Real Estate Trusts decision to discontinue the public sale of unsecured notes, the fee agreement was modified whereas the Advisor fee for any calendar month that the Real
Estate Trust did not issue notes under the programs was to be $7,500 for such month. The Advisor received $111,000 in such fees in fiscal 2006.

B. F. Saul
Insurance Agency of Maryland, Inc., a subsidiary of Saul Company, is a general insurance agency that receives commissions and counter-signature fees in connection with the Real Estate Trusts insurance program. Such commissions and fees
amounted to approximately $311,000 in fiscal 2006.

Under an existing unsecured note receivable from Saul Co., which was modified and amended on
October 1, 2005, not to exceed $30.0 million, the Real Estate Trust received net repayments of $2.8 million during fiscal 2006. During fiscal 2005 net additions totaled $5.4 million. At September 30, 2006 and September 30, 2005, the
note balance totaled $10.3 million and $13.1 million, respectively. Interest is computed on the note at 200 basis points over a floating rate index. Interest earned on the note amounted to $959,000, $616,000 and $108,000 during fiscal 2006, 2005 and
2004, respectively. The note is due and payable on September 30, 2015.

The Trust has retained the law firm of Pillsbury Winthrop Shaw Pittman LLP, at
which Mr. Rogers is senior counsel, to perform legal services for the Trust in fiscal 2006 and 2005.

The Board of Trustees of the Trust, including
the independent trustees, reviews the fees and compensation arrangements between the Real Estate Trust and Saul Company and its related entities and affiliates and believes that such fees and compensation arrangements are as favorable to the Real
Estate Trust as would be obtainable from unaffiliated sources.

Transactions with Saul Centers

Shared Services. The Trust shares with Saul Centers certain personnel and ancillary functions at cost, such as computer hardware, software and support services,
payroll services, benefits administration, in-house legal services and other direct and indirect administrative payroll. In addition the Trust shares insurance expense with Saul Centers on a pro rata basis. Depending on the service, the method of
determining the cost of the shared services is based upon head count, estimates of usage or estimates of time incurred, as applicable. Although the Trust believes that the amounts allocated to it for such shared services represent a fair allocation
between the Trust and Saul Centers, the Trust has not obtained a third party appraisal of the value of these services.

Exclusivity Agreement and Right
of First Refusal. The Real Estate Trust has entered into an Exclusivity Agreement with, and has granted a right of first refusal to, Saul Centers and Saul Holdings Limited Partnership. The purpose of these agreements is to minimize potential
conflicts of interest between the Real Estate Trust, Saul Centers and Saul Holdings Limited Partnership.

Saul Holdings Limited Partnership. The
exclusivity agreement and right of first refusal generally require the Real Estate Trust to conduct its shopping center business exclusively through Saul Centers and Saul Holdings Limited Partnership and to grant these entities a right of first
refusal to purchase commercial properties and development sites that become available to the Real Estate Trust in the District of Columbia or adjacent suburban Maryland. Subject to the exclusivity agreement and right of first refusal, the Real
Estate Trust will continue to develop, acquire, own and manage commercial properties and own land suitable for development as, among other things, shopping centers and other commercial properties.

Reimbursement Agreement. Pursuant to a reimbursement agreement among the partners of the Saul Holdings Limited Partnership and certain of their affiliates, the
Real Estate Trust and two of its subsidiaries have agreed to reimburse Saul Centers and the other partners in the event the Saul Holdings Limited Partnership fails to make payments with respect to certain portions of its debt obligations and Saul
Centers or any such other partners personally make payments with respect to such debt obligations. As of September 30, 2006, the maximum potential obligation of the Real Estate Trust and its subsidiaries under the agreement was approximately
$100 million. See Note 5 to the Consolidated Financial Statements in this report. The Real Estate Trust believes that Saul Holdings Limited Partnership will be able to make all payments due with respect to its debt obligations.

Tax Conflicts. The fair market value of each of the properties contributed to Saul Holdings Limited Partnership and its subsidiaries by the Real Estate Trust and
its subsidiaries in connection with the formation of Saul Centers and Saul Holdings Limited Partnership in 1993 exceeded the tax basis of such properties. In the event Saul Centers or its wholly owned subsidiary, Saul QRS, Inc., acting as general
partner, causes Saul Holdings Limited Partnership to dispose of, or there is an involuntary disposition of, one or more of such properties, a disproportionately large share of the total gain for federal income tax purposes would be allocated to the
Real Estate Trust and its subsidiaries as a result of the property disposition. See Note 5 to the Consolidated Financial Statements in this report.



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Other related party transactions

Remuneration of Trustees and Officers. For fiscal 2006, the Trust paid the trustees $94,000 in fees for their services. See Item 10. Trustees and Executive Officers of the Trust. No compensation was
paid to the officers of the Trust for acting as such; however, Messrs. Saul II, Halpin, Saul III and McCormick were paid by Chevy Chase for services as Officers of Chevy Chase. See Item 11. Executive Compensation. Messrs. Grosvenor,
Rogers, Saul II and Saul III receive compensation for their services as directors of Chevy Chase and Messrs. Rogers, Saul II, Saul III and Whitmore and all of the officers of the Real Estate Trust receive compensation from Saul Company and/or its
affiliated corporations as directors or officers thereof.

Related Party Rents. The Real Estate Trust leases space to Chevy Chase and the Saul
Property Co. at two of its income-producing properties. Minimum rents and expense recoveries paid under these leases amounted to approximately $5.8 million in fiscal 2006. Chevy Chase leases space in several of the shopping centers owned by Saul
Centers. The total rental payments made to Saul Centers by Chevy Chase in fiscal 2006 was $2.0 million. On September 24, 2001 Chevy Chase entered into an agreement to lease to Saul Company approximately 46,000 square feet of office space at its
new corporate headquarters at 7501 Wisconsin Avenue, Bethesda, Maryland. Total payments under the lease for fiscal 2006 were $2.2 million. In addition, Chevy Chase has retained Saul Company as its leasing agent to secure tenants for additional space
that will be available in the new corporate headquarters. The Trust believes that these leases have comparable terms to leases that would have been entered into with unaffiliated parties.



|ITEM 14. | PRINCIPAL INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FEES AND SERVICES
|-------- | -------------------------------------------------------------------------

Fees Paid to Independent Registered
Public Accounting Firm

During fiscal years 2006 and 2005, The Trust retained Ernst & Young LLP to provide services in the following categories
and amounts:



|                      |  |                  |           |                  |   |          
|--------------------- |  | ---------------- | --------- | ---------------- | - | ---------
|                      |  | Fiscal Year 2006 |           | Fiscal Year 2005
|Audit Fees(1)         |  | $                | 1,401,625 |                  | $ | 1,386,932
|Audit Related Fees(2) |  |                  | 62,500    |                  |   | 73,680   
|                      |  |                  |           |                  |   |          
|Subtotaled            |  |                  | 1,464,125 |                  |   | 1,460,612
|Tax Fees(3)           |  |                  | 80,000    |                  |   | 77,306   
|All Other Fees        |  |                  | 105,800   |                  |   | 226,000  
|                      |  |                  |           |                  |   |          
|Total Fees            |  | $                | 1,649,925 |                  | $ | 1,763,918
|                      |  |                  |           |                  |   |          



|(1) | Audit fees include the audit fee and fees for comfort letters, attest services, consents and assistance with and review of documents filed with the SEC and OTS.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Audit related fees consist of fees incurred for consultation concerning financial accounting
and reporting standards, performance of agreed-upon procedures, and other audit or attest services not required by statute or regulation.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Tax fees consist of fees for tax consultation and tax compliance services.
|--- | --------------------------------------------------------------------------

Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Registered Public Accounting Firm.

The Audit Committee has responsibility for appointing, setting compensation and overseeing the work of the independent registered public accounting
firm. In recognition of this responsibility, the Audit Committee has established a policy to pre-approve all audit and permissible non-audit services provided by the independent registered public accounting firm.

Prior to engagement of the independent registered public accounting firm for the next years audit, management will submit to the Audit Committee for approval an
aggregate of services expected to be rendered during that year for the services listed above.

Prior to engagement, the Audit Committee pre-approves these
services by types of service. The fees are budgeted and the Audit Committee requires the independent registered public accounting firm and management to report actual fees versus the budget periodically throughout the year by category of service.
During the year, circumstances may arise when it may become necessary to engage the independent registered public accounting firm for additional services not contemplated in the original pre-approval. In those instances, the Audit Committee requires
specific pre-approval before engaging them.

Pursuant to the Trusts Audit Committee Charter, the Audit Committee may delegate pre-approval authority
to the chairman of the Audit Committee, who shall promptly advise the remaining members of the Audit Committee of such approval at the next regularly scheduled meeting.



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##### Table of Contents

PART IV



|ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
|-------- | ------------------------------------------

(a) The following documents are filed as part of this
report:

1. Financial Statements

The following consolidated financial statements of the Trust are incorporated by reference in Part II, Item 8.



|    |  |                                                                                                                                           
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Report of Independent Auditors.                                                                                                           
|    | 
|(b) |  | Consolidated Balance SheetsAs of September 30, 2006 and 2005.                                                                            
|    | 
|(c) |  | Consolidated Statements of OperationsFor the years ended September 30, 2006, 2005 and 2004.                                              
|    | 
|(d) |  | Consolidated Statements of Comprehensive Income and Changes in Shareholders EquityFor the years ended September 30, 2006,
2005 and 2004.
|    | 
|(e) |  | Consolidated Statements of Cash FlowsFor the years ended September 30, 2006, 2005 and 2004.                                              
|    | 
|(f) |  | Notes to Consolidated Financial Statements.                                                                                               

2. Financial Statement Schedules and Supplementary Data

(a) Schedules of the Real Estate Trust:

Schedule ICondensed Financial InformationFor the years ended September 30, 2006, 2005 and 2004.

Schedule IIIConsolidated Schedule of Investment Properties As of September 30, 2006.

(b)
Exhibits



|                                                                             |  |                                                                                                                                                                                                                                                                                                                                                                         
|---------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBITS                                                                     |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                             
|3. ORGANIZATIONAL DOCUMENTS                                                 
|                                                                             | 
|(a)                                                                          |  | Second Amended and Restated Declaration of Trust filed with the Maryland State Department of Assessments and Taxation on May 23, 2002 as Exhibit 3(a) to Registration Statement 333-70753 is
hereby incorporated by reference.                                                                                                                                          
|                                                                             | 
|(b)                                                                          |  | Second Amended and Restated By-Laws of the Trust dated as of May 23, 2002 as Exhibit 3(b) to Registration Statement 333-70753 is hereby incorporated by reference.                                                                                                                                                                                                      
|                                                                            
|4. INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES
|                                                                             | 
|(a)                                                                          |  | Indenture, dated as of February 25, 2004, by and between the Trust and Wells Fargo Bank, National Association, as Trustee, with respect to the Trusts 71/2% Senior Secured Notes due 2014 and 71/2% Series B Senior Secured Notes due 2014, including Form of Note, as filed as Exhibit 4 (a) to Registration Statement 333-113640 is hereby incorporated by
reference.
|                                                                             | 
|(b)                                                                          |  | Indenture, dated as of April 14, 2003, between the Trust and U.S. Bank National Association, as Trustee, with respect to the Trusts Unsecured Notes Due for One Year to Ten Years from
Date of Issue, as filed as Exhibit 4 (a) to Registration Statement 333-104068 is hereby incorporated by reference.                                                              
|                                                                             | 
|(c)                                                                          |  | Indenture dated as of September 1, 1992 with respect to the Trusts Notes due from One to Ten Years form Date of Issue filed as Exhibit 4(a) to Registration Statement No. 33-34930 is
hereby incorporated by reference.                                                                                                                                                
|                                                                             | 
|(d)                                                                          |  | First Supplemental Indenture dated as of January 16, 1997 with respect to the Trusts Notes due from One to Ten Years from Date of Issue filed as Exhibit 4(b) to Registration Statement
No. 33-34930 is hereby incorporated by reference.                                                                                                                              
|                                                                             | 
|(e)                                                                          |  | Second Supplemental Indenture dated as of January 13, 1999 with respect to the Trusts Notes due from One to Ten Years from Date of Issuance as filed as Exhibit 4(l) to Registration
Statement No. 333-70753 is hereby incorporated by reference.                                                                                                                      



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|                       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|---------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBITS               |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10. MATERIAL CONTRACTS
|                       | 
|(a)                    |  | Amended and Restated Advisory Contract dated as of October 1, 2005 by and among the Trust, B.F. Saul Company and B.F. Saul Advisory Company, LLC, filed as Exhibit 10(a) to Trusts
September 30 2005 Form 8-K is hereby incorporated by reference.                                                                                                                                                                                                                                                                                                                                             
|                       | 
|(b)                    |  | Form of Commercial Asset Management and Leasing Agreement between the Trust and B.F. Saul Property Company filed as Exhibit 10(c) to the Trusts September 30, 2005 Form 8-K is
hereby incorporated by reference.                                                                                                                                                                                                                                                                                                                                                                               
|                       | 
|(c)                    |  | Tax Sharing Agreement dated June 28, 1990 among the Trust, Chevy Chase Bank F.S.B. and certain of their subsidiaries filed as Exhibit 10(c) to Registration Statement No. 33-34930 is
hereby incorporated by reference.                                                                                                                                                                                                                                                                                                                                                                         
|                       | 
|(d)                    |  | First Amendment to Tax Sharing Agreement effective May 16, 1995 among the Trust, Chevy Chase Bank F.S.B. and certain of their subsidiaries, as filed as Exhibit 10(f) to the Trusts
Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 2001 is hereby incorporated by reference.                                                                                                                                                                                                                                                                             
|                       | 
|(e)                    |  | Agreement dated June 28, 1990 among the Trust, B.F. Saul Company, Franklin Development Co., Inc., The Klingle Corporation and Westminster Investing Corporation relating to the transfer
of certain shares of Chevy Chase Bank, F.S.B. and certain real property to the Trust in exchange for Preferred Shares of the Trust filed as Exhibit 10(d) to Registration Statement No. 33-34930 is hereby incorporated by reference.                                                                                                                                                                  
|                       | 
|(f)                    |  | Regulatory Capital Maintenance/Dividend Agreement dated May 17, 1988 among B.F. Saul Company, the Trust and the Federal Savings and Loan Insurance Corporation filed as Exhibit 10(e) to
the Trusts Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 1991 is hereby incorporated by reference.                                                                                                                                                                                                                                                             
|                       | 
|(g)                    |  | Registration Rights and Lock-Up Agreement dated August 26, 1993 by and among Saul Centers, Inc. and the Trust, Westminster Investing Corporation, Van Ness Square Corporation, Dearborn,
L.L.C., B.F. Saul Property Company and Avenel Executive Park Phase II, Inc. as filed as Exhibit 10.6 to Registration Statement No. 33-64562 is hereby incorporated by reference.                                                                                                                                                                                                                       
|                       | 
|(h)                    |  | First Amendment to Registration Rights and Lock-Up Agreement dated September 29, 1999 by and among Saul Centers, Inc., the Trust, Westminster Investing Corporation, Van Ness Square
Corporation, Dearborn Corporation, Franklin Property Company and Avenel Executive Park Phase II, Inc., as filed as Exhibit 10(b) to the Trusts Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 2001 is
hereby incorporated by reference.                                                                                                                             
|                       | 
|(i)                    |  | Exclusivity and Right of First Refusal Agreement dated August 26, 1993 among Saul Centers, Inc., the Trust, B.F. Saul Company, Westminster Investing Corporation, B.F. Saul Property
Company, Van Ness Square Corporation, and Chevy Chase Savings Bank, F.S.B. as filed as Exhibit 10.7 to Registration Statement No. 33-64562 hereby incorporated by reference.                                                                                                                                                                                                                               
|                       | 
|(j)                    |  | Fourth Amended and Restated Reimbursement Agreement dated as of April 25, 2000 by and among Saul Centers, Inc., Saul Holdings Limited Partnership, Saul Subsidiary I Limited Partnership,
Saul Subsidiary II Limited Partnership, Saul QRS, Inc., B.F. Saul Property Company, Westminster Investing Corporation, Van Ness Square Corporation, Dearborn, L.L.C., Avenel Executive Park Phase II, L.L.C., and the Trust, as filed as Exhibit 10(k) to
the Trusts Quarterly Report on Form 10-Q (File No. 1-7184) for the fiscal quarter ended March 31, 2000 is hereby incorporated by reference.
|                       | 
|(k)                    |  | Bank Stock Registration Rights Agreement dated as of March 25, 1998 between the Trust and Norwest Bank Minnesota, National Association, as Trustee, as filed as Exhibit 4(d) to
Registration Statement No. 333-49937 is hereby incorporated by reference.                                                                                                                                                                                                                                                                                                                                       
|                       | 
|(l)                    |  | Amended and Restated Note Administration Fee Agreement dated as of October 1, 2005, between the Trust, B.F. Saul Company and B.F. Saul Advisory Company L.L.C., as filed as Exhibit 10(n)
to the Trusts September 30, 2005 Form 8-K is hereby incorporated by reference.                                                                                                                                                                                                                                                                                                                       
|                       | 
|(m)                    |  | Development Agreement dated as of October 1, 2005 between the Trust and B.F. Saul Property Company, as filed as Exhibit 10(o) to the Trusts September 30, 2005 Form 8-K is
hereby incorporated by reference.                                                                                                                                                                                                                                                                                                                                                                                   
|                       | 
|(n)                    |  | Amendment No.1 to Amended and Restated Advisory Contract, made as of April 3, 2006 by and among the Trust and B. F. Saul Company, as filed as Exhibit 10(a) to the Trusts April 3, 2006
Form 8-K is hereby incorporated by reference.                                                                                                                                                                                                                                                                                                                                                          
|                       | 
|12.                    |  | Ratio of Earnings to Fixed Charges (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                       | 
|12.1                   |  | Ratio of Consolidated Earnings to Fixed Charges (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                       | 
|21.                    |  | List of Subsidiaries of the Trust (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                       | 
|31.                    |  | Rule 13a  14(a)/15d  14(a) Certifications of Chief Executive Officer and Chief Financial Officer (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                       | 
|32.                    |  | Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            



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SCHEDULE I

B.F. SAUL REAL ESTATE INVESTMENT TRUST

CONDENSED FINANCIAL INFORMATION



|(a) | Required condensed financial information on the Trust is disclosed in the audited consolidated financial statements included herewith.
|--- | --------------------------------------------------------------------------------------------------------------------------------------



|(b) | Amounts of cash dividends paid to the Trust by consolidated subsidiaries were as follows:
|--- | -----------------------------------------------------------------------------------------



|                        |            |      |   |            |  |   |           
|----------------------- | ---------- | ---- | - | ---------- |  | - | ----------
|Year Ended September 30
|2006                    |            | 2005 |   | 2004      
|$                       | 32,000,000 |      | $ | 39,200,000 |  | $ | 24,800,000



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SCHEDULE III

CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIESREAL ESTATE TRUST

September 30, 2006

(Dollars in Thousands)



|                                                |  |                       |         |                                           |   |         |  |                                                  |        |       |   |         |  |   |        
|----------------------------------------------- |  | --------------------- | ------- | ----------------------------------------- | - | ------- |  | ------------------------------------------------ | ------ | ----- | - | ------- |  | - | -------
|Hotels                                          |  | Initial Basis toTrust |         | CostsCapitalizedSubsequent toAcquisitions |   | Land    |  | Basis at Close ofPeriodBuildings andImprovements |        | Total
|Courtyard - Tysons Corner, McLean VA           |  | $                     | 31,077  |                                           | $ | 16      |  | $                                                | 843    |       | $ | 30,250  |  | $ | 31,093 
|Crown Plaza - National Airport, Arlington VA    |  |                       | 26,979  |                                           |   | 9,091   |  |                                                  | 4,229  |       |   | 31,841  |  |   | 36,070 
|Hampton Inn - Dulles Airport, Sterling VA       |  |                       |        |                                           |   | 7,397   |  |                                                  | 290    |       |   | 7,107   |  |   | 7,397  
|Hampton Inn - Dulles South, Sterling, VA        |  |                       | 12,909  |                                           |   | 1,342   |  |                                                  | 3,164  |       |   | 11,087  |  |   | 14,251 
|Hampton Inn - Dulles Town Center, Sterling VA   |  |                       | 11,379  |                                           |   | 337     |  |                                                  | 795    |       |   | 10,921  |  |   | 11,716 
|Holiday Inn - Dulles Airport, Sterling VA       |  |                       | 6,950   |                                           |   | 25,354  |  |                                                  | 862    |       |   | 31,442  |  |   | 32,304 
|Holiday Inn, Gaithersburg MD                    |  |                       | 3,849   |                                           |   | 18,828  |  |                                                  | 1,781  |       |   | 20,896  |  |   | 22,677 
|Holiday Inn - National Airport, Arlington VA    |  |                       | 10,187  |                                           |   | 11,385  |  |                                                  | 1,183  |       |   | 20,389  |  |   | 21,572 
|Holiday Inn - Tysons Corner, McLean VA          |  |                       | 6,976   |                                           |   | 20,681  |  |                                                  | 2,265  |       |   | 25,392  |  |   | 27,657 
|Holiday Inn Express, Herdon VA                  |  |                       | 5,259   |                                           |   | 1,498   |  |                                                  | 1,178  |       |   | 5,579   |  |   | 6,757  
|Holiday Inn Select - Auburn Hills MI            |  |                       | 10,450  |                                           |   | 3,474   |  |                                                  | 1,031  |       |   | 12,893  |  |   | 13,924 
|SpringHill Suites, Boca Raton FL                |  |                       | 10,942  |                                           |   | 774     |  |                                                  | 1,220  |       |   | 10,496  |  |   | 11,716 
|TownePlace Suites, Boca Raton FL                |  |                       | 7,527   |                                           |   | 840     |  |                                                  | 869    |       |   | 7,498   |  |   | 8,367  
|TownePlace Suites - Dulles Airport, Sterling VA |  |                       | 5,849   |                                           |   | 943     |  |                                                  | 219    |       |   | 6,573   |  |   | 6,792  
|TownePlace Suites - Ft. Lauderdale FL           |  |                       | 7,059   |                                           |   | 801     |  |                                                  | 420    |       |   | 7,440   |  |   | 7,860  
|TownePlace Suites, Gaithersburg MD              |  |                       | 6,382   |                                           |   | 866     |  |                                                  | 107    |       |   | 7,141   |  |   | 7,248  
|The Hay Adams                                   |  |                       | 91,981  |                                           |   | 423     |  |                                                  | 15,759 |       |   | 76,645  |  |   | 92,404 
|                                                |  |                       |         |                                           |   |         |  |                                                  |        |       |   |         |  |   |        
|Subtotal - Hotels                               |  | $                     | 255,755 |                                           | $ | 104,050 |  | $                                                | 36,215 |       | $ | 323,590 |  | $ | 359,805
|                                                |  |                       |         |                                           |   |         |  |                                                  |        |       |   |         |  |   |        



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SCHEDULE III

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CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIESREAL ESTATE TRUST

September 30, 2006

(Dollars in Thousands)



|                                         |  |                       |         |                                           |   |        |      |  |                                                  |        |       |   |         |  |   |        
|---------------------------------------- |  | --------------------- | ------- | ----------------------------------------- | - | ------ | ---- |  | ------------------------------------------------ | ------ | ----- | - | ------- |  | - | -------
|Office and Industrial                    |  | Initial Basis toTrust |         | CostsCapitalizedSubsequent toAcquisitions |   |        | Land |  | Basis at Close ofPeriodBuildings andImprovements |        | Total
|900 Circle 75 Pkway, Atlanta GA          |  | $                     | 33,434  |                                           | $ | 5,363  |      |  | $                                                | 563    |       | $ | 38,234  |  | $ | 38,797 
|1000 Circle 75 Pkway, Atlanta GA         |  |                       | 2,820   |                                           |   | 2,496  |      |  |                                                  | 248    |       |   | 5,068   |  |   | 5,316  
|1100 Circle 75 Pkway, Atlanta GA         |  |                       | 22,746  |                                           |   | 5,801  |      |  |                                                  | 419    |       |   | 28,128  |  |   | 28,547 
|8001 Wisconsin Avenue, Bethesda, MD      |  |                       | 5,408   |                                           |   | 58     |      |  |                                                  | 1,895  |       |   | 3,571   |  |   | 5,466  
|8201 Greensboro, Tysons Corner VA        |  |                       | 28,890  |                                           |   | 7,321  |      |  |                                                  | 1,633  |       |   | 34,578  |  |   | 36,211 
|Commerce Ctr - Ph II, Ft. Lauderdale FL  |  |                       | 4,266   |                                           |   | 863    |      |  |                                                  | 782    |       |   | 4,347   |  |   | 5,129  
|Dulles North, Loudoun County VA          |  |                       | 5,882   |                                           |   | 528    |      |  |                                                  | 507    |       |   | 5,903   |  |   | 6,410  
|Dulles North Two, Loudoun County VA      |  |                       | 7,729   |                                           |   | 91     |      |  |                                                  | 404    |       |   | 7,416   |  |   | 7,820  
|Dulles North Four, Loudoun County VA     |  |                       | 11,093  |                                           |   | 178    |      |  |                                                  | 2,208  |       |   | 9,063   |  |   | 11,271 
|Dulles North Five, Loudoun County VA     |  |                       | 5,078   |                                           |   | (76    | )    |  |                                                  | 535    |       |   | 4,467   |  |   | 5,002  
|Dulles North Six, Loudoun County VA      |  |                       | 2,667   |                                           |   | 1,719  |      |  |                                                  | 257    |       |   | 4,129   |  |   | 4,386  
|Loudoun Tech Center I, Loudoun County VA |  |                       | 5,334   |                                           |   | 2,706  |      |  |                                                  | 1,075  |       |   | 6,965   |  |   | 8,040  
|Sweitzer Lane, Laurel MD                 |  |                       | 13,703  |                                           |   |       |      |  |                                                  | 3,701  |       |   | 10,002  |  |   | 13,703 
|Tysons Park Place, Tysons Corner VA      |  |                       | 21,811  |                                           |   | 12,106 |      |  |                                                  | 1,142  |       |   | 32,775  |  |   | 33,917 
|                                         |  |                       |         |                                           |   |        |      |  |                                                  |        |       |   |         |  |   |        
|Subtotal - Office and Industrial         |  | $                     | 170,861 |                                           | $ | 39,154 |      |  | $                                                | 15,369 |       | $ | 194,646 |  | $ | 210,015
|                                         |  |                       |         |                                           |   |        |      |  |                                                  |        |       |   |         |  |   |        



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SCHEDULE III

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CONSOLIDATED SCHEDULE OF INVESTMENTS PROPERTIESREAL ESTATE TRUST

September 30, 2006

(Dollars in Thousands)



|                                            |  |                       |         |                                           |   |         |      |  |                                                  |        |       |   |         |  |   |        
|------------------------------------------- |  | --------------------- | ------- | ----------------------------------------- | - | ------- | ---- |  | ------------------------------------------------ | ------ | ----- | - | ------- |  | - | -------
|Purchase - Leasebacks and other             |  | Initial Basis toTrust |         | CostsCapitalizedSubsequent toAcquisitions |   |         | Land |  | Basis at Close ofPeriodBuildings andImprovements |        | Total
|Country Club, Knoxville, TN                 |  | $                     | 500     |                                           | $ | (22     | )    |  | $                                                | 478    |       | $ |        |  | $ | 478    
|Houston Mall, Warner Robbins, GA            |  |                       | 650     |                                           |   |        |      |  |                                                  | 650    |       |   |        |  |   | 650    
|Subtotal - Purchase - Leasebacks and other  |  | $                     | 1,150   |                                           | $ | (22     | )    |  | $                                                | 1,128  |       | $ |        |  | $ | 1,128  
|                                            |  |                       |         |                                           |   |         |      |  |                                                  |        |       |   |         |  |   |        
|Total Income - Producing Properties         |  | $                     | 427,766 |                                           | $ | 143,182 |      |  | $                                                | 52,712 |       | $ | 518,236 |  | $ | 570,948
|                                            |  |                       |         |                                           |   |         |      |  |                                                  |        |       |   |         |  |   |        
|                                            |  |                       |         |                                           |  
|Land Parcels                                |  | Initial Basis toTrust |         | CostsCapitalizedSubsequent toAcquisitions |   |         | Land |  | Basis at Close ofPeriodBuildings andImprovements |        | Total
|Arvida Park of Commerce, Boca Raton, FL     |  | $                     | 7,378   |                                           | $ | (1,869  | )    |  | $                                                | 5,433  |       | $ | 76      |  | $ | 5,509  
|Ashburn Village, Loudoun Co., VA            |  |                       | 4,919   |                                           |   | 312     |      |  |                                                  | 4,919  |       |   | 312     |  |   | 5,231  
|Cedar Green, Loudoun Co., VA                |  |                       | 3,314   |                                           |   | 116     |      |  |                                                  | 2,832  |       |   | 598     |  |   | 3,430  
|Church Road, Loudoun Co., VA                |  |                       | 2,586   |                                           |   | 1,248   |      |  |                                                  | 3,834  |       |   |        |  |   | 3,834  
|Circle 75, Atlanta, GA                      |  |                       | 12,927  |                                           |   | 2,786   |      |  |                                                  | 14,680 |       |   | 1,033   |  |   | 15,713 
|Holiday Inn - Auburn Hills, Auburn Hills MI |  |                       | 218     |                                           |   |        |      |  |                                                  | 218    |       |   |        |  |   | 218    
|Loudoun Tech II, Sterling, VA               |  |                       | 939     |                                           |   | 7       |      |  |                                                  | 946    |       |   |        |  |   | 946    
|Overland Park, Overland Park, KA            |  |                       | 2,842   |                                           |   | 786     |      |  |                                                  | 3,568  |       |   | 60      |  |   | 3,628  
|Prospect Indust. Pk, Ft. Laud., FL          |  |                       | 2,203   |                                           |   | (1,943  | )    |  |                                                  | 260    |       |   |        |  |   | 260    
|Sterling Blvd., Loudoun Co., VA             |  |                       | 505     |                                           |   | 2,743   |      |  |                                                  | 1,070  |       |   | 2,178   |  |   | 3,248  
|Tysons Park Place II, Fairfax, VA           |  |                       |        |                                           |   | 2,565   |      |  |                                                  |       |       |   | 2,565   |  |   | 2,565  
|                                            |  |                       |         |                                           |   |         |      |  |                                                  |        |       |   |         |  |   |        
|Subtotal                                    |  | $                     | 37,831  |                                           | $ | 6,751   |      |  | $                                                | 37,760 |       | $ | 6,822   |  | $ | 44,582 
|                                            |  |                       |         |                                           |   |         |      |  |                                                  |        |       |   |         |  |   |        



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SCHEDULE III

(continued)

CONSOLIDATED SCHEDULE OF INVESTMENTS PROPERTIESREAL ESTATE TRUST

September 30, 2006

(Dollars in Thousands)



|                                        |  |                       |         |                                           |   |         |  |                                                  |        |       |   |         |  |   |        
|--------------------------------------- |  | --------------------- | ------- | ----------------------------------------- | - | ------- |  | ------------------------------------------------ | ------ | ----- | - | ------- |  | - | -------
|Construction in Progress                |  | Initial Basis toTrust |         | CostsCapitalizedSubsequent toAcquisitions |   | Land    |  | Basis at Close ofPeriodBuildings andImprovements |        | Total
|Circle 75, Atlanta, GA                  |  | $                     | 1,369   |                                           | $ | 15,032  |  | $                                                | 1,369  |       | $ | 15,032  |  | $ | 16,401 
|Hampton Inn - Dulles North, Sterling VA |  |                       | 748     |                                           |   | 1,116   |  |                                                  | 748    |       |   | 1,116   |  |   | 1,864  
|Springhill Suites, Sterling VA          |  |                       | 544     |                                           |   | 14,332  |  |                                                  | 544    |       |   | 14,332  |  |   | 14,876 
|Tysons Park Place II, Fairfax, VA       |  |                       | 1,312   |                                           |   | 493     |  |                                                  | 1,312  |       |   | 493     |  |   | 1,805  
|                                        |  |                       |         |                                           |   |         |  |                                                  |        |       |   |         |  |   |        
|Subtotal                                |  | $                     | 3,973   |                                           | $ | 30,973  |  | $                                                | 3,973  |       | $ | 30,973  |  | $ | 34,946 
|                                        |  |                       |         |                                           |   |         |  |                                                  |        |       |   |         |  |   |        
|Total Investment Properties (1)         |  | $                     | 469,570 |                                           | $ | 180,906 |  | $                                                | 94,445 |       | $ | 556,031 |  | $ | 650,476
|                                        |  |                       |         |                                           |   |         |  |                                                  |        |       |   |         |  |   |        



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SCHEDULE III

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CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIESREAL ESTATE TRUST

September 30, 2006

(Dollars in Thousands)



|                                                |  |                         |         |                  |   |                      |  |                            |  |                                                      |  |     
|----------------------------------------------- |  | ----------------------- | ------- | ---------------- | - | -------------------- |  | -------------------------- |  | ---------------------------------------------------- |  | ----
|Hotels                                          |  | AccumulatedDepreciation |         | (1) Related Debt |   | Date of Construction |  | Date Acquired/ Transferred |  | Buildings and Improvements Depreciable Lives (Years)
|Courtyard - Tysons Corner, McLean VA           |  | $                       | 9,954   |                  | $ | 24,888               |  | 2000                       |  | 12/00                                                |  | 40  
|Crown Plaza - National Airport, Arlington VA    |  |                         | 11,125  |                  |   | 14,509               |  | 1959                       |  | 12/97                                                |  | 39  
|Hampton Inn - Dulles Airport, Sterling VA       |  |                         | 4,200   |                  |   | 5,560                |  | 1987                       |  | 4/87                                                 |  | 31.5
|Hampton Inn - Dulles South, Sterling, VA        |  |                         | 362     |                  |   | 9,392                |  | 1989                       |  | 11/05                                                |  | 40  
|Hampton Inn - Dulles Town Center, Sterling VA   |  |                         | 4,846   |                  |   | 7,544                |  | 2000                       |  | 11/00                                                |  | 40  
|Holiday Inn - Dulles Airport, Sterling VA       |  |                         | 21,730  |                  |   | 44,922               |  | 1971                       |  | 11/84                                                |  | 28  
|Holiday Inn, Gaithersburg MD                    |  |                         | 12,005  |                  |   | 22,355               |  | 1972                       |  | 6/75                                                 |  | 45  
|Holiday Inn - National Airport, Arlington VA    |  |                         | 12,063  |                  |   | 11,029               |  | 1973                       |  | 11/83                                                |  | 30  
|Holiday Inn - Tysons Corner, McLean VA          |  |                         | 12,965  |                  |   | 39,930               |  | 1971                       |  | 6/75                                                 |  | 47  
|Holiday Inn Express, Herdon VA                  |  |                         | 1,886   |                  |   | 4,166                |  | 1987                       |  | 10/96                                                |  | 40  
|Holiday Inn Select - Auburn Hills MI            |  |                         | 5,737   |                  |   | 10,331               |  | 1989                       |  | 11/94                                                |  | 31.5
|SpringHill Suites, Boca Raton FL                |  |                         | 2,693   |                  |   | 5,675                |  | 1999                       |  | 9/99                                                 |  | 40  
|TownePlace Suites, Boca Raton FL                |  |                         | 1,620   |                  |   | 5,150                |  | 1999                       |  | 6/99                                                 |  | 40  
|TownePlace Suites - Dulles Airport, Sterling VA |  |                         | 1,600   |                  |   | 5,939                |  | 1998                       |  | 8/98                                                 |  | 40  
|TownePlace Suites - Ft. Lauderdale FL           |  |                         | 1,681   |                  |   | 4,224                |  | 1999                       |  | 10/99                                                |  | 40  
|TownePlace Suites, Gaithersburg MD              |  |                         | 1,656   |                  |   | 4,518                |  | 1999                       |  | 6/99                                                 |  | 40  
|The Hay Adams                                   |  |                         | 1,176   |                  |   | 65,000               |  | 1928                       |  | 3/06                                                 |  | 40  
|                                                |  |                         |         |                  |   |                      |  |                            |  |                                                      |  |     
|Subtotal - Hotels                               |  | $                       | 107,299 |                  | $ | 285,132              |  |                            |  |                                                      |  |     
|                                                |  |                         |         |                  |   |                      |  |                            |  |                                                      |  |     



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SCHEDULE III

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CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIESREAL ESTATE TRUST

September 30, 2006

(Dollars in Thousands)



|                                         |  |                         |         |                  |   |                     |  |                            |  |                                                      |  |     
|---------------------------------------- |  | ----------------------- | ------- | ---------------- | - | ------------------- |  | -------------------------- |  | ---------------------------------------------------- |  | ----
|Office and Industrial                    |  | AccumulatedDepreciation |         | (1) Related Debt |   | Date ofConstruction |  | Date Acquired/ Transferred |  | Buildings and Improvements Depreciable Lives (Years)
|900 Circle 75 Pkway, Atlanta GA          |  | $                       | 22,703  |                  | $ | 31,200              |  | 1985                       |  | 12/85                                                |  | 35  
|1000 Circle 75 Pkway, Atlanta GA         |  |                         | 3,335   |                  |   | 4,633               |  | 1974                       |  | 4/76                                                 |  | 40  
|1100 Circle 75 Pkway, Atlanta GA         |  |                         | 17,856  |                  |   | 11,071              |  | 1982                       |  | 9/82                                                 |  | 40  
|8001 Wisconsin Avenue, Bethesda, MD      |  |                         | 117     |                  |   |                    |  | 1986                       |  | 5/05                                                 |  | 40  
|8201 Greensboro, Tysons Corner VA        |  |                         | 18,849  |                  |   | 76,000              |  | 1985                       |  | 4/86                                                 |  | 35  
|Commerce Ctr - Ph II, Ft. Lauderdale FL  |  |                         | 2,393   |                  |   | 3,520               |  | 1986                       |  | 1/87                                                 |  | 35  
|Dulles North, Loudoun County VA          |  |                         | 2,817   |                  |   | 4,662               |  | 1990                       |  | 10/90                                                |  | 31.5
|Dulles North Two, Loudoun County VA      |  |                         | 3,058   |                  |   | 8,039               |  | 1999                       |  | 10/99                                                |  | 40  
|Dulles North Four, Loudoun County VA     |  |                         | 3,632   |                  |   | 8,077               |  | 2002                       |  | 4/02                                                 |  | 40  
|Dulles North Five, Loudoun County VA     |  |                         | 1,147   |                  |   | 6,315               |  | 2000                       |  | 3/00                                                 |  | 40  
|Dulles North Six, Loudoun County VA      |  |                         | 628     |                  |   | 4,330               |  | 2000                       |  | 10/00                                                |  | 40  
|Loudoun Tech Center I, Loudoun County VA |  |                         | 591     |                  |   | 5,768               |  | 2001                       |  | 12/01                                                |  | 40  
|Sweitzer Lane, Laurel MD                 |  |                         | 1,479   |                  |   | 10,007              |  | 1995                       |  | 11/00                                                |  | 40  
|Tysons Park Place, Tysons Corner VA      |  |                         | 11,832  |                  |   | 26,388              |  | 1976                       |  | 12/99                                                |  | 30  
|                                         |  |                         |         |                  |   |                     |  |                            |  |                                                      |  |     
|Subtotal - Office and Industrial         |  | $                       | 90,437  |                  | $ | 200,010             |  |                            |  |                                                      |  |     
|                                         |  |                         |         |                  |   |                     |  |                            |  |                                                      |  |     
|                                         |  |                         |         |                  |  
|Purchase - Leasebacks                    |  | AccumulatedDepreciation |         | Related Debt     |   | Date ofConstruction |  |                            |  | Date Acquired/Transferred                           
|Country Club, Knoxville, TN              |  |                         |        |                  |   |                    |  |                            |  |                                                      |  | 5/76
|Houston Mall, Warner Robbins, GA         |  |                         |        |                  |   |                    |  |                            |  |                                                      |  | 2/72
|                                         |  |                         |         |                  |   |                     |  |                            |  |                                                      |  |     
|Subtotal - Purchase - Leasebacks         |  | $                       |        |                  | $ |                    |  |                            |  |                                                      |  |     
|                                         |  |                         |         |                  |   |                     |  |                            |  |                                                      |  |     
|Total Income - Producing Properties      |  | $                       | 197,736 |                  | $ | 485,142             |  |                            |  |                                                      |  |     
|                                         |  |                         |         |                  |   |                     |  |                            |  |                                                      |  |     



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SCHEDULE III

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CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIESREAL ESTATE TRUST

September 30, 2006

(Dollars in Thousands)



|                                            |  |                         |         |              |   |                     |  |                           |  |               
|------------------------------------------- |  | ----------------------- | ------- | ------------ | - | ------------------- |  | ------------------------- |  | --------------
|Land Parcels                                |  | AccumulatedDepreciation |         | Related Debt |   | Date ofConstruction |  | Date Acquired/Transferred
|Arvida Park of Commerce, Boca Raton, FL     |  | $                       |        |              | $ |                    |  |                           |  | 12/84 & 5/85  
|Ashburn Village, Loudoun Co., VA            |  |                         |        |              |   |                    |  |                           |  | 9/05          
|Cedar Green, Loudoun Co., VA                |  |                         |        |              |   |                    |  |                           |  | 10/00         
|Church Road, Loudoun Co., VA                |  |                         |        |              |   |                    |  |                           |  | 9/84 & 4/85   
|Circle 75, Atlanta, GA                      |  |                         | 119     |              |   |                    |  |                           |  | 2/77 & 1/84   
|Holiday Inn - Auburn Hills, Auburn Hills MI |  |                         |        |              |   |                    |  |                           |  | 8/85          
|Holiday Inn - Rochester, Roch., NY          |  |                         |        |              |   |                    |  |                           |  | 7/97          
|Loudoun Tech II, Sterling, VA               |  |                         |         |              |   |                     |  |                           |  | 7/05          
|Overland Park, Overland Park, KA            |  |                         |        |              |   |                    |  |                           |  | 9/86          
|Prospect Indust. Pk, Ft. Laud., FL          |  |                         |        |              |   |                    |  |                           |  | 1/77 & 2/85   
|Sterling Blvd., Loudoun Co., VA             |  |                         |        |              |   |                    |  |                           |  | 10/83 & 8/84  
|Tysons Park Place II, Fairfax, VA           |  |                         |        |              |   |                    |  |                           |  | 4/84,2/00,3/00
|                                            |  |                         |         |              |   |                     |  |                           |  |               
|Subtotal                                    |  | $                       | 119     |              | $ |                    |  |                           |  |               
|                                            |  |                         |         |              |   |                     |  |                           |  |               
|                                            |  |                         |         |             
|Land Parcels                                |  | AccumulatedDepreciation |         | Related Debt |   | Date ofConstruction |  | Date Acquired/Transferred
|Circle 75, Atlanta, GA                      |  |                         |        |              |   |                    |  | 11/06                     |  |               
|Hampton Inn - Dulles North, Sterling VA     |  |                         |        |              |   |                    |  | 8/06                      |  |               
|Springhill Suites, Sterling VA              |  |                         |        |              |   | 4,011               |  | 11/06                     |  |               
|Tysons Park Place II, Fairfax, VA           |  |                         |        |              |   |                    |  | 9/06                      |  |               
|                                            |  |                         |         |              |   |                     |  |                           |  |               
|Subtotal                                    |  |                         |        |              | $ | 4,011               |  |                           |  |               
|                                            |  |                         |         |              |   |                     |  |                           |  |               
|                                            |  | $                       | 197,855 |              | $ | 489,153             |  |                           |  |               
|                                            |  |                         |         |              |   |                     |  |                           |  |               

NOTES:



|(1) | Includes hotel capital lease obligations of approximately $815,000.
|--- | -------------------------------------------------------------------



|(2) | See Summary of Significant Accounting Policies for basis of recording investment properties and computing depreciation. Investment properties are discussed in Note 6 to Consolidated
Financial Statements.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | A reconciliation of the basis of investment properties and accumulated depreciation follows.
|--- | --------------------------------------------------------------------------------------------



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SCHEDULE III

(continued)

CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIES-REAL ESTATE TRUST

BASIS OF INVESTMENT PROPERTIES AND ACCUMULATED DEPRECIATIONREAL ESTATE TRUST

(In thousands)



|                                                                  |  |                                 |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                  |  | For the year ended September 30 |        
|                                                                  |  | 2006                            |         |   | 2005 |   |         | 2004 | 
|Basis of investment properties (1)                                |  |                                 |         |   |      |   |         |      |  |   |         |  
|Balance at beginning of period                                    |  | $                               | 517,909 |   |      | $ | 498,873 |      |  | $ | 483,673 |  
|Additions (reductions during the period):                         |  |                                 |         |   |      |   |         |      |  |   |         |  
|Capital expenditures and property acquisitions from nonaffiliates |  |                                 | 165,843 |   |      |   | 21,770  |      |  |   | 17,973  |  
|Capital expenditures and property acquisitions from affiliates    |  |                                 |        |   |      |   | 5,874   |      |  |   |        |  
|Sales to nonaffiliates                                            |  |                                 | (28,258 | ) |      |   | (7,353  | )    |  |   |        |  
|Other                                                             |  |                                 | (5,018  | ) |      |   | (1,255  | )    |  |   | (2,773  | )
|                                                                  |  |                                 |         |   |      |   |         |      |  |   |         |  
|Balance at end of period                                          |  | $                               | 650,476 |   |      | $ | 517,909 |      |  | $ | 498,873 |  
|                                                                  |  |                                 |         |   |      |   |         |      |  |   |         |  
|Accumulated depreciation (1)                                      |  |                                 |         |   |      |   |         |      |  |   |         |  
|Balance at beginning of period                                    |  | $                               | 199,052 |   |      | $ | 183,859 |      |  | $ | 166,243 |  
|Additions (reductions during the period):                         |  |                                 |         |   |      |   |         |      |  |   |         |  
|Depreciation expense                                              |  |                                 | 20,390  |   |      |   | 19,857  |      |  |   | 19,053  |  
|Sales to nonaffiliates                                            |  |                                 | (16,797 | ) |      |   | (3,784  | )    |  |   |        |  
|Other                                                             |  |                                 | (4,790  | ) |      |   | (880    | )    |  |   | (1,437  | )
|                                                                  |  |                                 |         |   |      |   |         |      |  |   |         |  
|Balance at end of period                                          |  | $                               | 197,855 |   |      | $ | 199,052 |      |  | $ | 183,859 |  
|                                                                  |  |                                 |         |   |      |   |         |      |  |   |         |  



|(1) | Includes real estate held for sale.
|--- | -----------------------------------



159



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SIGNATURES

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



|                  |  |  |  |                                        |  |                        |  |                      
|----------------- |  |  |  | -------------------------------------- |  | ---------------------- |  | ---------------------
|                  |  |  |  | B.F. SAUL REAL ESTATE INVESTMENT TRUST
|                  |  |  | 
|December 19, 2006 |  |  |  | By:                                    |  | /s/ B. FRANCIS SAUL II
|                  |  |  |  |                                        |  |                        |  | B. Francis Saul II   
|                  |  |  |  |                                        |  |                        |  | Chairman of the Board

Pursuant to the requirements of the Securities Exchanges Act of 1934. This report had been signed below by the
following persons on behalf of the registrant and in the capacities indicated on the dates shown. Each person whose signature appears below hereby constitutes and appoints Stephen R. Halpin, Jr. and John A. Spain as his attorney-in-fact and agent,
with full power of substitution and resubstitution for him in any and all capacities, to sign any or all amendments to this Report and to file same, with exhibits thereto and other documents in connection therewith, granting unto such
attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary in connection with such matters and hereby ratifying and confirming all that such attorney-in-fact and agent of his
substitutes may do or cause to be done by virtue hereof.



|                                                     |  |                                                                                               |  |                  
|---------------------------------------------------- |  | --------------------------------------------------------------------------------------------- |  | -----------------
|Signature                                            |  | Title                                                                                         |  | Date             
|                                                     |  |                                                                                              
|/s/    B. FRANCIS SAUL
II B. Francis Saul II         |  | Trustee, Chairman of the Board (Principal Executive Officer)                                  |  | December 19, 2006
|                                                     |  |                                                                                              
|/s/    STEPHEN R. HALPIN,
JR. Stephen R. Halpin, Jr. |  | Vice President and Chief Financial Officer (Principal Financial Officer)                      |  | December 19, 2006
|                                                     |  |                                                                                              
|/s/    KENNETH D.
SHOOP Kenneth D. Shoop             |  | Vice President, Treasurer and Chief Accounting Officer (Principal Accounting Officer) Trustee |  | December 19, 2006
|                                                     |  |                                                                                              
|/s/    PHILIP D.
CARACI Philip D. Caraci             |  | Trustee                                                                                       |  | December 19, 2006
|                                                     |  |                                                                                              
|/s/    GILBERT M.
GROSVENOR Gilbert M. Grosvenor     |  | Trustee                                                                                       |  | December 19, 2006
|                                                     |  |                                                                                              
|/s/    GEORGE M. ROGERS,
JR. George M. Rogers, Jr.   |  | Trustee                                                                                       |  | December 19, 2006
|                                                     |  |                                                                                              
|/s/    B. FRANCIS SAUL
III B. Francis Saul III       |  | Trustee                                                                                       |  | December 19, 2006
|                                                     |  |                                                                                              
|/s/    JOHN R.
WHITMORE John R. Whitmore             |  | Trustee                                                                                       |  | December 19, 2006



160